the state of the global economy...the state of the global economy lawrence j. lau, ph. d. ralph and...

The State of the Global Economy

Lawrence J. Lau, Ph. D. Ralph and Claire Landau Professor of Economics, The Chinese Univ. of Hong Kong

and Kwoh-Ting Li Professor in Economic Development, Emeritus, Stanford University

Executive Leadership Programme

Institute of Global Economics and Finance The Chinese University of Hong Kong

26th August 2013

Tel: (852)3550-7070; Fax: (852)2104-6938 Email: [email protected]; WebPages: www.igef.cuhk.edu.hk/ljl

*All opinions expressed herein are the author’s own and do not necessarily reflect the views of any of the organisations with which the author is affiliated.

Lawrence J. Lau 2

Outline Introduction Changing Patterns in the Global Economy The Chinese Economy in the Global Context The Near-Term Macroeconomic Outlook of the World

Economy Concluding Remarks

Lawrence J. Lau 3

Introduction The global economy has been in a state of turmoil since the

outbreak of the global financial crisis in 2007, beginning with the sub-prime loan crisis in the United States, and followed by the bankruptcy of Lehman Brothers in September 2008.

And just when the global economy appeared to stabilise in 2009, the European sovereign debt crisis broke out, first in Greece, and then spread to Ireland, Portugal, Italy and Spain. The Euro Zone economies went into a recession and global trade flows declined. It took a couple of years before the Euro Zone economies began to stabilise and confidence in the long-term survival of the Euro as a major international reserve currency was restored.

Lawrence J. Lau 4

Introduction Recovery in the U.S. slowed in part because of the European

sovereign debt crisis, which reduced European demand for U.S. exports, even as the U.S. rate of interest became super-low because of combined effects of flight of capital to safe haven (the U.S.) and the successive waves of “Quantitative Easing (QE)—I, II and III”, launched by the U.S. Federal Reserve Board.

Japan, which has been stagnating since its property price bubble burst in the early 1990s, launched its own version of QE in the form of Abenomics in December 2012.

Throughout this crisis, however, the economies of the BRICS countries (Brazil, Russia, India, China and South Africa) did reasonably well. China, in particular, was able to maintain its average annual real rate of growth above 7.5%.

Lawrence J. Lau 5

Changing Patterns in the Global Economy: The Shifting Centre of Gravity One important reason for the relative resilience of the Chinese

and other East Asian economies is the shift, albeit gradual, of the centre of gravity of the global economy from the developed economies of North America and Europe to the economies of East Asia over the past three decades.

This gradual shift in the centre of gravity of the global economy means that the East Asian economies have been steadily coming into their own and becoming less dependent on the developed economies, enabling a “partial de-coupling” of the East Asian economies from the developed economies of the West.

The fact that the Chinese economy could continue to grow, albeit at a somewhat slower rate, even as the U.S. and European economies went into recession, lends credence to the “Partial De-Coupling Hypothesis”.

However, more recently, the other BRICS and East Asian economies have also begun to slow down because of the expectation of the end of QE on the part of the U.S.

Lawrence J. Lau 6

Changing Patterns in the Global Economy: GDP In 1970, the United States and Western Europe together

accounted for over 60% of World GDP. By comparison, East Asia (defined as the 10 Association of Southeast Asian Nations (ASEAN)--Brunei, Indonesia, Cambodia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam--+ 3 (China, Japan and the Republic of Korea) and South Asia combined accounted for less than 15% of World GDP.

In 1990, the United States and Western Europe together still accounted for over 55% of World GDP while East Asia and South Asia combined accounted for not quite 20% of World GDP.

By 2012, the share of United States and Western Europe in World GDP has declined to approximately 45% whereas the share of East Asia and South Asia have risen to 30%.

Lawrence J. Lau 7 7

The Distribution of World GDP, 1970, US$

United States35.4%

Euro Zone21.5%

Japan7.2%

China3.2%

India2.2%

Brazil1.5%

United Kingdom4.3%

Korea, Rep. of0.3%

Other Economies24.5%

The Distribution of World GDP in 1970, in USD

Lawrence J. Lau 8 8


United States26.1%

Euro Zone25.9%Japan

14.1%China1.6%

Russian Federation2.3%

India1.5%

Brazil2.1%

United Kingdom4.6%

Korea, Rep. of1.2%



Lawrence J. Lau 9 9


United States21.9%

Euro Zone17.0%

Japan8.3%

China11.5%

Russian Federation2.8%

India2.6%

Brazil3.1%

United Kingdom3.4%

Korea, Rep. of1.6%



Lawrence J. Lau 10

Changing Patterns in the Global Economy: GDP The East Asian (defined as the 10 Association of Southeast

Asian Nations (ASEAN) + 3 (China, Japan and the Republic of Korea) share of World GDP rose from just above 10% in 1970 to approximately 25% in 2012.

The Chinese share of World GDP alone rose from 3% in 1970 and only 4% in 2000 to over 11% in 2012.

Lawrence J. Lau 11 11

East Asian (ASEAN+3) Share of World GDP, current prices, 1980-present

14

16

18

20

22

24

26

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Perc

ent

The Shares of East Asiain (ASEAN+3) in World GDP, 1980-present


East Asian Share of World GDP, current prices, 1960-present

10

12

14

16

18

20

22

24

26

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Perc

ent

East Asian Share of World GDP, 1967-present


China’s Share of World GDP, current prices, 1960-present

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

12.0

1960

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Perc

ent

China's GDP as a Percentage of World GDP, 1960-present

Lawrence J. Lau 14

China and East Asia’s Share of World GDP, 1960-present (Current Prices)

0

2

4

6

8

10

12

14

16

18

20

22

24

26

1960

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Perc

ent

China's and East Asia's Share of World GDP, 1960-present

East Asian Economies

Mainland China

Lawrence J. Lau 15

Changing Patterns in the Global Economy: Economic Growth China, India and South Korea are among the fastest growing

economies during the past four decades. Russia has also grown at a very high rate during the past

decade because of its significant oil production and high oil prices.

Brazil has also grown very fast during the past decade because of the world natural resource boom.

However, all the developed economies—the U.S., Euro Zone, Japan, and the U.K.—had relatively low and declining growth rates during the past decades. Even though there are now early signs of a steady economic recovery, the rates of growth have remained low by the historical standards of these economies.


Average Annual Rates of Growth of Real GDP of Selected Economies

-6

-4

-2

0

2

4

6

8

10

12

14

United States Euro Zone Japan China Russian Federation

India Brazil United Kingdom

Korea, Rep. of

Perc

ent

Average Annual Rates of Growth of Real GDP of Selected Economies

1970-1980 1980-1990

1990-2000 2000-2012

Lawrence J. Lau 17

Changing Patterns in the Global Economy: Inflation The rate of global inflation has on the whole declined

significantly over the past few years. Both Brazil and Russia experienced hyper-inflation of the

order of 1,000% a year in the 1990s. Even China had a couple of years of double-digit inflation in the 1990s.

