In the press conference that the International Monetary Fund (IMF) held to release the World Economic Outlook (WEO—October 2009 edition) last week, one question and the response stood out in capturing the enormity of the difficulties that lie ahead for policymakers and for forecasters who have to both anticipate and guide policymakers.
The question was whether IMF saw a false dawn now given that not much has changed in the world since 2006/early 2007 when IMF saw high commodity prices, misaligned exchange rates and global imbalances. Economic counsellor to the fund and director of research Olivier Blanchard answered the question partially. He did not answer the question of whether we were witnessing a false dawn. On global imbalances too, his answer was partial.
He said private savings in the US were on the rise, which was one part of the global imbalance. He pointedly did not say that East Asian or Chinese consumption was on the rise. He added that (even) this adjustment has come about at a large cost to the world in terms of a large recession in the US and in many other parts of the world.
Looking back, it must now be apparent to many economists as to how the imbalances that the world saw in 2007 could have been rectified without a contraction in demand in the savings-short countries, to begin with.
Looking ahead, it is not too difficult to see that the other half of the rebalancing would be equally painful to achieve. Excess savers cannot do their bid to stimulate demand without simultaneously triggering asset-price and traditional inflation, given exchange rates and financial repression. The Global Financial Stability Report (GFSR) of IMF, released a day earlier, expresses its concern on both types of inflation risks in China.
To another question, Blanchard said it is hard to envisage global rebalancing happening at current exchange rates. Of course, he had in mind Asian currencies and China in particular. That too was left unsaid. The action is soon going to be on the exchange rate front. The Group of Seven (G-7) finance ministers expressed concern at the weak dollar. More precisely, they were worried about the strength of their currencies against the US dollar. They would like dollar weakness to cross not just the Atlantic, but also the Pacific. They, too, left it unsaid. They depend on China to finance their fiscal largesse, which may yet be larger.
This does not mean that China is getting away with “it”, for it is not clear that what it is getting away with is for its good. Low lending rates combined with state directed lending to state-owned enterprises is a recipe for the generation of bad loans. It has been the worldwide experience and China will prove to be no exception. At the same time, China is in a bind, for it has a stimulus exit timing problem as much as, if not more than, the developed world, given that its domestic growth is on steroids and external demand from the developed world looks set to weaken further.
The US employment report for September was simply too dreadful to warrant any optimism on the end of the recession or for China’s exporters. Employers continue to slash labour hours and those who lost their jobs are taking longer and longer to land another job. Based on the household survey, the ranks of the unemployed have swelled by about 1.2 million in the last two months. Credit card defaults are setting a new record at 11.52%, and banks with 20% unpaid loans are at an 18-year high.
That is why IMF thinks it can advocate early monetary restraint for the developing world and measured exit for the developed world. However, central banks on either side of the Atlantic will face a more complex reality. IMF’s work points to that.
In chapter 3 of WEO, IMF advises monetary authorities to pay attention to current account balances and credit growth, for they were better predictors of asset price busts than traditional output and inflation measures. In the same breath, the executive summary of WEO says central bankers in the developed world could afford to maintain their accommodative stance for an extended period, as inflation was likely to remain subdued. Both cannot be right, for several reasons.
First, the permanent capacity destruction and permanent reduction in trend growth that the document repeatedly mentions lowers the bar for the resurgence of inflation from accommodative monetary policies. Second, even if that is a remote risk, the resulting lack of need for investment spending leads to lower aggregate demand and lower corporate earnings. Third, this, in turn, raises bubble risk even if asset price levels are lower today than two years ago because potential and actual economic activity levels are appreciably lower now.
In sum, Bare Talk thinks IMF might have raised its growth forecast for the world after the growth spurt has passed and when the costs of that spurt are about to show up.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org