Global: Exporting the US Miracle
John Montgomery (New York)
The preliminary 2Q00 US national income data that were released last week represented another in a stream of remarkable US growth data. As my colleague Steve Roach has observed, the news has caused MSDW’s global economics team to ratchet up its projection of global growth another 0.1 percentage point to 4.8%. While certain aspects showed weakness, the overall report showed surprisingly strong growth coupled with subdued inflation. The report adds more grist for the mill of the ongoing debate about the contribution of new technologies to the superior performance of the US economy. The fundamental question is the degree to which the US growth story is driven by supply-side factors, particularly the productivity of computers, computer production, and networks, against the extent to which this a normal demand-driven boom that requires more contractionary demand-side policies (e.g., continued Fed tightening). My colleagues Steve Roach and Dick Berner have both written extensively on this subject.
This is an unresolved debate and is not likely to be resolved in the near future. However, I think it is fair to say that the weight of consensus is now that the supply side has contributed to at least part of this boom. A couple of recent academic studies have buttressed this view. Two economists at the Federal Reserve Board (Oliner and Sichel) recently issued a widely noticed study that concluded that the use of information technology -- and the production of computers -- contributed about 0.7 percentage point to the recent acceleration of US labor productivity. More general network effects do not appear to have a significant role, according to their estimates. Another recent study (Jorgenson and Stiroh) has documented an acceleration of total factor productivity and some tentative suggestion of the reach of this growth outside of the IT sector. They stress, however, the crucial importance of productivity gains within the IT sector.
Let’s turn from the US to the global economy. The OECD tackled this issue in its most recent Economic Outlook. International growth comparisons are difficult, and fraught with data inconsistencies. However, the OECD estimates suggest an improvement in productivity trends in Canada as well as the US. Among smaller economies, Australia, Denmark, Finland, New Zealand, and Sweden also show acceleration in productivity. However, this work is not detailed enough to allow us to determine the source of this productivity acceleration. Some other countries, including France and Italy, show a deceleration.
None of this evidence is clear cut, but here is a central scenario: Suppose the US productivity miracle is real and that it is at least in part due to the adoption of new IT technologies throughout the economy. The evidence on productivity -- as well as the analysis of MSDW’s global economics team in its special report "The Globalization of the Information Age" back in February -- suggests that most other countries (including Japan and most of Euroland) are in general well behind the US in the adoption of IT technologies. Then it seems only a matter of time before other countries begin to work intensively to adopt the same technologies. The process might be taking longer because competitive pressures are less intense, or because corporate governance is weaker, or because financial markets are not as efficient in financing new investment. I suspect it’s a combination of all three of these factors.
How might this affect global capital flows? If one looks at the data, it is apparent that demand for financing in the US is far outstripping the domestic supply of financing. That is why the United States is running a record current account deficit -- and consequently record quantities of international financing -- even while the government is running a budget surplus. The strong performance of the US economy creates the returns that attract this investment, be it through direct investment (including M&A) or portfolio channels.
It seems inevitable that the US boom in capital spending will spread around the world, or at least to other developed economies where the benefits to technology should be roughly similar. What that implies, especially for industries that compete internationally, is a surge in the need for external financing to finance this spending. That means an increasing competition for global financing. The direction of pressure on global real interest rates should be up as firms borrow. There could be two offsetting real exchange rate effects. As financial returns in non-US countries rise, real exchange rates may rise relative to the dollar. But second, as the US exports its IT expertise, goods and service exports could rise, pushing up the dollar. As Dick notes, US capital goods exports are already showing double-digit growth. Clearer winners should be the currencies of Asian economies with stronger positions in the IT production chain; another of my colleagues, Stephen Jen, has done detailed work on this subject. I am stressing that these effects are real, not nominal. Monetary expansion and inflation still have the capacity to drive nominal interest rates and exchange rates. (Steve Roach argues that global capacity constraints are likely to bind by mid-2001 and push up global inflation.)
If my central-case scenario comes anywhere close to panning out over the next five years, it will be an exciting time to live through. But mounting demand for financing and rising yields are likely to mean that aggregate asset markets will not perform as well as they have in recent years. There are likely to continue to be very big winners, both in tech and elsewhere, as well as a lot of losers. The gains to investors who can successfully pick the winners will be high. Are these new ideas? No, but the key point is that the increasing evidence of gains in US productivity means that international effects are likely to follow before long.
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Japan: BOJ Deputy Governor Yamaguchi Retreats
Takehiro Sato(Tokyo)
Speech edges away from ZIRP termination
Deputy governor Yutaka Yamaguchi’s speech at the National Press Club on August 4 toned down prospects for early termination of ZIRP (zero interest rate policy), especially when compared with his remarks of June 19, at JIJI Press, that "the tide is coming in." In particular, the deputy governor noted that "the majority of the Board would like to confirm with more confidence that such a mechanism is at work," regarding the virtuous cycle of income and consumption. He also noted that, "At the moment, we need to closely monitor whether there is the risk that the market may suddenly turn nervous, and this is, in my view, one of the factors that should be rightly taken into account in the conduct of monetary policy." Monetary policy actions would take into account the market concerns generated by the bankruptcy of Sogo. Deputy governor Yamaguchi’s view of ZIRP side effects also seems to differ from that of governor Masaru Hayami, who evidently wants early termination. In conclusion, this speech strengthens our view that early termination is unlikely. We maintain our view that the chances of ZIRP being terminated in August or September at still less than 50%.