The rate of inflation has come down for both major developed and developing economies in recent years, with the possible exception of India.


The Rate of Inflation in Selected Economies

-500

0

500

1000

1500

2000

2500

3000

3500

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Perc

ent

The Rate of Growth of CPI in Selected Economies

United States Euro ZoneJapan ChinaRussian Federation IndiaBrazil United KingdomKorea, Rep. of


The Rate of Inflation in Selected Economies (without Brazil)

-100

0

100

200

300

400

500

600

700

800

900

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Perc

ent

The Rate of Growth of CPI in Selected Economies (without Brazil)

United States Euro Zone

Japan China

Russian Federation India

United Kingdom Korea, Rep. of


The Rate of Inflation in Selected Economies (without Brazil and Russia)

-10

-5

0

5

10

15

20

25

30

35

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Perc

ent

The Rate of Growth of CPI of Selected Economies (without Brazil and Russia)

United States Euro Zone

Japan China

India United Kingdom

Korea, Rep. of

Lawrence J. Lau 21

Changing Patterns in the Global Economy: International Trade In 1970, the United States and Western Europe together

accounted for over 60% of World trade. By comparison, East Asia and South Asia combined accounted for less than 10% of World trade.

In 1990, the United States and Western Europe together still accounted for approximately 55% of World trade while East Asia and South Asia combined accounted for just over 10% of World trade.

By 2011, the share of United States and Western Europe in World trade has declined to below 45% whereas the share of East Asia and South Asia has risen to 30%.


The Distribution of Total International Trade in Goods and Services, 1970

The Distribution of Total International Trade in Goods and Services in 1970

United States14.9%

Japan5.4%India

0.6%


Korea, Rep. of0.4%

United Kingdom7.0%

Brazil0.8%

China0.6%

Euro Zone32.4%




United States13.5%


Japan7.0%Russian

Federation3.7%

Korea, Rep. of1.7%

United Kingdom5.8%

Brazil0.8%

India0.6% China

1.2%

Euro Zone34.4%



United States10.8%

Euro Zone25.7%

Japan4.2%

China9.7%

Russian Federation

1.6%

India2.3%

Brazil1.4%

United Kingdom3.7%

Korea, Rep. of2.8%



Lawrence J. Lau 25

Changing Patterns in the Global Economy: International Trade The East Asian (defined as the 10 Association of Southeast

Asian Nations (ASEAN) + 3 (China, Japan and the Republic of Korea) share of World trade rose from 9.9% in 1970 to 25.8% in 2012.

The Chinese share of World trade rose from 0.7% in 1970 to 10.7% in 2012.

Chinese international trade accounted for 41.2% of East Asian international trade in 2012.


The Rising Share of East Asian Trade in Total World Trade, 1960-present

0

5

10

15

20

25

30

35

1960

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Perc

ent

The Rising Share of East Asian Trade in Total World Trade, 1960-present

Share of World Exports

Share of World Imports

Share of Total World Trade


The Share of Chinese Trade in Total World Trade, 1950-present

0

1

2

3

4

5

6

7

8

9

10

11

12

1950

19

51

1952

19

53

1954

19

55

1956

19

57

1958

19

59

1960

19

61

1962

19

63

1964

19

65

1966

19

67

1968

19

69

1970

19

71

1972

19

73

1974

19

75

1976

19

77

1978

19

79

1980

19

81

1982

19

83

1984

19

85

1986

19

87

1988

19

89

1990

19

91

1992

19

93

1994

19

95

1996

19

97

1998

19

99

2000

20

01

2002

20

03

2004

20

05

2006

20

07

2008

20

09

2010

20

11

2012

Perc

ent

The Share of Chinese Trade in Total World Trade, 1950-present

The ratio of Chinese Exports to World Exports

The ratio of Chinese Imports to World Imports

The ratio of Chinese Total Trade to World Total Trade

Lawrence J. Lau 28 Lawrence J. Lau, The Chinese University of Hong Kong 28

The Share of Chinese Trade in Total East Asian Trade, 1952-present

0

5

10

15

20

25

30

35

40

45

1952

1953

1954

1955

1956

1957

1958

1959

1960

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Perc

ent

The Share of Chinese Trade in Total East Asian Trade, 1952-present

The Ratio of Chinese Exports to East Asian Exports

The Ratio of Chinese Imports to East Asian Imports

The Ratio of Chinese Total Trade to East Asian Total Trade

Lawrence J. Lau 29

Changing Patterns in the Global Economy: International Trade A particularly interesting development is the rise in intra-

East Asian international trade. The share of East Asian exports destined for East Asia has risen to over 50% in the past decade. This is a sea-change compared to 30 some years ago when most of the East Asian exports were destined for either the United States or Western Europe.

Similarly, the share of East Asian imports originated from East Asia has remained above 45%.


The Share of East Asian Exports Destined for East Asia

35

37

39

41

43

45

47

49

51

53

Jan-

98A

pr-9

8Ju

l-98

Oct

-98

Jan-

99A

pr-9

9Ju

l-99

Oct

-99

Jan-

00A

pr-0

0Ju

l-00

Oct

-00

Jan -

01A

pr-0

1Ju

l-01

Oct

-01

Jan-

02A

pr-0

2Ju

l-02

Oct

-02

Jan-

03A

pr-0

3Ju

l-03

Oct

-03

Jan-

04A

pr-0

4Ju

l-04

Oct

-04

Jan-

05A

pr-0

5Ju

l-05

Oct

-05

Jan-

06A

pr-0

6Ju

l-06

Oct

-06

Jan-

07A

pr-0

7Ju

l-07

Oct

-07

Jan-

08A

pr-0

8Ju

l-08

Oct

-08

Jan-

09A

pr-0

9Ju

l-09

Oct

-09

Jan-

10A

pr-1

0Ju

l-10

Oct

-10

Jan-

11A

pr-1

1Ju

l-11

Oct

-11

Jan-

12A

pr-1

2Ju

l-12

Oct

-12

Jan-

13

%

The Share of East Asian Exports Destined for East Asia

Lawrence J. Lau 31 Lawrence J. Lau, The Chinese University of Hong Kong 31

The Share of East Asian Imports Originated from East Asia

44

46

48

50

52

54

56

58

Jan-

98A

pr-9

8Ju

l-98

Oct

-98

Jan-

99A

pr-9

9Ju

l-99

Oct

-99

Jan-

00A

pr-0

0Ju

l-00

Oct

-00

Jan-

01A

pr-0

1Ju

l-01

Oct

-01

Jan-

02A

pr-0

2Ju

l-02

Oct

-02

Jan-

03A

pr-0

3Ju

l-03

Oct

-03

Jan-

04A

pr-0

4Ju

l-04

Oct

-04

Jan-

05A

pr-0

5Ju

l-05

Oct

-05

Jan-

06A

pr-0

6Ju

l-06

Oct

-06

Jan-

07A

pr-0

7Ju

l-07

Oct

-07

Jan-

08A

pr-0

8Ju

l-08

Oct

-08

Jan-

09A

pr-0

9Ju

l-09

Oct

-09

Jan-

10A

pr-1

0Ju

l-10

Oct

-10

Jan-

11A

pr-1

1Ju

l-11

Oct

-11

Jan-

12A

pr-1

2Ju

l-12

Oct

-12

Jan-

13

%

The Share of East Asian Imports Originated from East Asia

Lawrence J. Lau 32

Changing Patterns in the Global Economy: Growth in International Trade South Korea, and more recently, China, India, Brazil and

Russia, have had the highest rates of growth in international trade.

