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Monday October 19, 2009 - 09:55:27 GMT
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Economics Weekly - Orderly dollar depreciation is better than protectionism; Weekly economic data preview - Did the UK economy grow in Q3?


Economics Weekly - 19 October 2009

 

Orderly dollar depreciation is better than protectionism

 

 For all of the furore about the dollar’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 world’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 savings.

 

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 reassuring.

 

Global imbalances are correcting, though it is uncertain how long this trend will last…

Global imbalances are correcting. The IMF estimates that the global imbalance is now 1½% of global gdp, down from 2½% 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. China’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.

 

…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.

Trevor Williams, Chief Economist, Corporate Markets

 

Weekly economic data preview - 19 October 2009

 

Did the UK economy grow in Q3?

 

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 BoE’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 ‘flash’ PMIs for October and the German IFO

survey. We look for signs of a modest pick up in activity.

 

 In 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..

 

􀂄 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 £15.5bn in September, up from £9bn last year and taking the cumulative total so far this fiscal year to £80bn compared with a full year total of £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 trends.

 

􀂄 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.

 

􀂄 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.

Jeavon Lolay, Senior Global Macroeconomist

 

Economic Research,
Lloyds TSB Corporate
Markets,
10 Gresham Street,
London EC2V 7AE
,
Switchboard:
0207 626 - 1500
www.lloydstsb.com/corporatemarkets

 

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