Sunday, 10 March 2013

Why global economy is still stuck: Andy Xie

Commentary: World’s policy makers are focusing on wrong things

By Andy Xie
BEIJING (Caixin Online) — The global economic news is not good lately.
The Italian election was a statement against the austerity policy of the previous government, but failed to offer an alternative. The resulting uncertainty keeps Italy’s government bond market on thin ice, threatening to engulf the whole euro zone in a new financial storm.
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The U.S. government has been embroiled in a fight over something called “the sequester” for weeks without a solution. The resulting $85 billion cuts in government spending rekindle the risk of double-dip recession. The cuts are 0.5% of GDP and less than 1/10th of the United States’ fiscal deficit. The big worries over them reflect the fragile state of the American economy after massive stimulus over five years and a dysfunctional U.S. political system.
India just presented a budget that disappointed a market hoping for major reforms. While the budget promises some reduction of the deficit on good growth outlook, it does not really show any teeth in reining in the country’s long fiscal challenge due to extensive government subsidies and weak tax-collection efforts. The big and persistent government deficit, close to 1/10th of GDP, causes inflation and crowds out investment. It does not appear that India is working to create its own growth dynamic in a weak global economy.
China is still struggling with controlling property speculation after attempting it for five years, even though the government has complete control over tax and lending policies. It is a symbol of political failure. When an obvious wound to the economy is left to festering for so long, it is difficult to imagine the country will be able to tackle other tougher issues, like reforming the government and state-owned enterprises, increasing transparency and establishing the rule of law.
The leadership failures around the world reflect that the world has changed, but the kind people who lead remain the same, even though the faces may change from time to time.

Reuters
The existing generation of leaders thinks in terms of rising tides lifting all the boats and burying problems underneath. Their instinctive reaction to economic difficulties is to stimulate growth.
Unfortunately, such thinking does not apply now. The growth potential of the global economy is substantially lower than before under the best circumstances and, if the problems are not solved, is lower.
The current global growth rate, around 2%, is likely to remain the norm for years to come. Those who hope for rising tides to solve all the problems expose their economies to crisis again and soon.

The Bernanke Show

The U.S. government, both on the fiscal and monetary side, has adopted a stimulus approach since the 2008 crisis. It has the luxury to do so because the dollar is the global reserve currency. It gives the Fed room to expand money supply without worrying about a collapse in the dollar’s value. The government can borrow way beyond what others can. Washington’s policy has followed the path of least resistance.
The United States’ stimulus has worked magic in reviving speculative activities. The stock market is close to an all-time high and the credit spread an all-time low.
That is what the Fed wanted to achieve. It hoped that the lower risk premium would boost investment and, hence, revive growth. Unfortunately, the latter hasn’t happened. The Fed’s interpretation is that stimulus is not enough. Hence, it is pursuing QE3 and QE4.
The Fed’s balance sheet has quadrupled since the crisis to above $3 trillion. It is likely to add another $1 trillion this year. Again, it is working wonderfully in encouraging speculation, yet failing to boost investment and the GDP growth rate.
Even though most analysts interpret the spending cuts as a disaster, I view them as the first piece of positive news in Washington’s policy-making over the past five years. With baby boomers retiring, the trend is for spending to rise further. Unless some cuts are made to reverse this, even the dollar’s unique status cannot save the United States from a debt crisis within five years.
The fiscal tightening will encourage the Fed to stick with massive QE for longer. I suspect that Ben Bernanke will keep the policy until he leaves office next year.
The next chairman will have to deal with the messes that he leaves behind. Significant policy tightening is likely. If you are a speculator, better get out before Bernanke retires. What comes after could be quite bad.

Euro-zone austerity

The rejection of the austerity policy by Italian voters is the latest setback in resolving the euro-zone crisis. It adopted austerity because the bond market demands it. Euro-zone governments do not have room to increase debt like the United States. The critics of the austerity policy are ignoring market reality.
The problem with the austerity policy is that it has not worked on its own. A downward spiral seems to have seized the countries that adopt it. Austerity triggers recession, which increases fiscal deficit, which demands more austerity. There are no signs that this vicious cycle will stop any time soon. With staggering unemployment rates, political instability is likely to haunt Europe soon.
While the purpose of austerity is to cut the budget deficit, it works only if it leads to cost reductions and improving competitiveness with Northern Europe.
Unfortunately, the competitiveness gap between the North and South is large, possibly 30%. The required deflation of such magnitude would require a major economic collapse. It does not appear possible.
In addition to austerity in the South, some inflationary policy in the North is required for the adjustment to be possible. That is the missing piece in the euro-zone response to the crisis.
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When the competitiveness gap is closed, the fiscal situation in the South will stabilize through better revenue. However, the growth problem will not be resolved, just like in the United States. I have written several times arguing that macro policies can stabilize finance, but not create growth.
Click to Play

Economist: Jobs report paints strong picture

PNC chief economist Stuart Hoffman speaks about what February's robust employment data means for the U.S economy going forward. Photo: Getty Images.

