In October Spanish authorities reported a 0.1% decrease in the general level of prices which has suggested a repeat of a Japanese style stagnation. With the ECB cutting rates to 0.25% earlier this month to avoid such an issue it could be too little too late. Also with rates as low as they are they are starting to run out of ammunition to stimulate the economy. With little support in the eurozone area for quantitative easing or fiscal stimulus one wonders how they avoid the slide in prices.
The US Fed has used three rounds of quantitative easing to avoid a deflationary environment and Fed Chairman Ben Bernanke alluded to this in 2002 when he said:
“Deflation is in almost all cases a side effect of a collapse of aggregate demand – a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending – namely, recession, rising unemployment, and financial stress,”
Speaking before the Global Financial Crisis Bernanke debated the idea of QE as a potential solution after the lowering of interest rates. But the biggest worry for low inflation countires in the eurozone is deflationary expectations as cosumers delay purchases which ultimate reduces demand.
Many thanks to A2 student Emersen Tamura-Paki for this paper on Currency Wars by Fred Bergsten which was delivered in May this year. Although it is a long document it is very readable and contains some interesting points.
* Virtually every major country is looking to keep its currency weak in order to strengthen its eocnomy and save/create jobs.
* Over 20 countries have been intervening in foreign exchange markets to suppress their currency value which has led to the build-up of reserves totaling over US$10 trillion.
* It has been led by China but includes a numer of Asian as well as several oil exporters and European countries. They account for two-thirds of global current account surpluses.
Global surpluses of currency manipulators have increased by $700-900 billion per year – see Figure 1.
* The largest loser is the USA – current account deficits have been $200bn – $500bn per year as a result. Estimate that 1 – 5 million jobs have been lost under the present conditions and likely to continue.
* Japan this year talked down its exchange rate by about 30% against the US$.
* France has called for a weaker euro – which seems the only feasible excape from many more years of stagnation. This favours, in particular, the German economy with its export growth.
However some countries have been justified in their intervention. Some countries currencies have become overvalued and produced external deficits due to widespread manipulation. Brazil and New Zealand are countries which have been justified in their intervention. Our neighbours Australia have also expressed concerns as the appreciation of the AUS$ has been the result of the significant demand for minerals from China. This does leave other exporters struggling to maintain competitiveness especially if their goods/services are elastic in nature.
The systemic problem arrises when there is continued intervention and undervaluation of currencies. Fred Bergsten illustrates the application of these principles in grid where the orange coloured cell constitutes the objectionable behaviour.
According to Bergsten the practice is widespread and the flaw in the entire international financial architecture is its the failure to effectively sanction surplus countries, especially to counter and deter competitive currency policies.
Franz Nauschnigg wrote a piece in Project Syndicate about an emerging imbalance in the goods and services deficits that Portugal, Italy, Ireland, Greece and Spain (PIIGS) have with China. Up to 2004 the biggest deficits of the PIIGS economies was with the rest of the eurozone. But in subsequent years the figures were the following:
From the figures you can see that over the last 4 years the deficit with China has remained significant while it has narrowed with the eurozone especially with Germany. There are two reasons for this:
1. The euro has appreciated against the renminbi.
2000 – € = ¥7.4
2007 – € = ¥10.4
With this appreciation the eurozone countries exports became less competitive. The early 2000’s saw a lot of investment into the PIIGS economies which increased inflation and prices.
2. With the southern economies dependent on textiles, footwear etc the stronger euro made Chinese imports a lot cheaper than the domestic alternative. The IMF acknowldeged the fact that Chinese exports were responsible for the deficits in the PIIGS but Northern Europe wasn’t as badly affected as their export focus is more machine based which China is not able to compete with.
With monetary and fiscal expansion becoming ineffective external adjustments under three conditons might be the answer:
1. Stronger external demand
2. A less onerous financing environment
3. A weaker euro
Much of the above could be achieved by a weaker euro against the renminbi. This would provide the boost to export revenue and reduce fiscal and external deficits.