Growth in Chinese international trade has been particularly rapid during the past decade because of its accession to the World Trade Organisation (WTO) and because of the expiration of the Multi-Fibre Agreement governing world trade in textiles.

India, Russia and Brazil have also had exceptionally high growth in their international trade during the past decade.

However, all the developed economies—the U.S., Euro Zone, Japan, and the U.K.—had relatively low and declining rates of growth of international trade during the past decades.


Average Annual Rate of Growth of Total International Trade in Goods and Services

-5

0

5

10

15

20

United States Euro Zone Japan China Russian Federation

India Brazil United Kingdom

Korea, Rep. of

Perc

ent

Average Annual Rates of Growth of Total Real Trade in Goods and Services, in 2000 USD

1971-1980 1980-1990

1990-2000 2000-2011

Lawrence J. Lau 34

Changing Patterns in the Global Economy: Official Foreign Exchange Reserves The central banks of the East Asian and South Asian

economies combined now hold huge foreign exchange reserves. China leads the pack with foreign exchange reserves of almost US$3.5 trillion as of mid-year 2013, almost all of which has been acquired during the past decade, followed by Japan with US$1.2 trillion.

As of mid-year 2013, the People’s Bank of China, China’s central bank, is now the World’s largest holder of U.S. Treasury securities, with not quite US$1.3 trillion, followed by the Bank of Japan, with almost US$1.1 trillion.


Total Foreign Exchange Reserves minus Gold, Selected Countries and Regions

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

M1 1

985

M7 1

985

M1 1

986

M7 1

986

M1 1

987

M7 1

987

M1 1

988

M7 1

988

M1 1

989

M7 1

989

M1 1

990

M7 1

990

M1 1

991

M7 1

991

M1 1

992

M7 1

992

M1 1

993

M7 1

993

M1 1

994

M7 1

994

M1 1

995

M7 1

995

M1 1

996

M7 1

996

M1 1

997

M7 1

997

M1 1

998

M7 1

998

M1 1

999

M7 1

999

M1 2

000

M7 2

000

M1 2

001

M7 2

001

M1 2

002

M7 2

002

M1 2

003

M7 2

003

M1 2

004

M7 2

004

M1 2

005

M7 2

005

M1 2

006

M7 2

006

M1 2

007

M7 2

007

M1 2

008

M7 2

008

M1 2

009

M7 2

009

M1 2

010

M7 2

010

M1 2

011

M7 2

011

M1 2

012

M7 2

012

M1 2

013

USD

billio

ns

Total Reserves minus Gold of Selected Countries and Regions

China, MainlandJapanRussiaTaiwan Prov. Of ChinaIndia


Major Foreign Central Banks’ Holdings of U.S. Treasury Securities

0

200

400

600

800

1000

1200

1400

Mar

-00

Jun-

00Se

p-00

Dec-0

0M

ar-0

1Ju

n-01

Sep-

01De

c-01

Mar

-02

Jun-

02Se

p-02

Dec-0

2M

ar-0

3Ju

n-03

Sep-

03De

c-03

Mar

-04

Jun-

04Se

p-04

Dec-0

4M

ar-0

5Ju

n-05

Sep-

05De

c-05

Mar

-06

Jun-

06Se

p-06

Dec-0

6M

ar-0

7Ju

n-07

Sep-

07De

c-07

Mar

-08

Jun-

08Se

p-08

Dec-0

8M

ar-0

9Ju

n-09

Sep-

09De

c-09

Mar

-10

Jun-

10Se

p-10

Dec-1

0M

ar-11

Jun-

11Se

p-11

Dec-1

1M

ar-1

2Ju

n-12

Sep-

12De

c-12

Mar

-13

USD

billio

ns

Major Foreign Central Bank's Holders of U.S. Treasury Securities

China, MainlandJapanRussiaUnited KingdomBrazil

Lawrence J. Lau 37

Changing Patterns in the Global Economy: Capital Markets Over the years, the capital markets in East Asian economies

have also grown. At year end 2012, the combined market capitalisation of all East Asian stock exchanges amounted to US$14.2 trillion, behind the market capitalisation of U. S. stock exchanges of US$18.7 trillion but ahead of the market capitalisation of all European stock exchanges combined of US$10.4 trillion.

Again, this is a relatively recent phenomenon. For example, the Chinese stock exchanges at Shanghai and Shenzhen did not even get started until the mid-1990s.


End of Year Market Capitalisation of Selected Stock Exchanges

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

USD

billi

ons

End of Year Market Capitalisation of Selected Stock Exchanges, in USD billions

Hong Kong ExchangesTokyo SEShanghai+Shenzhen SENYSELondon SE

Lawrence J. Lau 39

Market Capitalization of Stock Exchanges Year End 2012 (US$) U.S.A. 18.7 trillion Europe 10.4 trillion East Asia 14.2 trillion

Exchanges:

U.S.A.: NASDAQ and NYSE Europe: Athens Exchange, BME Spanish Exchanges, Budapest

SE, Cyprus SE, Deutsche Borse, Irish SE, London SE group, Luxembourg SE, NYSE Euronext (Europe), Oslo Bors, SIX Swiss Exchange

East Asia: Bursa Malaysia, Hong Kong Exchanges, Indonesia SE, Korea Exchange, Philippine SE, Shanghai SE, Shenzhen SE, Singapore Exchange, Taiwan SE, Thailand SE, Tokyo SE Group

Data source: World Federation of Exchanges

Lawrence J. Lau 40

Changing Patterns in the Global Economy: The Shifting Centre of Gravity The strong performance of the Chinese, Indian and other

East Asian economies except the Japanese during the 2007-2009 global financial crisis and the subsequent European sovereign debt crisis and up through 2012 provided convincing empirical evidence of the “Partial De-Coupling Hypothesis”.

However, the Chinese economy alone is not large enough to turn the World economy around. The idea of a G-2 group of countries consisting of China and the United States leading the World economy is premature.

