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The Global Economy

Monthly letter from Swedbank’s Economic Research Department

by Cecilia Hermansson No.8 • 11 November, 2010

The G20 countries have to put an end to the

world economy’s destructive behaviour
• The global recovery is continuing, with signs of both positive and negative data.
The bright spots in the US include small businesses and the labour market. In
Europe, financial concerns are growing at the same time that budget consolidation
and the stronger euro are hurting growth prospects.

• In many cases, expectations going into to the G20 summit are low. Rhetorically
correct statements, but a lack of practical action, are pretty much what can be
expected. The US has toned down its demands to cap current account surpluses
and deficits, probably to mollify criticism about its new round of quantitative easing.
There is still a risk for a negative spiral of easing, carry trade, capital flows to
emerging countries, capital controls and taxes on derivatives trading, currency
interventions and in the long run potentially protectionism as well. It is vital that the
G20 breaks this destructive pattern and finds a framework that gradually reduces

Global demand: Mixed signals

Data released since our last monthly global letter In the third quarter China's GDP grew by 9.6% on
have been both positive and negative. Purchasing an annual basis, which is not an entirely
managers’ indexes in most large countries – except undesirable slowdown from just over 11% in the first
Japan – still point to good growth in manufacturing. half of the year. This could make it hard to maintain
our full-year forecast of 9.8%. It's more likely that
growth this year will exceed 10%. China is
Purchasing Managers’ Index (PMI)
becoming more important as an importer, which
70 Purchasing Managers Index (PMI) for Industrial Production certainly helps export-dependent Western nations.
For the US, it is positive is that confidence among
60 small businesses rose slightly in October, though
from depressed levels, and even more importantly
that employment rose more than expected, with
50 159 000 new jobs in the private sector. Even though
unemployment hasn’t yet begun to fall, this is a step
45 in the right direction. In our recently published US
UK analysis we stated that GDP growth will probably
40 Japan
have to be revised downward slightly this year and
35 China next, despite relatively positive growth data.
30 In Germany, exports remained strong, but new
orders and production have swung back and forth
06 07 08 09 10
between months, which have created some
uncertainty going forward. The stronger euro could
Source: Reuters EcoWin

In terms of GDP, Western economies are muddling make it more difficult for the Eurozone’s export
along, while emerging economies continue their sector, mainly the PIIGS countries, but a more
strong growth, though at a slightly slower rate than important reason for the slowdown is that the
before. previous growth rate was built on temporary

Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740
E-mail: Internet: Responsible publisher: Cecilia Hermansson, +46-8-
5859 7720, Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897
The Global Economy

Monthly newsletter from Swedbank’s Economic Research Department, continued

No. 8 • 11 November 2010

stimulus measures and an inventory recovery, taking flight to weaker currencies (or trying to fight
which are hard to maintain. the appreciation of their own currencies, like China).

Third-quarter GDP growth in the UK exceeded that Various currencies against the US-dollar
of the second quarter by 0.8%. Moreover, the gains (Index 2007-08-09 = 100)
were broader than the second quarter’s 1.2%, 190

which largely consisted of inventory restocking. 180

Korean Won
Although the construction industry contributed to the 170 Brazilean Real

unexpectedly strong growth, the government’s 160

austerity package is likely to dampen sentiment 150
going forward. The strong results may force us to
revise GDP growth for 2010 upward from the Swedish Krona
130 Euro
current 1.1% to about 1.5%.

The big, though expected, news in the last month 110

was the Federal Reserve's new round of USD 600 100
billion in Treasuries purchases through the second
quarter of next year. Yuan
80 Swiss Franc