David A. Rosenberg an economist with Clusken Sheff in Canada, has likened the world economy to that of a car being driven by a drunk – that is the car is moving back and across the centre line just missing the ditches on the side of the road. Currently he sees the car in the middle of the road although he questions as to whether this is due to the driver becoming more sober or steering towards the ditch on the other side.
Recently the US stock market (Dow Jones Industrial Average) went above 14000 for the first time in more than five years for the following reasons:
1. Better job figures – employers added 157,000 jobs in January and hired more workers in 2012 than had previously been thought. See chart below.
2. Corporate earnings have been stronger than expected,
3. US Federal Reserve has indicated that it will keep interest rates at near zero levels as well as continuing their policy of monthly $85 billion purchases of bonds and mortgage-backed securities, which injected $3 trillion into the banking system last week.
This third point is particularly important. In the New York Times, Rosenbery stated that he didn’t see the US economy in a recession as yet but could quickly go in that direction. “Anemic growth is my baseline scenario.” Also how long can the US Fed keep propping up equity markets and pumping money into the system? The conditions in Europe are not much better – unemployment rose to record levels in December last year and currently stands at 26.8% in Greece and 26.1% in Spain. Add to that the austerity measures which have impacted greatly on overall aggregate demand and the consumer slowdown in Germany, the eurozone area has its problems. So the car might be in the middle of the road right now but it might not take too much for it to deviate from a safe path.
The race for countries to devalue their currency (make their exports more competitive) has led to massive increase in monetary stimulus into the global financial system. We are all aware of the three rounds of Quantitative Easing from the US Fed and the indication that they would keep the Fed Funds Rate at virtually zero until 2015. To add fuel to the ‘dim embers’, in 2013 the US is going to inject US$1 trillion into the circular floe. However in China they have also embarked on some serious stimulus:
* More infrastructure development – US$60bn
* Additional credit – US$14 trillion in extra credit since 2009 (equal to entire US banking system)
Nevertheless even with all this artificial stimulus there might be some short-term growth but I can’t see it being sustainable when you consider the extent of global deleveraging. Also IMF figures show that the world saving rates are on the increase (* forecast):
With increased saving rates accompanied by significant austerity measures in many parts of Europe where is the consumer demand going to come from? Unemployment in Spain is 26% and predicted to hit 30% this year- more worrying is 50% of those under 25 are unemployed. Spanish protesters chanted “We don’t owe, we won’t pay” in a march against austerity. So in the US we have massive fiscal stimulus but across the water in Europe it’s all about “tightening the belt” and cutting government spending. Neither seems to be working and are we just putting off a significant downturn for a later date?
Here is a clip from PBS on the German economy as to why it is has been so successful.
* The secret to Germany’s success seems to be evident in small-to-medium-sized family firms that manufacture some highly specialized and indispensable piece of equipment. The Germans like to say, we make the thing that goes inside the thing that goes inside the thing.
* With just a quarter of America’s population and a quarter of its GDP, Germany exports more than the United States in total
* Germany have 1 percent of the labour force of the world, and 10 percent of the world exports.
Championed as an economy which has effectively weathered the GFC, Sweden’s output is now starting to slow. Like Germany their economy is very export dependent and specialises in high-value manufacturing and therefore has been affected by the slowdown in both Europe and China.
50% of GDP is export related and because of the global downturn industrial production is down 5% this year although the strong Swedish Krona hasn’t helped matters. The Swedes have some concerning debt issues in that households have a debt-to-income ration of 149% – the Dutch rate is even higher 250% and the Danes are at 267% – see graph below. However the public sector debt is low and gross national debt is 37% of GDP. For the private sector the house prices have increased relative to incomes and rents and this is in a country with so much land and so little population ought to be a worry for policymakers. With unemployment on the rise households will find it harder to to pay off their debts and the banks might have to take some big losses.