Lawrence J. Lau 41

The Chinese Economy in the Global Context China has made tremendous progress in its economic

development since it began its economic reform and opened to the World in 1978. China is currently the fastest growing economy in the World, averaging 9.84% per annum over the past 34 years (1978-2012). It is historically unprecedented for an economy to grow at such a high rate over such a long period of time.

Between 1978 and 2012, Chinese real GDP grew almost 24 times, from US$340 billion to US$8.26 trillion (2012 prices) to become the second largest economy in the World, after the U.S.

By comparison, the U.S. GDP (approx. US$15.7 trillion) was slightly less than 2 times Chinese GDP in 2012.

Lawrence J. Lau 42

Real GDP and Its Rate of Growth: A Comparison of China and the U.S. (2012$)

-4

-2

0

2

4

6

8

10

12

14

16

18

-4

-2

0

2

4

6

8

10

12

14

16

18

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

PercentU

SD tr

illio

ns, 2

012

pric

es

Real GDP and Its Rate of Growth: A Comparison of China and the U.S.

Growth Rate of U.S. Real GDP (right scale) Growth Rate of Chinese Real GDP (right scale)

U.S. Real GDP Chinese Real GDP

Lawrence J. Lau 43

The Chinese Economy in the Global Context Despite its rapid growth, in terms of its real GDP per capita,

China is still a developing economy. Between 1978 and 2012, Chinese real GDP per capita grew

17 times, from US$354 to US$6,102 (in 2012 prices), but it is still below the global average per capita GDP of US$10,000.

By comparison, the U.S. GDP per capita of US$49,907 was 8.2 times Chinese GDP per capita in 2012.

Lawrence J. Lau 44

Real Chinese and U.S. GDP per Capita in US$ Since 1952 (2012 Prices)

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

-18

-12

-6

0

6

12

18

24

30

36

42

48

54

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

PercentUS

D th

ousa

nds,

2012

pric

es

Real GDP per Capita and Its Rate of Growth: A Comparison of China and the U.S.

Growth Rate of U.S. Real GDP per Capita (right scale)Growth Rate of Chinese Real GDP per capita (right scale)U.S. Real GDP per CapitaReal GDP per capita of China

Lawrence J. Lau 45

The Chinese Economy in the Global Context While many problems have arisen in the Chinese economy

within the past decade—for example, increasing income disparity (both inter-regional and intra-regional), uneven access to basic education and health care, environmental degradation, inadequate infrastructure and corruption—it is fair to say that every Chinese citizen has benefitted from the economic reform and opening since 1978, albeit to varying degrees, and few want to return to the central planning days.

Lawrence J. Lau 46

The Chinese Economy in the Global Context The Chinese Government leaders have also amply

demonstrated their ability to confront important challenges and solve difficult problems over the past 34 years, surviving various economic and financial crises such as the 1997-1998 East Asian currency crisis, the 2007-2009 global financial crisis, the European sovereign debt crisis and more recently the anticipated tapering and winding down of QE3.

China is one of the very few socialist countries that have managed to make a smooth transition from a centrally planned to a market economy without a massive decline in real GDP. It is a model for other transition economies such as Vietnam and potential transition economies such as Cuba, Laos, and North Korea.

47

The Chinese Economy in the Global Context The emergence of the Chinese economy on the global scene is

probably the single most important development in the World economy during the past three decades.

China has become not only the World’s factory, but also has lately become the World’s most important growth market, especially since Chinese economic growth has been gradually transitioning from export-driven to domestic-demand driven.

The Chinese economy and its huge domestic demands are largely responsible for the partial de-coupling of the East Asian economies from North American and European economies.

Finally, the internationalisation of the Renminbi and its resultant rising use in the clearing and settlement of international transactions will offer more options to exporters, importers, direct investors and long-term portfolio investors. Such a development will have a long-term impact on the international monetary system.

Lawrence J. Lau 48

The Near-Term Macroeconomic Outlook of the World Economy The economic weakness in both the United States and the Euro

Zone has reduced economic growth rates around the World, including those of China and India.

The macroeconomic outlook of the World economy has turned slightly positive as the U.S. economy has continued to grow, albeit at relatively low rates. It has had positive rates of growth, year-over-year, for almost 50 consecutive months.

Even the Euro Zone economies have turned around to show a small positive growth recently, as the Euro managed to survive as a major international reserve currency and the sovereign debt crisis began to be resolved gradually.

Lawrence J. Lau 49

The Near-Term Macroeconomic Outlook of the World Economy The rates of unemployment have continued to be high for both the

U.S. (7.4%) and the Euro Zone (12.1%) and are unlikely to decline significantly in the near term.

Much of the recent decline of the unemployment rate in the U.S. may be attributed to discouraged workers withdrawing from the labour force. The unemployment rate is equal to (the number of job-seekers – employment) divided by the number of job-seekers and is in turn equal to 1 – employment/number of job-seekers. A decline in the number of job-seekers increases the employment/number of job-seekers ratio and hence decreases the unemployment rate.

Fortunately, the rates of inflation have remained relatively subdued in the developed economies and in China, where the rate of inflation has begun to come down significantly.


The Rates of Growth of Real GDP of China, U.S. and the Euro Zone

-5

0

5

10

15

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Perc

ent

The Rates of Growth of Real GDP of China, U.S. and the Euro Zone

China U.S. Euro Area


The Rates of Unemployment of China, U.S. and the Euro Zone

-1

1

3

5

7

9

11

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Perc

ent

The Rates of Unemployment of China, U.S. and the Eurozone

China

U.S.

Euro Area


The Rates of Inflation of China, U.S. and the Euro Zone

-2

-1

0

1

2

3

4

5

6

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Perc

ent

The Rates of Inflation of China, U.S. and the Euro Zone

China U.S. Euro Area

Lawrence J. Lau 53

The Near-Term Macroeconomic Outlook of the World Economy The slow growth of the World economies has reduced

aggregate demand and especially consumption in the developed economies and hence their demand for imports. In addition, their relative economic stagnation has also encouraged protectionist sentiments. Under these circumstances, inevitably, the real rate of growth of world trade, especially world trade in goods, has also declined significantly.


Nominal and Real Rates of Growth of World Trade in Goods and Services

-22 -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 6 8

10 12 14 16 18 20 22

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Perc

ent

Rates of Growth of Nominal and Real World Trade in Goods and Services

Real Growth Rates of World Trade in Goods and Services

Nominal Growth Rates of World Trade in Goods and Services


Nominal and Real Rates of Growth of World Trade in Goods

-24 -22 -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 6 8

10 12 14 16 18 20 22 24

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012Perc

ent

Rates of Growth of Nominal and Real World Trade in Goods

Real Growth Rates of World Trade in Goods

Nominal Growth Rates of World Trade in Goods

Lawrence J. Lau 56

The Near-Term Macroeconomic Outlook: The U.S. Economy Economic recovery in the U.S. has remained slow, despite

all the quantitative easing, affected internally by the failure to achieve a consensus on the government budget and externally by the European sovereign debt crisis and the resulting recession in the Euro Zone economies. It also appears likely that QE3 will come to an end by year-end 2013.