Since this was expected, the US dollar had already 70 Yen

weakened, long-term interest rates had retreated 60

and stock prices had risen. We are also seeing 03 04 05 06 07 08 09 10

higher commodity prices – especially for precious Source: Reuters EcoWin

metals and grain – and rising inflation in countries

When the US starts cranking up the printing
where food accounts for a relatively large portion of
presses to buy Treasuries, and depreciating the
household spending, e.g., in Eastern Europe.
value of the dollar, it will launch a wave of activity in
emerging countries. Low interest rates in the West
Increased tensions at G20- summit increase the carry trade, and capital seeks out
countries with higher returns. Emerging countries,
Today, November 11, marks the start of the G20
which are seeing their currencies rise and capital
summit in South Korea's capital, Seoul. The finance
inflows grow more volatile, are resorting to capital
ministers of the 20 countries met on October 22-23,
controls and taxes on the derivatives trading. Brazil,
and the countries of the Asia Pacific Economic
for example, has tightened controls, and Thailand
Cooperation (APEC) held a meeting of their finance
and other Asian countries are close behind.
ministers on November 6. The latter meeting
provided a foreshadowing of the issues that will China is seeing its currency portfolio, now valued at
command attention at the current meeting. USD 2.65 trillion, shrink in value, since two thirds of
it is in US dollars, creating a need for diversification.
Even before the meeting the countries had reached
China is buying Korean won and Japanese yen.
agreement how to more evenly divide the IMF’s
These countries feel forced to intervene to avoid
votes between Western countries and emerging
volatility (read: to stop their currencies from rising,
countries. Despite the need to discuss how the
which could threaten their export sectors).
world can combat climate change and strengthen
financial regulation, currency tensions and trade The quantitative easing (QE2) that has started in
imbalances will dominate the agenda. the US and which will invest USD 600 billion in
Treasuries of various maturities (mainly in the
Countries with large current account deficits and
segment 2.5-10 years) has already been interpreted
deleveraging need a nominal and real currency
as insufficient by the financial markets. Now QE3
depreciation. This is especially true of the US.
and QE4 await. Expectations like these weaken the
Countries with large current account deficits instead
dollar and could launch a new negative spiral of
will have to watch their currencies appreciate, their
capital controls, currency interventions and
savings decline and domestic demand take over as
eventually the possibility of a trade war.
more of a growth engine.
Various proposals are being offered to undo the
At a time when the global economic outlook feels
knots chaining the global financial system. A few
uncertain and fiscal and monetary policy don't have
are discussed below:
enough ammunition left, countries are too easily

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The Global Economy

Monthly newsletter from Swedbank’s Economic Research Department, continued

No. 8 • 11 November 2010

1. Instead of focusing on currency policy for in the US. The next step is for China's currency
countries that peg their currencies to the dollar, to drop the peg to the dollar, no longer giving the
the US proposed a cap on current account US the benefit of the dollar as a reserve
surpluses/deficits. It suggested a limit of 4% of currency.
GDP. Critics were quick to respond, saying that
such a proposal doesn't account for It is not likely that the G20 countries will reach
demographics, savings and whether currencies agreements at the summit in Seoul that go beyond
are already market-based or not. The risk is that their previous statement that “we will move towards
it would restrict trade and sabotage global more market-determined exchange rate systems
growth. The US withdrew the proposal at the that reflect underlying economic fundamentals
recent APEC summit and will instead focus on without competing to force down currencies.” The
“how to build a framework for cooperation that US will continue to cite a “strong dollar policy”, but
will reduce the risk that future growth is imperiled in practice QE2 weakens the dollar. Countries will
by the reemergence of large external also talk about “avoiding beggar-thy-neighbor
imbalances.” currency policies to spur growth.”

Current account balance as a share of world GDP While politically correct, these statements aren’t
in some countries / groups of countries being followed by actions that live up to the rhetoric.
Oil producers USA
3 Japan Germany Europe – third wheel under the wagon
China Rest of Asia
Rest of world
Germany feels that the EU’s current account
surplus or deficit should be seen from the
1 perspective of the Union as a whole, not by
individual EU country. In other words, problems in
0 the Eurozone should “stay within the family.”
The thing is that a stronger euro is not as big a
-2 problem for Germany as for the PIIGS countries.
Germany will begin a period of fiscal austerity as
-3 early as next year despite that it could wait another
1970 1975 1980 1985 1990 1995 2000 2005 2010 year or so. Representatives of the German central
bank may soon consider raising interest rates and
want to cancel the bond purchases that the ECB,
2. A couple of days after the APEC summit World
despite German objections, is making.
Bank President Robert Zoellick suggested that a
new international monetary system was needed The EU Council’s approval of the German-French
to replace Bretton Woods. This new system proposal that any crisis management mechanism
would include the major currencies as well as should include a greater commitment from the
gold, as an “international reference point of private sector has again raised interest rate
market expectations about inflation, deflation spreads. Concerns mainly focus on Portugal and
and future currency values.” Criticism was Ireland, each of which has to borrow about 55 billion
severe. The supply of gold falls far short of the euros during the period 2011-2013. If Spain is also
supply of money. A few large central banks own included, that figure exceeds the current
a disproportionately large share. Switching to the stabilisation fund of 440 million euros. This worries
gold standard would create deflation. Global the financial markets, as do individual events such
trade wouldn’t grow as hoped, since the gold as political uncertainty about local elections in
supply would keep it in check. The price of gold Greece and Ireland's growing mortgage crisis.
poorly reflects inflation as a whole in the

