Tuesday, October 16, 2012

How the G8 Looks this Year

CAMP DAVID, MD - MAY 19:  In this handout prov...

Next year when Germany takes the helm of the G8 it is expected to refocus on global economic matters and in particular global imbalances, according to an article in The Financial Times. Indeed, the Germans feel that recent G8 meetings have become a little too broad covering areas such as climate change and global poverty - very much a theme of the British leadership.

They also don't seem to keen on admitting new members to the club such as Brazil and China. Apparently, it makes meetings to difficult to manage and hard to find a consensus if there are too many participants. Yet the likes of China, India and Brazil are becoming increasingly important, it seems crazy to exclude from being part of the G8. China and no doubt India will soon surpass Germany in size and the former has already overtaken the UK and France. Maybe Canada and Italy should be dropped in favor of China and India, both are arguably more important economically. However, this doesn't appear to be up for debate right now.

But the refocusing on economic matters and in particular global imbalances is interesting. Looking at the back of my Economist the US is forecast to have a current account deficit of 6.8% of GDP for 2006. Others come in at -7.7% for Spain, -5.6% for Australia, -2.9% of the UK, -1.8% for France and -1.6% for Italy. The last two countries had surpluses in recent years. On the other side of the balance sheet you have Switzerland at +13.4%, Sweden at 6.6%, Netherlands at 5.9%, Japan at 3.8% and Germany (now the world's biggest exporter) at 3.7%. Then there are various Asian countries running surpluses of 2 to 7%.

Then there are other imbalances. The US economy tends to motor with rapidly rising productivity to boot. By contrast Europe tends to be much more pedestrian in these areas. Much to discuss about imbalances then. So when Angela Merkel takes the helm she could consider setting an example herself. German policy makers seemed to have decided to rely almost exclusively on exports to generate economic growth. This is fine as part of a strategy for growth. Consider for a moment that exports generate one third of the economy and contribute a quarter of the jobs. It sounds impressive and it is.

But the other 2/3rds of GDP, the domestic side of the economy, generates 75% of the jobs. This is arguably the much more important bit and it seems to be ignored with the result that Germany has a very low average growth rate - about 1%. Merkel could start focussing instead on stimulating domestic demand, ie scrapping those VAT hikes for example. This would be good for Germany, create more jobs and make the country a little more self-reliant for growth. It would also help stimulate growth across the rest of Europe, which in turn would be good for German exports. A kind of virtuous cycle. Germany is after all the number three economy in the world. But, Germany is very vulnerable to any vagueries in the world economy.

The Anglo-Saxons in contrast rely heavily on consumer spending (plus public sector spending for the UK) to propel their economies along and this has insulated them from slow downs in the world economy. However, they to have generated imbalances, in the case of the US they are extreme and matter a lot more to the world economy than the German ones.

Quite simply the US is relying on the status of the dollar to get away with those imbalances. It is the world's main reserve currency. But the Americans are debasing it by running huge current account deficits and the dollar will only hold its own out there for as long as people have confidence in it. Arguably, US deficits are compensated to an extent by the fact that the US regularly clocks up stellar economic growth figures. It makes the country very attractive to invest in. Also, the dollar is used as the main currency for commodity and many other international trade transactions, thereby creating a demand for them. With commodities prices rocketing this means people need more dollars to buy oil, gas, copper, nickel etc... Then of course there are the Euro markets which recycle all these offshore surplus dollars into loan instruments such as Eurobonds. Strong global growth helps recycle and mop up many of these surplus dollars.

But the general trend of the US importing $2 worth of goods for every $1 it exports must be unsustainable in the long-run. There will be a day of reckoning. That's regardless of clever theories of "dark matter" dreamed up by economists to talk away the seriousness of the deficit. They are basically nonesense. It is a problem the US must address or it and the rest of the world faces a potential financial meltdown at some point. As the deficit grows so does the potential for a hard landing as opposed to a gentler more managed landing. I wonder if Merkel has considered that her country's fortunes are so heavily tied to US imbalances? A US meltdown would hit Germany and many of her clients particularly hard.

But Germany is in a very different situation to China which absolutely needs exports to develop and grow. Germany is well beyond that stage. She has a large wealthy domestic population and if she can get them spending Germany would have a much healthier balanced economy and would be better insulated from the vagueries of the global economy. Germany would also import more and would act as another pole of growth in the world economy. China to an extent is starting to do that particularly for the Asia Pacific region. Then at least the status of US imbalances won't be quite so critical to the health of the world economy.

So far signs aren't encouraging. The Americans tend to see it more as everyone else's problem. However, they might change their tune should the Asians ever decide to pull the plug on the dollar. They not only help prop it up, but have played a key part in keeping US interest rates relatively low by buying sack loads of US Treasuries. Of course that is in their own interest, but one day it might not seem so important to them. Once the US is fataly weakened economically one can only imagine what that would do for world peace with the global policeman effectively bankrupt! All the thugs out there would feel free to settle scores as they pleased. It could be anarchy.

In the shorter-term, talking about imbalances at G8 Summits, particularly US ones, will no doubt bring markets to focus more intensily on those deficits thereby further weakening the dollar.

1 comment:

  1. Its so sad that picture dosnt work in your page but like we used to say in Germany: kinderbekleidung it means, Head up