The unemployment rate has stayed stubbornly high, above 7.4%, and is unlikely to fall significantly in the near term.

The effectiveness of an easy monetary policy is in serious doubt. In fact, the real rate of interest, the difference between the nominal rate of interest and the rate of inflation (measured by the consumer price index (CPI)), has been negative since November 2009 (see the following Charts). The U.S. economy is in a classical “liquidity trap” situation.


Seasonally Adjusted Annualised Quarterly Rates of Growth of Real GDP of the U.S.

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

8

Q1 1

990

Q3 1

990

Q1 1

991

Q3 1

991

Q1 1

992

Q3 1

992

Q1 1

993

Q3 1

993

Q1 1

994

Q3 1

994

Q1 1

995

Q3 1

995

Q1 1

996

Q3 1

996

Q1 1

997

Q3 1

997

Q1 1

998

Q3 1

998

Q1 1

999

Q3 1

999

Q1 2

000

Q3 2

000

Q1 2

001

Q3 2

001

Q1 2

002

Q3 2

002

Q1 2

003

Q3 2

003

Q1 2

004

Q3 2

004

Q1 2

005

Q3 2

005

Q1 2

006

Q3 2

006

Q1 2

007

Q3 2

007

Q1 2

008

Q3 2

008

Q1 2

009

Q3 2

009

Q1 2

010

Q3 2

010

Q1 2

011

Q3 2

011

Q1 2

012

Q3 2

012

Q1 2

013

Perc

ent p

er a

nnum

Seasonally Adjusted Annualized Quarterly Rates of Growth of Real GDP of the U.S.


The Rates of Change of CPI, Interest, & Unemployment, & Index of Euro/US$ Exchange Rate

80

85

90

95

100

105

110

-2

-1

0

1

2

3

4

5

6

7

8

9

10

11

Jan-

2007

Apr

-200

7

Jul-2

007

Oct

-200

7

Jan-

2008

Apr

-200

8

Jul-2

008

Oct

-200

8

Jan-

2009

Apr

-200

9

Jul-2

009

Oct

-200

9

Jan-

2010

Apr

-201

0

Jul-2

010

Oct

-201

0

Jan-

2011

Apr

-201

1

Jul-2

011

Oct

-201

1

Jan-

2012

Apr

-201

2

Jul-2

012

Oct

-201

2

Jan-

2013

Apr

-201

3

Jul-2

013

2007

M1=

100

Perc

ent

The Rates of Change of U.S. CPI, Interest, and Unemployment,and Index of Euro/US$ Exchange Rate

The Rate of Change of CPI

The Rate of Interest (1-year U.S. Treasury)

Unemployment Rate

Euro/USD, 2007M1=100 (right scale)

Lawrence J. Lau 59

The Near-Term Macroeconomic Outlook: The U.S. Economy As is well known, one can pull on a string but not push on a

string. Further lowering of the rate of interest and release of liquidity in the U.S. has not increased and is unlikely to increase domestic investment significantly.

Despite the announcement by the Federal Reserve Board that interest rate would be kept low until 2015 and that as long as unemployment rate is above 6.5% (subsequently raised to 7%) and the inflation rate is below 2.5%, the long-term rate of interest, which is what is really relevant for new investment, has already begun to rise.

While the unemployment rate is unlikely to fall below 6.5% by the end of 2013, the core rate of inflation, which is currently running at approximately 2% per annum, can easily and quickly rise to 2.5%.

Lawrence J. Lau 60

The Near-Term Macroeconomic Outlook: The U.S. Economy However, it does appear that the recovery is solid and real,

and that with the resolution of the European sovereign debt crisis, the U.S. economy should be able to embark on a renewed path of steady, albeit relatively slow, growth.


Seasonally Adjusted Monthly Rates of Unemployment in the U.S.

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

Jan-

94Ju

l-94

Jan-

95Ju

l-95

Jan-

96Ju

l-96

Jan-

97Ju

l-97

Jan-

98Ju

l-98

Jan-

99Ju

l-99

Jan-

00Ju

l-00

Jan-

01Ju

l-01

Jan-

02Ju

l-02

Jan-

03Ju

l-03

Jan-

04Ju

l -04

Jan-

05Ju

l-05

Jan-

06Ju

l-06

Jan-

07Ju

l-07

Jan-

08Ju

l-08

Jan-

09Ju

l-09

Jan-

10Ju

l-10

Jan-

11Ju

l-11

Jan-

12Ju

l-12

Jan-

13Ju

l-13

Perc

ent




2.02.53.03.54.04.55.05.56.06.57.07.58.08.59.09.5

10.010.511.011.5

Jan-

1948

Jan-

1949

Jan-

1950

Jan-

1951

Jan-

1952

Jan-

1953

Jan-

1954

Jan-

1955

Jan-

1956

Jan-

1957

Jan-

1958

Jan-

1959

Jan-

1960

Jan-

1961

Jan-

1962

Jan-

1963

Jan-

1964

Jan-

1965

Jan-

1966

Jan-

1967

Jan-

1968

Jan-

1969

Jan-

1970

Jan-

1971

Jan-

1972

Jan-

1973

Jan-

1974

Jan-

1975

Jan-

1976

Jan-

1977

Jan-

1978

Jan-

1979

Jan-

1980

Jan-

1981

Jan-

1982

Jan-

1983

Jan-

1984

Jan-

1985

Jan-

1986

Jan-

1987

Jan-

1988

Jan-

1989

Jan-

1990

Jan-

1991

Jan-

1992

Jan-

1993

Jan-

1994

Jan-

1995

Jan-

1996

Jan-

1997

Jan-

1998

Jan-

1999

Jan-

2000

Jan-

2001

Jan-

2002

Jan-

2003

Jan-

2004

Jan-

2005

Jan-

2006

Jan-

2007

Jan-

2008

Jan-

2009

Jan-

2010

Jan-

2011

Jan-

2012

Jan-

2013

Perc

ent


Lawrence J. Lau 63

The Near-Term Macroeconomic Outlook: The U.S. Economy One problem face by the U.S. economy is that expectations can be

self-fulfilling in the absence of any clear signal of change. If firms and households expect the economy to do terribly and act accordingly by reducing investment and consumption respectively, the economy will indeed turn out to be terrible, fulfilling their expectations.

This may lead them to expect a further worsening of the economy, and act accordingly, resulting in an even further decline of the economy, creating a self-perpetuating downward spiral in which negative expectations lead to declines and declines feed into even more negative expectations.

