Sunday, August 18, 2013

IIF Meeting in Paris (III) – Global Outlook and Risks

On June 25 and 26, 2013, the Institute of International Finance held its spring membership meeting in Paris. The third discussion dealt with the current state, outlook, and risks for the major economies in the world.

Axel A. Weber, Chairman, UBS AG


Axel Weber delivers a very fact-based, if not unemotional speech. He introduces the discussion by quickly mentioning the major current evolutions in the world economy:

  • The Euro is still in an extended recession, although its financial markets have stabilized.
  • The US is closer to “self-sustainable recovery” and debates about unwinding exceptional monetary policy measures.
  • Unprecedented steps of the Bank of Japan and a slower growth momentum, especially in China, mark the Asian economy.

What’s more, the world economy today shows divergent economic policies in different countries, triggered by varying stages of the economies’ business cycle.


The economic outlook has improved since last year but the recovery is still fragile.”

Currencies ideally should reflect economic fundamentals and the relative strengths of the economies and should actually act as a stabilizing mechanism in the world economy. But in a condition of extreme monetary policy measures in many jurisdictions, this may distort the picture and, going forward, it might also distort the way exchange rates move between major trading partners.”

Dr. Olivier Blanchard, Economic Counsellor and Director, Research Department, International Monetary Fund


Olivier begins his speech strikingly by describing 3.5 stages of today’s economic recovery:

  • Emerging markets are doing best.
  • The US is doing ok.
  • Europe is doing poorly.
  • Japan is somewhere in-between.

Even though emerging markets currently show the best economic performance, it is getting less strong than we are used to. Dr. Blanchard is wondering – Is this decrease cyclical? – and doesn’t give a clear answer: “Although there are differences from country to country, the bottom line is: It is a decline in potential growth with some cyclical components.”
As regards declining Chinese exports, they have been compensated by increasing investments: As a matter of fact, the Chinese investment rate has moved from 39 % in 2007 to 45 % today. The question is, however, whether such a high rate will be sustainable.
A decreasing growth of the BRICS should also worry the USA and the Eurozone: The IMF predicts that a 2 % decrease in BRICS’ growth would lead to a 0.5 % growth decrease in the US and the Euro area.

In the US, “recovery is there, private demand is strong, and fiscal consolidation is at break“.

Olivier Blanchard’s appreciation of the European economy is best described by the term “hope”. Above all, periphery countries still need to improve their competitiveness and increase internal demand.

In Japan, the central bank currently tries to grow aggregate demand through lowering real interest rates. In Olivier’s view, it will actually take a long time for this monetary policy (“abenomics”) to prove successful. In the meantime, it generates a lot of volatility in Japan and, by implication, in the world economy.


We clearly have a world with divergent [economic] evolutions.”

Uncertainty is part of the game.”

[The USA] is an economy that is recovering.”

The right word [to describe the state of the European economy] is still working progress.”

In the core, the numbers are really bad, but there are some reasons to believe, going forward, that they are getting better.”

It's going to be a long time before we actually know whether “abenomics” work.”

Dr. Ethan Harris, Co-head of Global Economics Research, Bank of America Merrill Lynch Global Research

Ethan draws a positive picture of the US economy, saying that the US is close to a self-sustained economic recovery, namely driven by a stronger housing market.

In his view, the main recovery factor in the US is the accommodative monetary policy of the FED, because it has allowed households and companies to improve their balance sheets. Dr. Harries believes that an exit from the current monetary policies will not be made quickly, at the earliest by the end of 2014.

Today, the main challenge in the US is to cut government spending; Ethan calls this the “fiscal shock”. This leads the speaker to a blunt critique of US politicians: Ethan says that politicians have repeatedly made abrupt shifts in economic policy which were and are very bad for the confidence in the US economy.


There is no question that we [the US] are getting closer to a self-sustained [economic] recovery.”

The most bullish sign in the US is the recovery of the housing market.”

Washington will become less of a negative factor.”