Gross debt-to-income ratio of households % Source: http://epp.eurostat.ec.europa.eu
Western European economies went back into recession (defined as two consecutive quarters of negative GDP) as the injection of demand into the circular flow was more than offset by public austerity programmes in certain countries. The conditions in the Euro-zone don’t seem to be very conducive to any sort of recovery – contractionary fiscal policy is prevalent in many countries and a lack of confidence across the region stifles any upturn.
Greece is still has serious concerns over any recovery – IMF boss Christine Lagarde stated that Greece should be given “a bit more time”.
“This is what I have advocated for Spain, Portugal and what we are advocating for Greece. An additional two years was necessary for the country to actually face the fiscal consolidation programme that is considered.”
However there is still some more hardship to come before any sort of economic recovery. I was surprised at the German growth levels over the last tow quarters. Quite like this graph showing annual GDP in the Euro-zone.
Nobel Laureate Joseph Stiglitz came out strongly against the recent QE3 by the US Fed and the ECB’s announcement that it would buy government bonds of indebted eurozone member countries. With this announcement stock prices in the US reached post-recession highs although some worried about future inflation and significant government spending. According to Stiglitz these concerns are unwarranted as there is so much underutilisation and no serious risk of inflation. But the US Fed and the ECB sent three clear messages:
1. Previous actions didn’t work – ie QE1 and 2
2. The US Fed announcement that it will keep rates low until 2015 and buy $40bn worth of mortgage backed securities suggested the recovery is not going to take place soon.
3. The Fed and the ECB are saying that the markets won’t restore full employment soon – fiscal stimulus is needed.
In textbook economics increased liquidity means more lending, mostly to investors thereby shifting the AD curve to the right and thereby increasing demand and employment. But if you consider Spain an increase in liquidity will be cancelled out by an austerity package.
For both Europe and America, the danger now is that politicians and markets believe that monetary policy can revive the economy. Unfortunately, its main impact at this point is to distract attention from measures that would truly stimulate growth, including an expansionary fiscal policy and financial-sector reforms that boost lending. Joseph Stiglitz
The recent job summit called by Engineering, Printing and Manufacturing Union (EPMU) focused on the strength of the NZ dollar and the impact it is having on manufacturing jobs in the New Zealand economy. This has been area that the opposition parties have targeted especially the Greens. Although a weaker dollar would make exports more competitive there are concerns about the mechanism used to achieve. Certain procedures to reduce the value of a currency have been well documented. They are as follows:
1. Quantitive Easing – printing money.
You need to look no further than the US economy to to see what has been the impact of 3 rounds of QE. Although the US dollar fell after QE1 in late 2008 a lot of could be said to have been caused by the collapse of Lehman Brothers and others around that time. QE2 in November 2010 correlated with the fall in the US dollar but again some have indicated that this was a result of the US economy being energised by the Federal Reserve and therefore it was safe to buy risky investments (US dollar seen as safe). You don’t have to look for another example where QE has had a limited impact – Japan since 2001. Here the Japanese authorities have found that QE has seen the Yen strengthen.
2. RBNZ enter the foreign exchange market and buy NZ dollars with currency reserves
This has been tried before with little success – equilibrium is restored at pre-intervention levels and the venture has proved very costly. Furthermore, there is the specter of inflation to contend with in years to come. The currency value has been more influenced by which stage of the business cycle the NZ economy is sitting at. In the 1990’s the Bank of Japan has spent billions of dollars trying to stop the appreciation of the Yen against the US dollar. The Swiss National Bank had to spend the equivalent to 70% of its GDP buying euros to cap the Swiss franc.
3. Drop the Reserve Bank’s Official Cash Rate (OCR)
When an economy’s interest rates are relatively high compared to other economies there is the incentive to park your currency where you get higher returns i.e. borrow from Japan at near 0% and investing in Australia at 5%. However lower interest rates doesn’t necessarily mean a lower exchange rate – the Reserve Bank of Australia has dropped rates from 4.75% to 3.25% over the last couple of years but the Aussie dollar hasn’t moved. This is most likely due to the mining boom.
