martin wolf notes 27sep10

8/8/2019 Martin Wolf Notes 27Sep10

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Ants, grasshoppers and locusts:Prospects for the UK and eurozoneMartin Wolf, Associate Editor & ChiefEconomics Commentator, Financial Times

The S&P Future of Finance Series

Drapers Hall, Throgmorton St, London

27th September 2010


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Ants, grasshoppers and locusts


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Ants, grasshoppers and locusts: my story

Ants: China, Japan, Germany and the Netherlands;and the non-financial corporate sector;

Grasshoppers: US, UK, Greece, Ireland, Portugaland Spain; and, above all, the households andgovernments within them;

Locusts: the financial sector intermediating sobrilliantly between the two;

Then crisis, rescue and post-crisis de-leveraging;


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Ants, grasshoppers and locusts

So where are we now and where are we going?

Questions I intend to address:1. Are the bad times over?

2. What are the internal threats facing the UK and eurozone

economies?3. What are the external threats facing the UK and eurozone

economies?

4. What is the right response by investors?


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1. Are the bad times over?

Carmen Reinhart and Kenneth Rogoff, in their masterpiece,This Time is Different, argue that the legacy of financial crises

in advanced countries includes: Asset market collapses: real housing price declines averaging 35

percent over six years, while equity price collapses average 55percent over a about three and a half years.

Profound declines in output and employment: the unemploymentrate rises an average of 7 percentage points over the down phaseof the cycle, which lasts on average over four years, while outputfalls (from peak to trough) average over 9 percent

Exploding public debt: debt rises by an average of 86 percent of

GDP. The main cause of debt explosions is not the widely citedcosts of bailing out and recapitalizing the banking system, but therecessions.


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1. Are the bad times over?

What has happened this time is consistent with this pattern:

The good news is:

Aggressive monetary and fiscal policy, combined with the rescue ofthe financial system, created a relatively mild recession, though notone of the major economies has GDP back to pre-crisis levels.

The bad news is:

the crisis has affected all the worlds biggest economies, which makesan export-led escape impossible;

Monetary and fiscal policies remain dramatically abnormal; and

There is a long period of private sector de-leveraging and fiscal

pressure ahead, in the context of what are also by now relativelyslow-growing economies.

Weak growth of demand and chronic uncertainty are guaranteed


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2. The internal threats

What are the internal challenges confronting the UKand the eurozone?

Shared threats:

High private sector financial surpluses combined withpressures for fiscal retrenchment;

If private spending does not rise, as the fiscal deficits areclosed, there will be very weak aggregate demand even anew recession - and so a severe risk of deflation;

This makes likely a prolonged period of very lowintervention rates from central banks and further bouts ofunconventional monetary policy.


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Internal threats for the UK:

The good news: policy autonomy, a devalued exchange rate and a relatively

aggressive central bank;

The bad news:

Huge household debt overhang;

Overvalued housing stock;

De-leveraging financial sector;

Structurally weak export capability; and

A government determined to implement a structural fiscal

tightening of 8 per cent of GDP over five years.


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Internal threats for the eurozone:

The good news:

policy autonomy and a recently devalued exchange rate (largelybecause of the crises).

The bad news:

Weak aggregate private demand in solvent core countries;

Fiscal retrenchment across the eurozone;

But huge past divergences in competitiveness;

And private and public retrenchment in peripheral countries;

Threat of fiscal and banking crises and so need for more bail-outs;

Deflation in peripheral countries, which would worsen debt difficulties;

Deep and prolonged structural recessions; and even

A Possibility of break-up of eurozone.


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3. The external threats

What are the external dangers for UK andeurozone?

Shared dangers:

Weak demand in the US;

Weak demand in core Europe;

Continued exchange rate intervention in emergingcountries, particularly China, and failure to rebalance worldeconomy;

Trade wars and protectionism;

Commodity price spikes; and

Break-down of the global order.


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4. Issues for investors

Deflation or inflation?

Deflation in the short term; and, maybe, Inflation in the very long term.

More unconventional monetary policy, or not?

Weak economies and deflation says yes;

Worries over the signal of panic says no.

Fiscal retrenchment, or not?

Governments will try to cut deficits;

But they may just cause recessions.


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4. Issues for investors

Asset price bubbles, or not?

Much monetary ease pushes asset prices up; but Normalisation of profits makes asset prices weak.

Global rebalancing or prolonged recessions?

Rebalancing is the way out for deficit countries;

Without it, we have recessions, trade wars and/or even aeurozone break up


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Corporate ants

NET CORPORATE SAVINGS

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Germany Japan UK USA

HOW NON-FINANCIAL CORPORATES SAVE


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The Great Recession

ECONOMIC PERFORMANCE IN THE GREAT RECESSION

90.0

92.0

94.0

96.0

98.0

100.0

102.0

Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Q2 10

US Japan Germany France Italy UK

THE DEEP DECLINE


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Imbalances

THE RISE OF THE IMBALANCES

GLOBAL CURRENT ACCOUNT IMBALANCES

(as share of global gross domestic product)

-3

-2

-1

0

1

2

3

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

US OIL DEU+JPN OCADC CHN+EMA ROW

Source: IMF, WEO April


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Imbalances

RISE OF FOREIGN CURRENCY RESERVES

RISE OF FOREIGN CURRENCY RESERVES ($m)

