Stephen King: Economic dependence can be hard to quit
'The US has borrowed from the future to keep its economy growing in the short term'
13 April 2004
Ssshhh. Don't say it too loud. The global economic recovery is showing signs of coming unstuck.
"Huh," you say. This, surely, is no more than a bit of unseasonable pessimism. After all, it's Easter, the daffodils are out, spring has most definitely arrived, so what could possibly go wrong?
The problem, I think, is that some economies are too reliant on others which, for one reason or another, will not be able to sustain the rates of economic expansion seen in recent quarters. If I were to isolate two key areas of support for the global economy as a whole, they would be the US and China. Both have played pivotal roles in maintaining the momentum of global economic expansion. Both can be used to explain the - admittedly weak - signs of recovery in Europe and the outright strength in parts of Asia, notably Japan. Both, though, may be running out of puff.
In both cases, policy plays a part, but the scripts differ. For the US, the effect of earlier expansionary policies will slowly fade from view as we progress through the year. In China, progressively tighter policies will be seen in 2004 as the authorities act to quell the boom that has led to growth in capital spending at a rate well in excess of 40 per cent year-on-year.
Both of these developments will have an impact on the rest of the world. The eurozone, faced with a lack of domestic economic recovery, has become incredibly dependent on the success or otherwise of the US economy. When the US does well, the eurozone just about grows. When the US does badly, the eurozone is more likely to find itself in the economic equivalent of a coma.
Japan, a major exporter, has suddenly discovered that China is a rather important trading neighbour, one that has boosted Japanese exports dramatically in recent quarters. Any signs of slippage from China would, then, be most unwelcome on the other side of the Sea of Japan. Meanwhile, commodity producers the world over - I'm thinking here of Brazil and Australia, Indonesia and Chile - stand to lose out should the pace of growth wilt in China, thereby reducing the level of demand for, and the price of, the world's basic commodities.
Of course, given the recent welcome recovery in the US labour market, it might seem a bit odd to be so downbeat. When everything appears to be moving in the right direction, why worry? One obvious concern is the role of the US consumer. My calculations suggest that the combined effect of tax cuts and interest rate reductions boosted US consumer spending by about 2 per cent a year in each of the past three years. This policy action certainly kept the US economy going in its time of need and, equally certainly, provided a much needed boost for exporters in other parts of the world - but the effects are now beginning to fade.
The policy actions of the past three years achieved two things. They supported post-tax US household incomes at a time when pre-tax incomes were under tremendous downward pressure through corporate restructuring. And they prevented a rise in the saving ratio at a time when household wealth was shrinking in response to falls in equity prices.
Nothing wrong with any of this, but problems are likely to arise if the marginal benefits of policy changes begin to fade. We know already that the direct benefits of the Bush tax cuts will run out by the middle of this year. We also know that, barring an imminent catastrophe, the Federal Reserve is more likely to be contemplating a rise in interest rates rather than a cut.
Put another way, even if pre-tax incomes show some sign of recovery, post-tax income growth may still weaken. And if, at the same time, the monetary environment doesn't become any easier, there could be upward pressure on the saving ratio. This is hardly the stuff of buoyant economic recovery.
And if things are little less helpful on the eastern side of the Pacific, they're also likely to become less supportive on the western side. A lot of people have got themselves worked up about an imminent revaluation of the renminbi, China's currency. The argument is simple. China's economy is overheating. Exports and domestic demand are both growing too quickly. Interest rates cannot be raised without putting upward pressure on the currency. Therefore, wouldn't it be much simpler to allow the currency itself to take the strain? A higher renminbi would slow foreign demand for Chinese exports and, in the process, put the brakes on an otherwise inflation-prone domestic economy.
In my view, this argument is flawed. China's broad economic aims are simple and mostly revolve around getting workers out of agriculture, where they are under-employed, into industry, where they can be used more productively. And a competitive exchange rate would appear to be an important component of this story.
No, I think the best way to consider China is to think about western economies not now but back in the 1950s and 1960s, when they were part of the Bretton Woods exchange rate system and when controls placed significant limits on capital flows into and out of countries. Back then, monetary policy worked not so much through the price of money - the rate of interest - but rather through controls on the quantity of money available at any given price.
The Chinese are now engaged in the same game: if the economy is to slow down - a stated aim of Chinese policymakers this year - the best way to do this is through the imposition of quantitative controls on credit expansion. Not very free market, admittedly, but it may do the trick. China's export success would then continue but, if domestic demand began to slow, life wouldn't be so easy for the Japanese and the world's commodity producers, the main winners from China's domestic overheating in recent quarters.
I'm really making a very simple point. Policymakers around the world have every right to highlight their successes. The global recession was relatively shallow. The recovery has been sustained when, a while ago, there was talk of a "double-dip". Inflationary pressures remain largely absent. Yet, throughout, two broad risks have arisen. First, the US has "borrowed from the future". Its policies have kept growth going in the short term but the main impact of these policies may now be over. Second, a global "dependency culture" has grown, enabling the eurozone and Japan to claim some modest economic success, even though the reasons for their success - US policy support, Chinese overheating - may be on the wane.
Although we appear to be in an economic spring, it may just be that the summer will be short-lived and we will then have to confront the problems of autumn and winter.
As this week's charts suggest, we're currently on a bit of a high, with business surveys at remarkably high levels. But a closer look at these charts reveals that, whereas business optimism was once heading upwards, it's now heading downwards. Watch the US and China very carefully because I suspect that Europe's economic fate - including that of the UK - rests very much in their hands.
Stephen King is managing director of economics at HSBC
stephen.king@hsbcib.com |
