By Martin Wolf
Published: July 6 2010 20:24
Fiscal default is nigh, insist the doomsayers: repent and retrench before it is too late. Yet I have a question: do we believe that markets are unable to price anything right, even the public debt of the world’s largest advanced countries, the best understood and most liquid assets in the world? I suggest not. Markets are saying something important.
On Monday, the yield on 10-year government bonds was 1.1 per cent in Japan, 2.6 per cent in Germany, 3 per cent in the US and 3.3 per cent in the UK (see chart). Based on yields on index-linked securities, real interest rates on borrowing by these governments are very low (1.2 per cent, or less, in the US, Germany and UK). Investors are saying that they view the risk of depression and deflation as greater than that of default and inflation.
Why should it be so easy to fund such huge fiscal deficits even after central banks have stopped their buying of government bonds? In response, here is a calculation that can be derived from the figures for fiscal and current account balances in the latest Economic Outlook from the Organisation for Economic Co-operation and Development: the private sector – households and corporations – of advanced countries is forecast to run an excess of income over spending this year of 7 per cent of gross domestic product. In round numbers, this is $3,000bn. In the US and eurozone, the implied private surplus is about $1,000bn, in each case. In Japan, it is about $500bn. In the UK, it is $200bn.
Focus on the $3,000bn: this is the amount by which the private sectors of the advanced countries are forecast to increase their net claims on governments and foreigners in 2010. That means massive private retrenchment, with corporations particularly frugal at the moment.
Where could this money go? A possibility might be emerging countries. One might imagine, for example, that advanced countries eliminated their fiscal deficits but maintained these private surpluses. That would mean an aggregate current account surplus of $3,000bn, (or 7 per cent of GDP). The OECD region would become a mega-Germany. Rich countries would be pouring capital into poorer ones.
In practice, however, this is not going to happen. Far from running a current account deficit of $3,000bn, emerging countries are forecast to run a surplus: the latest from the Washington-based Institute for International Finance is for an aggregate surplus of about $300bn, two-thirds of which will be generated by China. This is smaller than two years before. But it still means that the emerging world will be a net provider of capital to advanced countries, not the other way around.
That is not all. According to the IIF, the net flow of private funds from advanced countries to emerging countries will be close to $700bn this year. But that will be almost entirely offset by an official outflow, in the form of foreign currency reserves, of close to $600bn. These huge official interventions prevent the emergence of large net capital inflows into emerging countries. Instead, the private sectors of the advanced countries accumulate net claims on the private sectors of emerging countries, while the governments of emerging countries accumulate offsetting claims on the governments of advanced countries (see charts).
The bottom line is clear: there exists, at present, a gigantic net flow of funds into the liabilities of the governments of advanced countries. Of course, some countries can still get into difficulties. But it is quite wrong to argue that the difficulties of a Greece or a Spain entail difficulties ahead for the US, or even the UK. The opposite is far more likely: flight from risk entails flight into something less risky. What is the least perilous asset for the investment of gigantic private financial surpluses? The only answer is the public debt of the big advanced countries.
These flows of funds consist only of identities. So what are the causal factors? Maybe, the collapse in private spending in the wake of the financial crisis was caused by terror of the fiscal deficits to come. Maybe, the moon is made of green cheese, too. There is also next to no sign of crowding out in capital markets. The plausible hypothesis, then, is that the fiscal deficits were a response to the collapsing desire to spend of the crisis-hit private sector. Fiscal policy could have been tighter. But the result would have been a depression.
What then of the future? Suppose there is no significant change in policy in emerging economies. Then if a fiscal contraction in advanced countries is not to cause a slowdown, even a second recession, it must be accompanied by an upsurge in private spending.
The argument must be that improved confidence in the long-run sustainability of public finances would lead to greater private consumption and investment spending now, even if there is no significant effects on interest rates or the exchange rate. I am highly sceptical of this argument (see “Why it is right for central banks to keep printing”, Financial Times, June 22, 2010). But grant that this is true. Then the best policy is to slow the long-term growth in spending on age-related programmes. This comes out clearly from the discussion of long-term fiscal trends in the excellent new annual report from the Bank for International Settlements.
The arguments for a dramatic short-term fiscal contraction, however, are weak. Yes, we are enjoying a recovery. But economies are still far below peak levels of activity and also below almost any plausible estimate of the long-term trend (see chart). This is particularly true in the US, where unemployment rates have shot up by far more than in other advanced countries. Unless the US has suddenly become continental European, why should equilibrium unemployment have jumped by as much as that?
My conclusion, then, is that the advanced countries remain highly short of demand. In this environment, rapid cuts in fiscal support make sense if, and only if, monetary policy can be effective on its own and expanding the interest-elastic parts of the economy is the best way to climb out of the hole. There is reason to doubt both ideas.
At the summit of the Group of 20 countries in Canada, leaders pledged to “halve fiscal deficits by 2013 and stabilise or reduce government debt-to-GDP ratios by 2016”. It would make far better sense for governments to focus their efforts on altering the long-term trajectory of spending. They may hope that retrenchment now will spur on private spending. But what is their plan if it turns out that it does not?
Copyright The Financial Times Limited 2010.
0 comments:
Publicar un comentario