This has been, unfortunately, the story of the Japanese economy since its property price bubble burst in 1990. In order for expectations to change, there must be some concrete action or development that can act as a signal to the firms and households that the economy will be improving soon. For the U.S., the rapid development of the shale gas and oil industry may have such an impact on the economy.

Lawrence J. Lau 64

The Near-Term Macroeconomic Outlook: The U.S. Economy The World economy has already experienced “Quantitative

Easing I (QE-I)”, “Quantitative Easing II (QE-II)”, and “Quantitative Easing III (QE-III)” operations by the U.S. Federal Reserve Board. However, almost five years later, these operations did not seem to have improved the U.S. real economy significantly. Much of the excess liquidity generated went overseas, driving up exchange rates and asset prices elsewhere. If the U.S. had some form of capital control, so that the excess liquidity had to be kept and used within the U.S., it might perhaps have driven up some U.S. asset prices and led to some additional domestic investment. However, that has not been the case.

Lawrence J. Lau 65

The Near-Term Macroeconomic Outlook: The U.S. Economy At this point, only an expansion of real aggregate demand

can serve as an effective signal for a change in expectations. However, it does not appear likely that the U.S. Congress will authorise a fiscal expansion, even though that is exactly what is needed.

There is ample excess capacity in the U.S. economy, especially in the construction sector and the building materials sector. What the U.S. Government should undertake is an expansion in capital expenditures focused on public infrastructure on the one hand and a reduction in recurrent expenditures to match recurrent revenue on the other. It should be supporting growth and at the same time imposing austerity in terms of balancing recurrent revenue and recurrent expenditure in the medium term.

Lawrence J. Lau 66

The Near-Term Macroeconomic Outlook: The U.S. Economy What have the QEs accomplished for the U.S. economy? First of all, the QEs have prevented the financial system in

the U.S. from collapsing totally. The major banks and insurance companies have managed to survive, with government assistance. The QEs have released sufficient liquidity and have taken the bulk of the mortgage-backed securities off the balance sheet of the banks.

A total collapse of the U.S. financial system would have led to a situation much worse than that experienced during the Great Depression of the 1930s not only for the U.S. but for the entire World economy.

Lawrence J. Lau 67

The Near-Term Macroeconomic Outlook: The U.S. Economy Second, the QEs have enabled the U.S. Dollar to devalue

significantly with respect to almost all of the major currencies in the World, with the possible exception of the Euro. This has helped increase U.S. exports and decrease U.S. imports, other things being equal. (As the U.S. is ideologically incapable of intervening directly in foreign exchange markets, the QEs are one of the very few feasible options for engineering a devaluation. “Jawboning” is another feasible, but probably less effective, option.)

Japan, as part of its Abenomics initiatives, has countered with its own QE in December2012, and reversed the appreciation of the Japanese Yen vis-a-vis the U.S. Dollar.

Moreover, in anticipation of the tapering and possible termination of the QEs, the exchange rates of many currencies have already begun to devalue with respect to the U.S. Dollar since May 2013.

Lawrence J. Lau 68

The Near-Term Macroeconomic Outlook: The U.S. Economy Third, the QEs have enabled the U.S. long-term rate of

interest to decline significantly and remain low until May 2013. The low long-term interest rate is meant to encourage domestic U.S. investment.

The exceptionally low long-term interest rate has driven up the prices of securities and real assets, including housing. As a result, the housing market has shown signs of a revival, but with prices still significantly below its peak in 2006. The prices of financial assets—stocks and bonds—may have to undergo a significant adjustment as the long-term interest rate rises when the QE is finally terminated.

Lawrence J. Lau 69

The Near-Term Macroeconomic Outlook: The U.S. Economy Apart from the above, the QEs have not had much direct

effect on the real economy. The low long-term interest rate does not seem to have induced many U.S. firms or federal or state governments to increase their domestic investments, which is the key to creating jobs. Hence it has not had a direct impact on U.S. aggregate demand or economic growth.

70

U.S. Federal Funds Rate, the 10-Year U.S. Treasury Rate, and Unemployment Rate

0

2

4

6

8

10

12

2007

-01-

0220

07-0

2-02

2007

-03-

0220

07-0

4-02

2007

-05-

0220

07-0

6-02

2007

-07-

0220

07-0

8-02

2007

-09-

0220

07-1

0-02

2007

-11-

0220

07-1

2-02

2008

-01-

0220

08-0

2-02

2008

-03-

0220

08-0

4-02

2008

-05-

0220

08-0

6-02

2008

-07-

0220

08-0

8-02

2008

-09-

0220

08-1

0-02

2008

-11-

0220

08-1

2-02

2009

-01-

0220

09-0

2-02

2009

-03-

0220

09-0

4-02

2009

-05-

0220

09-0

6-02

2009

-07-

0220

09-0

8-02

2009

-09-

0220

09-1

0-02

2009

-11-

0220

09-1

2-02

2010

-01-

0220

10-0

2-02

2010

-03-

0220

10-0

4-02

2010

-05-

0220

10-0

6-02

2010

-07 -

0220

10-0

8-02

2010

-09-

0220

10-1

0-02

2010

-11-

0220

10-1

2 -02

2011

-01-

0220

11- 0

2-02

2011

-03-

0220

11-0

4-02

2011

-05 -

0220

11-0

6-02

2011

-07-

0220

11-0

8-02

2011

-09-

0220

11-1

0 -02

2011

-11-

0220

11-1

2-02

2012

-01-

0220

12-0

2-02

2012

-03-

0220

12-0

4-02

2012

-05-

0220

12-0

6-02

2012

-07-

0220

12-0

8-02

2012

-09-

0220

12-1

0-02

2012

-11-

0220

12-1

2-02

2013

-01-

0220

13-0

2-02

2013

-03-

0220

13-0

4-02

2013

-05 -

0220

13-0

6-02

2013

-07-

0220

13-0

8-02

U.S. Federal Funds Rate, the 10-year U.S. Treasury Rate, and Unemployment Rate

Federal Funds Effective Rate

The 10-year U.S. Treasury Rate

Unemployment Rate: sa

71

Exchange Rate Index of Selected Economies since QEI (11/25/2008=100)