Cautious outlook on personal consumption.
Regarding consumption, the deputy governor commented that "we cannot yet confirm a recovery of private consumption as a whole." He also expressed a more cautious stance than anticipated about the consumption outlook when he noted that "restructuring of the corporate sector is a prerequisite for sustainable growth of the overall economy including the household." Regarding the putative link between corporate earnings and individual consumption -- the so-called "dam theory" that at some level the first spills over into the second -- Mr. Yamaguchi indicated that he supported the notion of such a cyclical mechanism. However, with regard to the BoJ’s statement of July 17, he cautioned that the board "would like to confirm with more confidence that such a mechanism is at work." In our view, market developments in the near term are more likely to erode than to support such confidence."
Concern remains about debt levels and systemic risk
On the subject of bad loans, "It is extremely important to incorporate the assessment of the financial system into economic outlooks," and that "this is one reason we believe the economic recovery is more likely to be moderate than robust." Regarding the Sogo bankruptcy, he added that, "We need to closely monitor whether there is the risk that the market may suddenly turn nervous, and this is, in my view, one of the factors that should be rightly taken into account in the conduct of monetary policy." We think this renewed reference to structural recovery as a crucial factor marks a policy milestone.
In our view, one of the deficiencies in earlier discussions of ZIRP termination was the excessive focus on cyclical rather than structural factors. However, historically, economic expansion periods have lasted on average a bit less than three years, and so there is a good chance that economic recovery has now passed the halfway point. As we have stressed a number of times, a genuinely forward-looking, preemptive monetary policy cannot terminate ZIRP based on cyclical considerations alone, but must also consider structural issues like excessive debt levels and overall financial stability. Deputy governor Yamaguchi’s speech seems to acknowledge this.
Structural adjustment and moral hazard
We realize, of course, that Mr Yamaguchi guarded against any misapprehension by the market that ZIRP would simply continue until all structural problems are solved. The deputy governor cautioned that "to deal with the decline in potential growth stemming from structural factors, a policy targeted to solve structural problems and the firm’s own efforts for restructuring are indispensable. There is no other way. In short, monetary policy cannot replace structural policy." So monetary policy is no substitute for structural reform. But at the same time, deputy governor Yamaguchi does not seem to embrace the need to terminate ZIRP in order to remove moral hazard, which is the view of BoJ governor Hayami. Deputy governor Yamaguchi seems to be drawing a clear line between his own view and that of the governor, who favors early termination. In addition, the deputy governor gave no support to the argument for raising rates on behalf of pensioners.
The next anti-ZIRP argument has already appeared
With equity prices declining in line with the bursting of the IT stock bubble, prospects for ZIRP termination are now receding, after rising in June and July. But the outlook must be monitored closely, because the desire of the BoJ secretariat to terminate ZIRP in September has not faded. There are signs that a new anti-ZIRP campaign has begun, based on the uncertainty of future inflation risks, while earlier arguments based on a bias toward easing after ZIRP have been dropped.
At a time when prices continue to trend downward for both goods & services and for assets, the BoJ’s argument, as made clear in Mr Yamaguchi’s speech, is that: (1)"the policy change in response to a clear and present risk of inflation would inevitably be monetary tightening, and, moreover, cumulative interest rate hikes would probably be necessary; and (2) if the zero interest rate policy continues for a long period after the economy clearly more economic agents will tend to conduct activities based on the expectation that current extremely low interest rates will be sustained indefinitely."
But while the BoJ has made a rather vague statement of its criteria for interest rate hikes, the reaffirmation of structural problems suggests that rate hikes are not likely immediately. The cautionary statement that the continuation of ZIRP now might require large-scale adjustments in interest rates in the future is probably insufficient to generate agreement on a rate hike now, with prices still trending downward. In particular, while the decline in consumer prices leads to an increase in consumers’ surplus, by the same token it cuts into the resources available to the supply side. A weakening of corporate earnings would be likely to have a negative impact downstream, in the household sector, which could poke a hole in one part of the dam theory, on which the ZIRP termination case relies.
In addition, if lower prices "maximize the nation’s economic welfare," they must in effect boost real income, thereby strengthening the virtuous circle of spending and production. But at a time when nominal consumer incomes have barely stopped declining, consumer sentiment probably cannot improve by enough to bolster this cyclical mechanism.
Deputy governor Yamaguchi’s remarks therefore to some extent indicate renewed caution about ZIRP termination. But on the other hand, GDP growth for the second (April-June) quarter is likely to be positive for the second quarter running, and as September 14 draws near, we are likely to see another anti-ZIRP campaign along with rising expectations for termination.
But until we see a united front of political, bureaucratic and financial sector leadership in favor of termination, opinion is likely to remain divided into pro- and anti-termination camps, and the pro-termination members of the BoJ board are unlikely to prevail. If the BoJ tries to force through a proposal to end ZIRP, the government might well exercise its legal right to put off a vote on the issue. In July, the government temporarily denied this, but with the recent stock market decline, neither the government nor the LDP can afford this luxury. The pro- and anti-termination factors are likely to continue arguing for some time, but the crucial thing would be to maintain consistency in the eyes of investors. |