3. A continued appreciation of the Chinese

currency, the renminbi, against the dollar and a
gradual internationalisation, where the renminbi
is increasingly used outside China’s borders.
This process will take time, but is becoming
unavoidable. Europe dropped its peg to the
dollar in the early 1970s, when inflation jumped

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The Global Economy

Monthly newsletter from Swedbank’s Economic Research Department, continued

No. 8 • 11 November 2010

Interest spreads between German 10 years government A few closing words

bonds and ditto for other European countries
(percentage points) To date the IMF has been able to place conditions
10 on countries with current account deficits that have
programmes with the IMF. On the other hand, it
Greece lacks the means to pressure countries with
surpluses that don't have programmes with the IMF,
7 i.e., Japan, China, Germany and even Sweden,
6 where the current account surplus exceeds 6-7% of
Ireland GDP.

Although it may seem that countries with deficits are
3 the ones that have erred, i.e., that they have
maintained exceptionally expansive economic
Italy policies and encouraged imbalances in household
1 Spain
purchasing, consumer loans, etc., it is not enough
0 to correct only these countries and leave the others
UK Belgium
-1 France with surpluses alone.
jan maj sep jan maj sep jan maj sep jan maj sep
07 08 09 10 The problem is that the world would find itself in a
Source: Reuters EcoWin

deflationary and depressive cycle. If there are no

Because the ECB now has to delay its exit strategy currency corrections in that direction to ease the
for purchasing bonds, since the banking system adjustment in the US, and in part of the Eurozone,
could again be at risk, tensions are growing these countries will have to resort to internal
between Germany on the one hand and the PIIGS devaluations in the form of lower salaries and
countries on the other. In the past week the ECB prices, which is something that is already
has bought 711 million euro in government bonds, a happening in the PIIGS countries in the absence of
relatively small sum compared with how much it has other available means.
bought since May – 64 billion.
The currency policies of emerging countries are
In other words, the crisis extends beyond Europe also contributing to the US having to resort to QE2,
and is growing. In 2011 the debt ratio in the and possibly even QE3 and QE4. This in turn will
Eurozone as a whole will pass 90%. Among the create new spirals, making it vital that the G20
larger countries, only Germany and Spain will have summit introduce a process that breaks this pattern.
a debt ratio below the average. Loan requirements
are huge. The weakening of the US dollar against the
currencies of emerging countries and oil producers,
Growth prospects are being hurt by the need for as well as against developed countries such as
budget consolidation and the relatively strong euro Sweden and Norway, where market adjustments
(in PPP terms, the long-term rate should be around can be made, would be a good thing. It is also
1.1, according to the OECD, i.e., a far cry from important that the Eurozone find an arrangement so
today's 1.38). The Conference Board expects the that Germany and the PIIGS countries can better
Eurozone to slow by 0.5-1 bp in 2011 due to lower share the burden of adjustment.
government spending and private consumption. In
the longer term it is important to improve growth We eagerly await the outcome of the G20 summit.
prospects for the Eurozone, which does not have Perhaps it is reasonable to hope for the best, but it
the same opportunities as the US, for example, with is even more reasonable to prepare for the worst …
its more active monetary policy, reserve currency,
Cecilia Hermansson
ability to utilise transfers between states and more
flexible workforce.
Economic Research Department Swedbank’s monthly The Global Economy newsletter is published as a service to our
SE-105 34 Stockholm, Sweden customers. We believe that we have used reliable sources and methods in the preparation
Phone +46-8-5859 7740 of the analyses reported in this publication. However, we cannot guarantee the accuracy or completeness of the report and cannot be held responsible for any error or omission in the underlying material or its use. Readers are encouraged to base any (investment) decisions
Legally responsible publisher on other material as well. Neither Swedbank nor its employees may be held responsible for
Cecilia Hermansson, +46-88-5859 7720. losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s
Magnus Alvesson, +46-8-5859 3341 monthly The Global Economy newsletter.
Jörgen Kennemar, +46-8-5859 7730

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