4. Contractionary Fiscal Policy
As Don Brash (Former RBNZ Governor) stated in the NZ Herald, the best way of reducing the value of the NZ dollar would be for the government returning to a surplus by reducing government spending and increasing taxes. This would take money out of the circular flow and therefore reduce aggregate demand. With inflation nearing the bottom of the target range the RBNZ would be forced to reduce the OCR and ultimately the NZ dollar without the threat of inflation.
Getting the exchange rate down is a very complex task and it seems that the foreign exchange market doesn’t punish negative figures of economic indicators i.e. high inflation. I suppose a increase in the value of the NZ dollar is due to our desire to fund our spending from overseas borrowing.
Since the start of the global financial crisis in 2008 and with the exception of Germany, none of Europe’s biggest economies have returned to the level of economic output they had in the pre GFC days. In Japan in the 1990’s there was the need for the central bank to aggressively fight deflation, and let banks take credit losses quickly, suggesting that expansionary fiscal policy did not offer a way out of low economic growth.
According to the New York Times – economic growth not realised represents investments in education that were never made, research was never financed, businesses that failed and careers that ended too early or never got off the ground.
Economists warn that the euro zone is on the same path as Japan was in the 1990’s, when failure to deal with weak banks led to a decade of stagnation. The Japanese never fixed their banks and as banks in Europe have limited cash reserves they are reluctant to take the risk of lending money. Although the ECB has supplied banks with significant amounts of cash they cannot force them to lend the money out to investors which ultimately creates growth and jobs. Below are some statistics which allude to this.
Demand for housing loans in Q1 2012
Italy – business loans 38%↓
Recessions can be beneficial as they can improve efficiency and reduce risky lending. However for the eurozone this is no normal recession in that its duration will be significantly longer than the norm. See the interview below with investor George Soros.
According to Business Week, as the US was embarking on a US$787bn stimulus package in 2009 Estonian authorities decided to march in the opposite direction and avoided running budget deficits and borrowing money to try and trigger higher growth levels. In order to maintain a balanced budget the government employed a contractionary fiscal policy and did the following:
- they froze state pensions
- lowered salaries by 10%
- raised the tax on goods and services by 2%
As a result of this:
- GDP in Estonia fell by 14% in 2009
- Unemployment in rose to 16%
GDP grew by 7.5% and unemployment down to 10.8% which is still worrying but not as bad as Spain or Greece. However, Estonia has shown that a contractionary monetary and fiscal stance by government does lead to economic hardship but does in the long run generate growth. The IMF praised the country’s export-led recovery and its sought after fiscal position. A lot of Estonia’s success has been its desire to become part of the west since it regained independence in 1991 after the collapse of the USSR and joined the European Union in 2004. The country employed free market policies and with an open, efficient, and wired infrastructure the World Bank ranks it 24th out of 183 countries in “The Ease of Doing Business Index” – see graph.
One area that Estonia is very different than its European counterparts is their ability to follow through on prudent measures. The average salary in Estonia is 10% below the minimum salary in Greece. Furthermore pensions are also much lower and civil servants retire 15 years later. Although the graph below shows the peak of the boom in 2007 Estonian economists believe that this was fueled by cheap household credit and not realistic growth. Whilst the growth from 2010 – 2011 came from mainly exports and therefore seen as genuine. Their belief is “no pain, no gain”.
ECB President Draghi has insinuated that there is a lot more ammunition to be fired. Draghi was determined to build on his comments in London last week when he pledged to do ‘whatever it takes’ to save the euro. He says that ‘financial fragmentation’ as hindering the monetary transmission mechanism. However, his key point was the ‘risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner.’
In order to create the fundamental conditions for such risk premia to disappear, policy-makers in the euro area need to push ahead with fiscal consolidation, structural reform and European institution-building with great determination. As implementation takes time and financial markets often only adjust once success becomes clearly visible, governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist – with strict and effective conditionality in line with the established guidelines. Source: BNZ
The graph below shows that the ECB have a bit of cash.
