A V Rajwade: A new G20 agenda?

Many conventional correlations in the global economy are breaking down

As preparations for the next G20 summit (Seoul, November) gather momentum, there has been some progress since the last summit — the Basel Committee on Banking Supervision constituted by Mathe Bank for International Settlements has agreed on new norms for banks’ capital adequacy standards (Basel III). These norms prescribe a significant increase in shareholders’ funds, and have also increased the capital charge for market risk. The US has enacted tighter and highly complex banking regulations, and the European Union (EU) is also well on its way to finalising financial reforms later this year. Neither of these may achieve the full extent of the reforms envisaged by the G20, but very strong and powerful bank lobbies have been working hard, in Basel, Brussels, London and Washington, to dilute the prescriptions (more on the new regulations in a later article).

 

There is also the question of whether the cost of new capital ratios and other regulations will be passed on to and borne entirely by the banks’ customers — higher lending rates, for example, would, over the long term, affect global growth. One major unresolved issue is the convergence of accounting standards prescribed by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB): this is unlikely to be achieved in the current year, as originally targeted.

On the other hand, major problems and contradictions in the global economy are coming to the fore. Many conventional correlations seem to be breaking down. For example, loose monetary and fiscal policies are supposed to be inflationary. There is no sign of this in the US, Europe and Japan. Again, gold is supposed to be an inflation hedge and conventional wisdom suggests that its price would go up in anticipation of high inflation. The gold price has been setting new records, but the yields on inflation-adjusted bonds in the US, for example, show few signs of inflation rising.

The other major disconnect is that the substantial fiscal and monetary stimuli have, broadly speaking, failed to trigger sustained economic growth: to be sure, some economists, Paul Krugman for example, had predicted that, in the US the fiscal stimulus would prove to be inadequate. In the recently published Annual Outlook for 2011, the United Nations Conference on Trade and Development (UNCTAD) apprehends a contraction in the world economy in 2011, and worries that an exit from stimulus-driven macro-economic policies in the developed countries may lead to a “deflationary spiral”. To be sure, some members of the G20, China and India for example, seem to have been broadly unaffected by the diseases of the developed world.

Ominously, global imbalances (a code word for Chinese surpluses) have started widening again. As the yuan appreciation continues at a snail’s pace, China’s surplus is a potential danger to global economic co-operation. As trade tensions rise, a Bill providing for punitive tariffs on Chinese imports is making its way through the US Congress; the EU has also warned against increased tariffs on the import of car wheel rims from China. Given China’s status as the world’s largest market for light vehicles (China 15.6 million, Japan 9.1 million and the US 7.1 million — 2010 estimates), its capacity to retaliate should not be underestimated. The EU, for example, exported auto parts worth $5 billion to China last year, besides a large number of cars.

In the US, unemployment stubbornly remains close to double digits, even as the number of those classified as being in “involuntary part-time” working, continues to rise, the latest number being 9 million. And, Japan, now the third largest economy in the world, continues to experience stagflation (“flation” preceded by “de”, not “in”) exacerbated by an appreciating yen. After six years, Japan intervened in the exchange market last week when the currency fell below ¥83 to a dollar; it is also blaming China for fuelling yen appreciation through its purchases of yen bonds for its reserves. Though the yen is back above 85 post-intervention, its longer-term success is questionable since the continued appreciation of the Swiss franc, despite sizeable intervention, shows that it has fallen below parity against the dollar. (Another interesting contradiction is Switzerland, along with Germany, the fastest growing economy in Europe.)

The growth picture in the EU is getting more confusing. The European Commission has recently revised its earlier forecast for growth in the current year, from 0.9 per cent to 1.7 per cent (eurozone) and 1.8 per cent for the EU as a whole. On the other hand, latest data suggest stagnation in factory output in the eurozone. And, the reputed ZEW economic research institute recently reported a sharp fall in its index of expectations for the economy; the index has now plunged into negative territory.  

Finally, President Obama may find himself on a weak political wicket by the time the G20 summit begins as poll after poll suggest a sharp setback to his Democratic Party in the mid-term elections later this year — in the US, the conservative right is making a strong comeback.     

avrajwade@gmail.com