Economics Weekly - Orderly dollar depreciation is better than protectionism; Weekly economic data preview - Did the UK economy grow in Q3?
Economics Weekly - 19
depreciation is better than protectionism
For all of the furore
about the dollarâ€™s slide, it is easy to lose sight of the underlying forces at
play. However, we should not be complacent, as these forces can still have
destructive effects on global growth prospects. Global imbalances, represented broadly
in the growing US current account deficit and rising surpluses in many other
parts of the world, were one of the prime - for some, the only - reasons for
the global crisis that is still unwinding. A necessary part of the adjustment
to global imbalances is that the dollar must fall, or the US erects trade barriers
to bring down its external deficits or there must be a recession so severe that
it brings imports to a halt. That would be the ultimate nightmare scenario for
the world economy.
Thankfully, it is also
the option that no one wants to see. This is why the global financial and
economic crisis has not turned into a replay of the 1930s great depression -
because economies were kept open and countries broadly agreed to use monetary
and fiscal policy tools to help offset the effects of the downturn and the
collapse in financial markets. But is the global imbalances genie back in the
box and is sustainable rebalancing occurring?
The US represents the worldâ€™s
largest economy and has its largest deficit
In 2007, the US current account
deficit was the largest in the world in value terms, at $726bn (it peaked the year
before at $803.5bn). This represented 6% of its $14trn gdp in nominal terms
that year. For illustration, China had a current account surplus of 11.4% of
its 2007 gdp, equivalent to $372bn. Germany had a similar profile, with a
surplus of $266bn in 2007, or 8% of gdp.
So, what led to the
imbalances captured in chart a? The short answer is shown in chart b. It
appears to be no coincidence that the countries running deficits were also the
ones with the lowest saving rates. In 2007, the US personal sector saving
rate was 1.7% of annual disposable income. The equivalent figure for China was 28.3% and for Germany it was 10.7%. A
similar profile was evident in fiscal balances as well, with the US running a deficit of
2.8% of gdp, but Germany had a surplus of 0.4%
of gdp and China had one of 0.7% of gdp
in 2007. It seems, therefore, that what links these deficits and surpluses are
High global savings
exist in some countries, mirroring the US deficit
The argument is that
high global savings drove down interest rates and led to the increased leverage
that then sowed the seeds of the current global recession and financial
collapse. Therefore, these imbalances need to be addressed for the world
economy to recover in a sustainable manner. Effectively, the savings economies
must save less and the spending economies must save more. Injections of demand
by governments will prevent the adjustment from being too abrupt, but cannot
act as a long term substitute. Ultimately, leverage must fall in the indebted
countries and rise in the less indebted economies. Some of this will come from
governments in the latter saving less and some from encouraging spending by
consumers. Another part of this process, though, also comes from exchange rate
adjustments. Therefore, if this is indeed the case, recent trends should be
Global imbalances are
correcting, though it is uncertain how long this trend will lastâ€¦
Global imbalances are
correcting. The IMF estimates that the global imbalance is now 1Â½% of global gdp,
down from 2Â½% as recently as 2008. Sticking to the focus on the US and Germany/eurozone
and China, illustrates how this
is happening. Chart c shows that the US dollar has seen an orderly depreciation
since the crisis broke in 2007. Effectively, a fall in the US dollar means that
US consumers get less for their consumption and more demand for their exports.
This is an incentive for them to invest more, in order to export and so to
consume fewer goods made abroad. For the exporting or saving economies, it
means the opposite: they get more from importing (i.e. their consumers are
better off) and less for exporting, as their currencies appreciate. This should
encourage spending behaviour and a reduction in savings. Hence, the recent fall
in the US dollar, which is not against all currencies but mainly focused on
those that it has big deficits with, does not presage the end of the dollar as
the key global reserve currency. In fact, the reverse seems likely: a
successful adjustment will make the eventual US recovery more
sustainable and so dollar investments more value preserving.
Charts d and e show
that US households are saving more and that the current account deficit has fallen.
The opposite is happening in the surplus/saving economies. In 2009, the US current account deficit
is estimated to be $410bn, 2.9% of gdp. US household savings are up to 4% of
household disposable income in 2009 from the sub-2% two years before. Chinaâ€™s current account
surplus in 2009 is projected at $331bn, and further reductions are projected.