50

60

70

80

90

100

110

2008

-11-

2520

08-1

2-25

2009

-01-

2520

09-0

2-25

2009

-03-

2520

09-0

4-25

2009

-05-

2520

09-0

6-25

2009

-07-

2520

09-0

8-25

2009

-09 -

2520

09-1

0-25

2009

-11-

2520

09-1

2-25

2010

-01-

2520

10-0

2-25

2010

-03-

2520

10-0

4-25

2010

-05-

2520

10-0

6-25

2010

-07-

2520

10-0

8-25

2010

-09-

2520

10-1

0-25

2010

-11-

2520

10-1

2-25

2011

-01-

2520

11-0

2-25

2011

-03-

2520

11-0

4-25

2011

-05-

2520

11-0

6-25

2011

-07-

2520

11-0

8-25

2011

-09-

2520

11-1

0-25

2011

-11-

2520

11-1

2-25

2012

-01-

2520

12-0

2-25

2012

-03-

2520

12-0

4-25

2012

-05-

2520

12-0

6-25

2012

-07-

2520

12-0

8-25

2012

-09-

2520

12-1

0-25

2012

-11-

2520

12- 1

2-25

2013

-01-

2520

13-0

2-25

2013

-03-

2520

13-0

4-25

2013

-05-

2520

13-0

6-25

2013

-07-

25

Exchange Rate Index of Selected Economies (11/25/2008=100)

RMB

Euro

Japanese Yen

Australian Dollar

72

Exchange Rate Index of Selected Economies since QEI (11/25/2008=100)

60

70

80

90

100

110

120

130

2008

-11-

2520

08-1

2-25

2009

-01-

2520

09-0

2-25

2009

-03-

2520

09-0

4-25

2009

-05-

2520

09-0

6-25

2009

-07-

2520

09-0

8-25

2009

-09-

2520

09-1

0-25

2009

-11-

2520

09-1

2-25

2010

-01-

2520

10-0

2-25

2010

-03-

2520

10-0

4-25

2010

-05-

2520

10-0

6-25

2010

-07-

2520

10-0

8-25

2010

-09-

2520

10-1

0-25

2010

-11-

2520

10-1

2-25

2011

-01-

2520

11-0

2-25

2011

-03-

2520

11-0

4-25

2011

-05-

2520

11-0

6-25

2011

-07-

2520

11-0

8-25

2011

-09-

2520

11-1

0-25

2011

-11-

2520

11-1

2-25

2012

-01-

2520

12-0

2-25

2012

-03-

2520

12-0

4-25

2012

-05-

2520

12-0

6-25

2012

-07-

2520

12-0

8-25

2012

-09-

2520

12-1

0-25

2012

-11-

2520

12-1

2-25

2013

-01-

2520

13-0

2-25

2013

-03-

2520

13-0

4-25

2013

-05-

2520

13-0

6-25

2013

-07-

25

Exchange Rate Index of Selected Economies (11/25/2008=100)

RMB Korean WonNew Taiwan Dollar Indonesian RupiahMalaysian Ringgit Philippines PesoSingapore Dollar Thai BahtVietnamese Dong


The Exchange Rate Revaluations/Devaluations During QEI-III

The Exchange Rate Revaluation/devaluation during QE1 11/25/2008-8/23/2013

Currency 11/25/2008 8/23/2013 Revaluation/devaluation

against USD RMB 6.8245 6.1205 10.32% Euro 0.76748 0.74675 2.70% Japanese Yen 95.532 98.547 -3.16% Australian Dollar 1.54135 1.1066 28.21% Korean Won 1501.72 1113.9 25.83% New Taiwan Dollar 33.349 29.906 10.32% Indonesian Rupiah 12209 10729.6 12.12% Malaysian Ringgit 3.6207 3.3014 8.82% Philippines Peso 49.409 44.144 10.66% Singapore Dollar 1.5108 1.2795 15.31% Thai Baht 35.205 31.893 9.41% Vietnamese Dong 16957 21030 -24.02% Indian Rupee 49.894 63.229 -26.73%

Lawrence J. Lau 74

The Near-Term Macroeconomic Outlook: The Euro Zone Economies The Euro Zone economies, including Germany, fell into

recession as the European sovereign debt crisis was allowed to fester and spread to other Euro Zone economies from Greece.

What is needed is some resolute action to reassure the World that the Euro Zone economies will do whatever it takes for the Euro to survive as a major international reserve currency. It does appear that the Euro Zone Governments have managed to convince the market that this is indeed the case. The Euro has finally begun to stabilise and the interest-rate spreads among Euro Zone economies have begun to narrow significantly.

Lawrence J. Lau 75

The Near-Term Macroeconomic Outlook: The Euro Zone Economies Stable relative exchange rates among economies can and do

enhance the international trade and investment flows among them significantly, much more so than a free trade area or a common market among them.

The introduction of the Euro as a single currency for countries in the Euro Zone is a good example—intra-Euro Zone trade tripled to approximately 3 trillion Euro (or US$4 trillion) after the introduction of the Euro in the late 1990s even though there had been no tariffs among the major countries in the Euro Zone since the 1960s.

The benefits to the major Euro Zone economies such as France and Germany of maintaining the Euro far exceed the costs of doing so.


Intra-Euro Zone Trade, Billions Euro, Pre-and Post the Introduction of the Euro

0

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billi

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Intra-Euro Zone Trade, Billions Euro, Pre-and Post the Introduction of the Euro

Intra-Euro Zone Total Trade

Intra-Euro Zone Exports

Intra-Euro Zone Imports

Lawrence J. Lau 77

What Caused the European Sovereign Debt Crisis? The source of the European sovereign debt crisis is the

accumulation of public debt by a Euro Zone country, incurred to support a continuing series of government budget deficits, to a level that is beyond the servicing capacity of the individual country.

Moreover, it is important to make a distinction between internal debt and external debt. Internal debt is debt owed by a country to its own citizens and firms. External debt is debt owed by a country to non-nationals. Debt repayments to a country’s own citizens and firms stay in the country, not so debt repayments to non-nationals.

Lawrence J. Lau 78

What Caused the European Sovereign Debt Crisis? If the public debt is mostly internal, as in Japan, where despite a

public debt to GDP ratio of almost 250%, only 5% of the public debt is held by non-nationals, the problem is manageable.

Internal debt is a little like debt within the same family. The son borrows from the father. When the father demands repayment from the son, the son goes to the mother and asks for money to repay the father. The mother asks the father for money. Father gives money to mother, mother gives money to son, and son repays the father. This completes the circle. This arrangement can continue more or less indefinitely, especially if the rate of interest is low, as long as the money stays within the family.

However, if the debt is external to the family, this recycling breaks down. Debt repayment then becomes a real burden for the family.

Lawrence J. Lau 79

What Caused the European Sovereign Debt Crisis? As long as the public debt is internal to a country, the

government can issue new debt to its citizens and firms and repay the old debt with the proceeds from the new debt. This process can continue indefinitely if the domestic citizens and firms have confidence in the government’s ability to repay, and especially if the nominal interest rate is low. (The government can also increase taxes and repay the old debt with the additional taxes collected.)

However, this process breaks down if the debt is held externally, by non-nationals. In this case, net real resources must flow out of the country in order to repay the debt. And when a country fails to repay the debt, it is in default.

Lawrence J. Lau 80

What Caused the European Sovereign Debt Crisis? Unfortunately, in the case of Greece, much of the debt is external.