-

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

31/01/1999

31/07/1999

31/01/2000

31/07/2000

31/01/2001

31/07/2001

31/01/2002

31/07/2002

31/01/2003

31/07/2003

31/01/2004

31/07/2004

31/01/2005

31/07/2005

31/01/2006

31/07/2006

31/01/2007

31/07/2007

31/01/2008

31/07/2008

31/01/2009

31/07/2009

31/01/2010

Other developing

MexicoBrazil

Algeria

Saudi Arabia

Russia

Other industrial

Australia

UK

EurozoneUS

Other Asia

Thailand

Malaysia

Hong Kong

Singapore

Korea

TaiwanIndia

Japan

China


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UK household indebtedness

WHERE THE BORROWERS WERE

HOUSEHOLD INDEBTEDNESS

(relative to disposable incomes)

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

200.0

United

Kingdom

United

States

Canada Japan Germany France Italy

1997 2002 2006 2007 2008

Source: OECD


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Monetary policy

REAL SHORT-TERM INTEREST RATES (per cent)

-3

-2

-1

0

1

2

3

4

2000

M1

2000

M6

2000

M11

2001

M4

2001

M9

2002

M2

2002

M7

2002

M12

2003

M5

2003

M10

2004

M3

2004

M8

2005

M1

2005

M6

2005

M11

2006

M4

2006

M9

2007

M2

2007

M7

2007

M12

2008

M5

2008

M10

2009

M3

2009

M8

2010

M1

United States Euro Area Japan

Source: IMF WEO April

MONETARY AGGRESSION


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Fiscal policy

FISCAL FIREPOWER USED

FISCAL BALANCES OVER GDP

-10

-8

-6

-4

-2

0

2

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

Advanced economies Emerging and developing economies World


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Recovery

SUCCESSIVE CONSENSUS FORECASTS FOR 2011

0

0.5

1

1.5

2

2.5

3

3.5

US UK Japan Eurozone Germany France Italy Spain

Jan-10 Jun-10 Jul-10 Aug-10

A SLIGHTLY WEAKENING RECOVERY IN 2011


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Financial balances

HOW PRIVATE DEFICITS COLLAPSED

SECTORAL IMBALANCES IN THE G7 2006 (per cent of GDP)

-10

-8

-6

-4

-2

0

2

4

6

8

10

Germany Japan France Italy Canada UK US

General Government Net Capital Inflow Private

Source: IMF WEO April 2010


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Financial balances


SECTORAL BALANCES IN THE G7 2010 (as per cent of GDP)

-15

-10

-5

0

5

10

15



Source: IMF WEO April 2010


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Financial balances


CHANGE IN FINANCIAL BALANCES, 2006-10

(as per cent of GDP)

-15

-10

-5

0

5

10

15



Source: IMF,WEO April 2010


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Competitiveness

LOST COMPETITIVENESS IN THE PERIPHERY

RELATIVE UNIT LABOUR COSTS IN MANUFACTURING

80

90

100

110

120

130

140

150

160

170

Q120

02

Q320

02

Q120

03

Q320

03

Q120

04

Q320

04

Q120

05

Q320

05

Q120

06

Q320

06

Q120

07

Q320

07

Q120

08

Q320

08

Q120

09

Q320

09

Greece Portugal Spain Italy Ireland


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Fiscal rules

NUMBER OF BREACHES OF THE 3 PER CENT DEFICIT RULE

0 1 2 3 4 5 6 7 8 9 10

Greece

Italy

France

Germany

Portugal

Austria

Ireland

Netherlands

SpainBelgium

Finland

Luxembourg

Source: Unicredit

THE GOOD, THE BAD AND THE UGLY


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Fiscal crisis in the eurozone

ROAD TO THE FISCAL DEFICITS

GENERAL GOVERNMENT BALANCE

(as per cent of GDP)

-14

-12

-10

-8

-6

-4

-2

0

2

4

2005 2006 2007 2008 2009 2010 2011

Portugal Ireland Spain Greece

Source: IMF, WEO, April 2010


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Fiscal crisis in the eurozone

ROAD TO THE FISCAL DEFICITS

NET PUBLIC DEBT

(ratio to GDP)

-20.0

0.0

20.0

40.0

60.0

80.0

100.0

120.0

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Greece Ireland Portugal Spain

Source: OECD


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Eurozone fiscal crisis

SOVEREIGN BOND YIELDS IN THE EUROZONE (%)

0

24

6

8

10

12

14

0

1/01/1999

0

1/07/1999

0

1/01/2000

0

1/07/2000

0

1/01/2001

0

1/07/2001

0

1/01/2002

0

1/07/2002

0

1/01/2003

0

1/07/2003

0

1/01/2004

0

1/07/2004

0

1/01/2005

0

1/07/2005

0

1/01/2006

0

1/07/2006

0

1/01/2007

0

1/07/2007

0

1/01/2008

0

1/07/2008

0

1/01/2009

0

1/07/2009

0

1/01/2010

0

1/07/2010

Germany France Portugal Ireland Italy Greece Spain

RISK GOES AND COMES FROM SOVEREIGN DEBT


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Eurozone vulnerability

VULNERABILITY INDEX OF EUROZONE MEMBERS, 2010(Average of the ratios of current account deficits, general government deficits and net

public debt ratios to eurozone average)

-100.0%

-50.0%

0.0%

50.0%

100.0%

150.0%

200.0%

250.0%

300.0%

350.0%

400.0%

Gree

ce

Portu

gal

Spain Ita

ly

Fran

ce

Belgi

um

Slov

akRep

ublic

Irelan

d

Austr

ia

Finla

nd

Germ

any

Neth

erlan

ds

Aver

age

Source: IMF and OECD

WHOS THE MOST VULNERABLE OF THEM ALL?

martin wolf notes 27sep10

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