Yen devaluation

The market has suddenly become very bullish on Japan’s economy, believing that a weak yen will revive its growth. This is just wrong.
I have always believed that the yen will go down due to weakening fundamentals in the Japanese economy. The yen’s decline now reflects the country’s weaknesses. Curing deflation may help on the margin, but the impediments to growth — a declining labor force and deteriorating corporate competitiveness — will not be cured by a weaker yen.
Curing deflation would rearrange income in Japan. It would shift more to the government. The household sector would suffer an inflation tax, which will not be good for consumption. Japan’s wages have fallen much more than CPI. It is a consequence of Japan’s declining competitiveness.
Curing deflation will not spark a rising trend in real wages. So I don’t see how the yen’s devaluation will somehow send the economy on a growth path and the Nikkei Average JP:100000018 +0.60%  with it.
A short yen is the right trade. A long Nikkei isn’t.

Emerging economies

Since the global financial crisis, emerging economies have maintained growth. The talk of decoupling was popular. Now it is has been exposed that hot money due to the easy monetary policy in developed economies has been a big part of the growth story in emerging economies. It fueled bubbles like the property bubble in China and the consumer-credit one in India.
Emerging economies ignored the risks associated with bubble-fueled growth because their leaders did not see an alternative. A bubble needs exponentially more money over time to sustain itself. Unfortunately, the hot money has declined. This is why growth problems have emerged among emerging economies.
Emerging economies have growth potential due to a low base. However, only structural reforms can unleash it. Otherwise, why are the emerging economies still emerging? There must be structural reasons that have held these countries back for decades.
This is why the enthusiasm towards emerging markets on potential is usually misplaced, and most financial investors have not made money there.
The emerging economies were in good financial shape in 2008 because the 1997-98 crisis seared the fear of debt into them. It was a great opportunity to institute structural reforms to establish their own dynamic.
Unfortunately, too many abused their sound financial system for growth. The big emerging economies like Brazil, China and India have become over-levered into low-quality assets. The debt orgy has also left behind an inflation problem. They face greater difficulties now than in 2008.
The responses so far are squarely in the muddling-through and hoping-for-a-miracle camp. I believe that emerging economies may experience a crisis over the next two years like Europe and the United States before.
They could avoid it by instituting structural reforms soon to increase growth expectations. The resulting investment by the private sector may help them to stave off a crisis.
That, unfortunately, is nowhere in sight. India has blown this opportunity in its latest budget. China keeps up its dance with speculation, hoping that the level of speculation could be controlled at just the right level to keep the economy going. This fantasy that economic management is all about psychology could send China into a major crisis.
I believe that emerging markets will perform worse than developed markets this year and next. They lived off bubbles for too long. The bill is large, and it is due.

Demand management

Globalization, accelerated by the IT revolution, is severely reducing the effectiveness of demand management.
It is no longer just the trade of manufactured goods, 1/5th of the global economy today. Multinationals can locate virtually any type of job anywhere in the world, except a few occupations like making coffee, cooking food or cutting hair. The supply side has effectively become one for the whole global economy.
So when a country boosts demand through stimulus, the local supply response would be quite small. The weak feedback makes stimulus ineffective. This is why the massive stimulus in the United States sparked a big emerging-market bubble rather than boosting employment at home.
In today’s global economy, a country can improve its economy through boosting competitiveness, not demand. The most important elements in the competitiveness calculation are housing, health care and education.
Monetary stimulus works the other way. It boosts inflation in non-tradables like housing, health care and education. Traditional macroeconomic policy generates little benefit in the short term and a lot of harm in the long term.
The main impediment to growth in Europe is labor-market inflexibility. Europe has an aged labor force. Without flexibility, it is likely to suffer declining productivity. Its existing focus on macro-management will not solve its difficulties. Until Europe undertakes major labor-market reforms, it will continue to stagnate.
The United States needs to boost education quality and decrease health-care cost. Despite talk, it has done nothing on either. The actions are in pouring money into stimulus, reviving speculative activities. The resulting wealth increase among speculators gives them the wherewithal to influence the government. That force is trapping the U.S. government into adopting pro-speculation policies in the name of stimulating the economy.
Five years after the global financial crisis, policy formulation continues to be targeting the wrong things. In some cases, the policies are used to support speculation, which shifts wealth from many to a few. The global economy remains unstable as a result.
See this Andy Xie commentary at Caixin Online.
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