The Wolfson Economics Prize was awarded to the person who is able to articulate how best to manage the orderly exit of one or more member states from the European Monetary Union. Roger Bootle and his colleagues from Capital Economics in London won the £250,000 prize. Their main proposal was a Northern Monetary Union not including France as the economic climate there has resembled the peripheral economies – current account deficit as opposed to Germany’s significant surplus and its primary budget deficit which resembles that of Greece. However, France would form a Southern Monetary Union. There was also the option of all those not in the Northern Monetary Union reverting back to local currencies like the pre-euro environment. Below is a flow chart to outline his plan.
Having arrived in Spain (Mallorca) last night just before the euro final I could not post something about football – the Spanish know how to celebrate. Spain showed their class and are an exceptional team to have won three major tournaments in the last four years. Some have likened them to the Brazil team of 1970.
In keeping with Spanish football, I came across Simon Kuper, co-author of Soccernomics, on the eZonomics website by ING. One particular part of the site focuses on soccer – Cup-o-nomics – in which current issues in the sport are related to economics. With the Euro 2012 Championship on he has written several articles about players. managers etc.
In July 2007, the Spanish striker Fernando Torres moved from Athletico Madrid to Liverpool. Torres commanded a salary of £90,000 (NZ$175,500) a week at Liverpool, equivalent to £4.6m (NZ$9.1m) a year. Interestingly enough this was a salary cut as at Athletico he was on an annual salary of €8 million (about NZ$10.5 million). However within a year of signing for Liverpool the purchasing power of his income decreased for the following reasons:
1. The pound depreciated against the euro (hard to believe now) by around 20%. Most foreign players tend to send home a lot of their salary and therefore Torres needed to use more pounds to buy euros.
2. After 2008 and the financial crisis the UK experienced over 5% inflation which again would have lessened the purchasing poser of his income. Most soccer players are on a given salary for the duration of their contract and therefore don’t have their income indexed to the CPI or cost of living.
Even all this said, Fernando Torres is probably not too worried about exchange rate fluctuations or inflation rates when you look at his salary and the season he has just had with Chelsea and Spain.
The Greek economy is now into its sixth year of recession and it is no surprise that its economy is in tatters. Brian Gaynor from the NZ Herald wrote a very good summary of how Greece got into the mess that it is currently in. Below are some statistics over the last 6 years and this year sees a fifth year of recession – negative GDP for two consecutive quarters.
So what were the reasons for such a collapse on the Greek economy.
1. Tax avoidance has been endemic within the country especially amongst the higher income groups. Therefore there is a huge shortfall in government revenue relative to their expenditure. This means a government debt-driven recession.
2. The Greek economy boomed, like many others, with the availability of cheap credit in the early 2000’s and with the Olympics in Greece in 2004 economic activity was moving very nicely indeed.
3. Hosting the Olympics proved to be very costly in the long-run and there was little planning regarding the use of facilities post games. Many stadiums lie idle.
4. The Greek government was borrowing heavily overseas to fund its deficit.
5. Low interest rates and cheap money from overseas fueled a residential property boom – prices went up 100% from 2000-2008
6. Investment in assets with borrowed money that generated no overseas income.
Today the building industry has collapsed and residential property prices are down 20% from their peak in 2008 – isn’t this a familiar story worldwide especially with the sub-prime escapade. Also, as in Spain, there is a huge level of youth unemployment in Greece – 52.8% of under 25s are unemployed. As Brian Gaynor said at the end of the article
“The basic problem is that most Western countries, including New Zealand, have lived well beyond their means over the past 20 years, and Greece is just the worst example of this. The borrowing party is over and we are now experiencing the hangovers, particularly in Europe. These hangovers are not easily cured.”
Ben Cahill of Senior College put a cartoon on the Tutor2u blog about the role Angela Merkel has in determining the destiny of Greece. The cartoon below has Merkel showing the Greeks to their only option ie. the labyrinth to be consumed by the minotaur. What she basically saying to the Greeks is that you have no choice but to stick to the reform measures and strict austerity measures. Furthermore one could say that after the soccer quarter-final on Friday “One gone, one to go”.