Its saving rate is also down, though only to 27.5% from 28%. For Germany, the household saving
rate is still at 11% but the current account surplus has fallen to $129bn from
the $266bn recorded in 2007.
â€¦but dollar weakness is
a necessary part of this adjustment
It is easy to lose
sight of the fact that the weakness of the dollar is necessary to right some of
the imbalances that led to the global collapse. In fact, thinking of this as
purely dollar weakness is wrong, in our view. Many of the currencies the dollar
is depreciating against have large dollar reserves, not because their economies
are more productive than the US or more competitive,
but because they have been deliberately keeping their currencies weak. This has
contributed to big surpluses in the case of these economies and big deficits in
the case of the US. But, at some stage
there needs to be an adjustment - better it comes though market forces pushing
these other currencies higher than from US protectionism.
The main data highlight in the UK this week is provided by the preliminary Q3
gdp figures on Friday. The expectation is that the economy returned to growth
for the first time since the first quarter of 2008, confirming the end of the
recession. However, recent weak data, notably August industrial production
(-2.5% m/m), suggest expansion, if any, is likely to have been very modest.
With speculation rising about whether the MPC will increase its Asset Purchase
Facility (APF) next month, there will also be considerable interest in the
minutes of the MPC meeting held earlier this month, the latest money supply
data and the BoEâ€™s Trends in Lending report this week. The focus in the US will be on the housing market this week,
where signs of stabilisation have emerged in recent months. It is also a busy
week for Fed speakers, including chairman Bernanke taking to the stage this
afternoon and on Friday. A quiet start to the week for euro zone data culminates
in a flurry of key economic figures on Friday, headed up by â€˜flashâ€™ PMIs for
October and the German IFO
survey. We look for signs of a modest pick
up in activity.
other key events this week, we expect the Bank of Canada to keep its benchmark
lending rate at 0.25% on Tuesday, while the publication earlier in the morning
of the minutes of the 6 October Reserve Bank of Australia interest rate meeting
(when rates were raised by 0.25% to 3.25%) should provide clues about how much
it may raise interest rates next month. China publishes its Q3 gdp data early on Thursday
morning, with a sharp pick-up widely expected in its annual growth rate. We
look for an acceleration to at least 9%, from 7.9% in Q2..
ô€‚„ The preliminary estimate of third quarter UK gdp, due on Friday, is
expected to show the economy expanded by 0.1% on the quarter, which would
confirm that the recession has ended. The annual growth rate is forecast to
improve to -4.6% from -5.5% in Q2. The UK gdp data are published
ahead of most other major economies and so will be watched closely as the
recovery paths are likely to be different, leading to important implications
for currency and interest rate markets. Although the recession may be over, the
mounting cost of unemployment and declining corporate profits will be reflected
in another disappointing set of public finances data on Tuesday. We forecast
public sector net borrowing rose to Â£15.5bn in September, up from Â£9bn last year
and taking the cumulative total so far this fiscal year to Â£80bn compared with
a full year total of Â£88.1bn in 2008/09. The Bank of England MPC minutes from
its 7-8 October meeting on Wednesday might provide some guidance about the
likely decision next month. We believe the prospect of an extended period of
weak economic growth could lead the committee to further increase the size of
the APF. September retail sales volumes, due on Thursday, are expected to show
a 0.4% increase, pushing the annual growth rate to 2.7% from 2.1% previously.
However, we expect rising unemployment, weak earnings growth and ongoing
household deleveraging to continue to weigh on consumer spending prospects. The
CBI industrial trends survey and BBA loans for house purchase data, also
published this week, will have useful information on economic
ô€‚„ The US housing market is
showing signs of stabilisation, which should be reflected in a further modest rise
in the National Association of Home Builders (NAHB) confidence index this
afternoon. However, conditions remain challenging and most respondents are
likely to view conditions as poor. Nevertheless, we also look for better news
from housing starts and building permits on Tuesday and existing home sales
data are also expected to have improved in September. Initial jobless claims, due
on Thursday, are forecast to fall to 510K from 514K in the previous week.
ô€‚„ Eurozone PMIs are published on Friday, with the October figures
for both services and manufacturing forecast to show a modest rise from
September. German business confidence, as measured by the IFO business climate
index, should also show a small rise, to 92.5 in October from 91.3 in
September, primarily reflecting the pick-up in exports and equities.
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