The situation is therefore not sustainable. The other option of solving the problem through printing more money

is also not available to Greece, because it does not have the authority to issue Euros (unlike the United States and Japan, which can increase the supply of U.S. Dollars and Japanese Yen respectively at will).

The solution for Greece is therefore limited to severe austerity or outright default (which implies exit from the Euro Zone).

It does not help that there are many speculators speculating on an eventual Greek default. The indiscriminate sale of credit default swaps (CDSs) on Greek debt, and for that matter on the debts of other member countries of the Euro Zone, to speculators who do not own the underlying bonds, exacerbated an already bad situation.

Lawrence J. Lau 81

What Caused the European Sovereign Debt Crisis? Fiscal contraction at a time of recession feeds negative

expectations about the future. It is better to have a short-term fiscal expansion in capital expenditures (but not recurrent expenditures) to promote the resumption of growth, coupled with a longer-term plan for achieving fiscal balance between recurrent expenditures and recurrent revenues in the long run.

Lawrence J. Lau 82

The Near-Term Macroeconomic Outlook: The Euro Zone Economies The Greek economy accounts for only 2% of the Euro Zone

GDP. It is almost immaterial to the Euro Zone if Greece exits from the Euro Zone. And some Euro Zone countries may even welcome it.

However, the costs to Greece will be much greater leaving the Euro Zone than staying. By leaving the Euro Zone, Greece will have to bring back its own currency, the drachma, which is certain to devalue sharply with respect to the Euro, resulting in a high rate of inflation in Greece for a while, even though it may promote some exports. Moreover, the problem of insufficient government revenue, whether in Euro or in drachma, will persist, necessitating a severe austerity programme either way. Thus, the painful adjustment by the government cannot be avoided.


The Distribution of the GDP of Euro Zone in 2012

Austria3.3%

Belgium4.0%

Cyprus0.2%

Finland2.0%

France21.4%

Germany27.9%

Greece2.0%

Ireland1.7%

Italy16.5%

Luxembourg0.5%

Malta0.1%

Netherlands6.3%

Portugal1.7%

Slovak Republic0.8%

Slovenia0.4%

Spain11.1%

Estonia0.2%

The Distribution of the GDP of Euro Zone in 2012, in Euro billions

Lawrence J. Lau 84

The Near-Term Macroeconomic Outlook: The Euro Zone Economies What Greece should do is to reduce its recurrent

government expenditures significantly to match its recurrent revenue based on actual collections, but at the same time undertake some capital projects, possibly with the support of other Euro Zone economies such as France and Germany, so as to maintain some economic growth and prevent unemployment from becoming too high. It must promote growth and impose austerity at the same time.

Lawrence J. Lau 85

The Near-Term Macroeconomic Outlook: World Bank Global Economic Prospects The World Bank, in its Global Economic Prospects report

published in June 2013, has forecast that the Global GDP, which grew 2.3% in 2012, will grow at 2.2% (down from the original forecast of 2.4%) in 2013, 3.0% (down from 3.1%) in 2014 and 3.3% in 2015. So there should be steady improvement in the World economy over time.

The developed economies are forecast to grow a modest 1.2% in 2013, strengthening to 2.0% in 2014 and 2.3% in 2015, whereas the developing economies are forecast to grow at 5.1% in 2013, the same as in 2012, strengthening to 5.6 % and 5.7 % (down from 5.8%) in 2014 and 2015, respectively.

China is forecast to grow 7.7% in 2013, strengthening to 8.0 and 7.9 % in 2014 and 2015 respectively.

Lawrence J. Lau 86

Concluding Remarks The centre of gravity of the World economy is gradually

shifting to Asia (East Asia and South Asia) from North America and Europe. The shift is still on-going.

Despite the shift, China is still very much a developing economy in per capita terms.

If current trends continue, it will probably take 15 years or so for Chinese real GDP to catch up to the level of the United States real GDP. In the meantime, the U.S. economy will still be the largest in the World.

It will take another 30 years, until around 2060, for China to reach the same level of real GDP per capita as the United States (bear in mind that in the meantime, the U.S. economy will also continue to grow, albeit at rates significantly lower than those of the Chinese economy and that the Chinese population is likely to reach a plateau in 2045).

87

Concluding Remarks The partial de-coupling of East Asia is likely to accelerate

the integration of the East Asian economies themselves as well as other multilateral initiatives such as the ASEAN Free Trade Area (+3—China, Japan and Korea, +6—Australia, New Zealand and the U.S.), Regional Comprehensive Economic Partnership (RCEP—ASEAN + 3 + Australia, New Zealand and India), and the Chiangmai Initiative.

Lawrence J. Lau 88

Concluding Remarks The energy markets of the World, going forward, should

shift in favour of consumers rather than producers as the anticipated additional supplies of unconventional sources of energy, including shale oil and gas, materialise, especially from the U.S.

However, the possibility of another global financial crisis cannot be ruled out. Despite the implementation of the Basel III rules for the regulation of banks and the passage of the Dodd-Frank Act in the U.S., the regulation and supervision of financial institutions in the developed economies remain weak and can be further watered down by lobbyists for the financial institutions.

Lawrence J. Lau 89

Concluding Remarks The long-term outlook for the U.S. economy is, however,

quite positive. The innovative capacity of the U.S. economy is unmatched in the World—think of the internet, the micro-processor, the I-phone and the I-pad. The U.S. is also likely to become a net energy exporter within the next decade, taking advantage of its huge reserves of shale gas and oil and advanced hydraulic fracturing technology.

It is in the interests of the Euro Zone authorities to step in decisively and forcefully as necessary to maintain confidence in the Euro and Euro Zone debt. Confidence, once lost, is extremely difficult and costly to restore.

90

Concluding Remarks Gong forward, Chinese economic growth will be driven by

the growth of its own internal demand, consisting of both investment and consumption, rather than the growth of exports, and in time by innovation and technical progress in addition to growth in tangible inputs.

China has also been gradually changing from its role as the World’s factory to the World’s new growth market. It is already the World’s largest exporting country and is on its way to becoming the largest importing country in a couple of years.

The Chinese trade surplus vis-a-vis the World has been declining and will continue to decline until Chinese international trade is approximately balanced.

91

Concluding Remarks The Renminbi has since 2009 been used in the clearing and

settlement of Chinese international transactions. Currently, 16% of Chinese international trade (approximately US$330 billion) is settled in Renminbi. The use of the Renminbi for international settlement will continue to increase, especially in East Asia. The is a natural development, as settlement in own currencies reduces both transactions costs and exchange rate risks.

The Renminbi has been current accounts convertible since 1994. It is likely to become capital accounts convertible within the next five years, perhaps with the imposition of a Tobin-like fee on conversion into and out of Renminbi to discourage short-term round-trip capital flows.

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