This cartoon also reminded me of book that I recently read called the Global Minotaur by Yanis Varoufakis. The Minotaur is a tragic mythological figure. Its story is packed with greed, divine retribution, revenge and much suffering. It is also a symbol of a particular form of political and economic equilibrium straddling vastly different, faraway lands: a precarious geopolitical balance that collapsed with the beast’s slaughter, thus giving rise to a new era.
According to the myth’s main variant, King Minos of Crete, the most powerful ruler of his time, asked Poseidon for a fine bull as a sign of divine endorsement, pledging to sacrifice it in god’s honour. After Poseidon obliged him , Minos recklessly decided to spare the animal, captivated as he was by its beauty and poise. The gods, never allowing a good excuse for horrible retribution to go begging, chose an interesting punishment for Minos: using Aphrodite’s special skills, they had Minos’s wife, Queen Pasiphae, fall in lust with the bull. Using various props constructed by Daedalus, the lengendary engineer, she managed to impregnate herself, the result of that brief encounter being the Minotaur: a creature half-human, half-bull (Minotaur translates as ‘Minos’s Bull’, from the greek taurus, ‘bull’).
When the Minotaur grew larger and increasingly unruly, King Minos instructed Daedalus to build a labyrinth, an immense underground maze where the Minotaur was kept. Unable to nourish itself with normal food, the beast had to feast on human flesh. This proved an excellent opportunity for Minos to take revenge on the Athenians whose King Aegus, a lousy loser, had had Minos’s son killed after the young man won all races and contests in the Pan-Athenian Games. After a brief war with Athens, Aegus was forced to send seven young boys and seven unwed girls to be devoured by the minotaur every year (or every nine years according to another version). Thus, so the myth has it, a Pax Cretana was established across the know lands and seas on the basis of regular foreign tribute that kept the Minotaur alive.
Beyond myth, historians suggest that Minoan Crete was the economic and political hegemon of the Aegan region. Weaker-city states, like Athens, had to pay tribute to Crete regularly as a sign of subjugation. This may well have included the shipment of teenagers to be sacrificed by priests wearing bull masks.
Returning to the realm of the myth, the eventual slaughter of the Minotaur by Thesus, son of King of Aegeus of Athens, marked the emancipation of Athens from Cretan Hegemony and the dawn of a new era.
Aegeus only grudgingly allowed his son to set off to Crete on that dangerous mission. He asked Theseus to make sure that, before sailing back to Piraeus, he replaced the original mournful black sails with white ones, as a signal to his waiting father that the mission had been successful and that Theseus was returning from Crete victorious. Alas, consumed by the joy at having slaughtered the Minotaur, Theseus forgot to raise the white sails. On spotting the ship’s black sails from afar, and thinking that his son had died in the clutches of the Minotaur, Aegus plunged to his death in the sea below, thus giving his name to the Aegean sea.
This suggests a tale of a hegemonic power projecting its authority across the seas, and acting as custodian of far-reaching peace and international trade, in return for regular tributes that keep nourishing the beast from within. The role of the beast was America’s twin deficits, and the tribute took the form of incoming goods and capital. Its end came from the collapse of the banking system. The book is well worth the read and not too long either.
Below is a very good video from The Economist on the impact of Greece leaving the Euro. Thanks to John Wilson of AGS for sharing this on twitter.
A hat tip to A2 student Georgia Harrison for this clip from the European Parliament – Nigel Farage MEP, Leader of the UK Independence Party (UKIP) gives his view of the whole euro debacle. Some very valid points to a rather stunned audience. Here is part of his speech. Worth a look.
A hundred billion [euro] is put up for the Spanish banking system, and 20 per cent of that money has to come from Italy. And under the deal the Italians have to lend to the Spanish banks at 3 per cent but to get that money they have to borrow on the markets at 7 per cent. It’s genius isn’t it. It really is brilliant.