I sometimes tell clients that the best thing that could happen to the US would be to cut off Washington and to push it into the Atlantic Ocean. But I don't want it to go too far and make it to Europe.”

My hope is that – well – Washington won't be very productive –, at least, it won't be counterproductive.”

I think that the message the markets will get [from the FED as regards exiting accommodative monetary policies] in the coming months will be: We're in no hurry here!”

Dr. Otmar Issing, President, Center for Financial Studies


Otmar Issing concentrates on the situation in Europe and identifies interest rate spreads between companies in the center of Europe and the periphery as the most decisive challenge Europe faces today. However, those spreads are not linked to monetary parameters of the common European currency but to national economic policies and sovereign risk. Therefore, significant reforms at member state level are necessary today. But carrying out necessary reforms is subject to moral hazard: All too often, individual countries neglect the need for reforms unless they are faced with unsustainably rising interest rates.

In the second part of his talk, Otmar turns to a fundamental lack of the common European currency that he calls a “currency without a state”. In this view, Eurozone member states will have to transfer more elements of sovereignty to the EU level to provide democratic legitimacy to a common monetary policy. However, he takes a rather critical position on the question whether member states will be willing to do so.


In my interpretation, the Euro area is at a fundamental crossroads.”

When the Euro started, it was called a currency without a state.”

As soon as taxpayers' money is included, you come to the question of sovereignty and monetary policy.”

It's [monetary decisions on interest rates] taxation without representation. […] This is not the way Europe should go.”

I'm not sure how many countries will finally be ready to transfer fundamental elements of sovereignty to the European level.”

We are in a crucial moment of the [European] institutional setting.”

Stephen King, Group Chief Economist, HSBC


Stephen analyzes the economic situation in the UK and China.

His opinion on the UK economy is very negative; pointing out that no significant recovery has taken place over the last years. Obviously, the main basket of the UK economy, the financial sector, experiences currently low or even negative growth rates and this affects other key sectors in the UK, namely construction and the public sector.

As regards the Chinese economy, its tremendous growth was, prior to the financial crisis, driven by growing exports. After the financial crisis, falling exports have been compensated by increasing government spending, namely in the infrastructure sector. In the speaker’s opinion, this increases the risk of financial bubbles as well as the realization of tail risks. Ultimately, China’s growth will shift from a purely quantitative growth to a more qualitative (meaning growth based on market-based prices for inputs) growth.


The UK is actually an emerging market in some way or another.”

For the UK, there have been elements of wishful thinking over the last few years – optimism bias.”

Each year, the forecast [for the growth of the UK economy] is virtually the same: Next year is the first year of recovery. It's just that next year never arrives.”

The quality of growth [in China] has been declining [since the financial crisis].”

The intention to reduce tail risk in the longer term certainly leads to lower short-term growth rate [in China].”

From the point of view of the global economy, there has been a kind of increasing dependence on the assumption of China being strong. […] That raises new risks for current account funding in some parts of the emerging world.”

François Pérol, Chief Executive Officer and President of the Management Board, BPCE


Francois emphasizes the importance of common policy measures in Europe. In his view, the absence of a common budget and a common economic policy is a huge bet on the Euro.

On the negative side,

  • Francois wonders whether economic imbalances within the Eurozone (for example full employment in Germany vs. very high unemployment in Greece and Spain) are tolerable, from a social point of view.
  • Recessions are deepening in Eurozone periphery countries.
  • Even in the core of the Eurozone (namely Germany and France), economic activity is slowing down.

On the positive side, financial markets are less nervous since Mario Draghi’s “Whatever it takes” announcement and seem to think that the risk on the common currency has now faded away.

Towards the end of his speech, Francois Pérol specifically comments on the European banking regulation. In his view, reforms are highly important but focus too much on capital markets. As Europe still finances its economy predominantly through banks and a transition towards a capital-market based financing model will take time, today’s regulation should not ignore the necessary transition period.


No common budget, no common economic policy, but a common currency. Maybe we did not know that at that time, but it was a huge bet.”

Is this level [of differences in unemployment rates within the Eurozone] socially tolerable?”

It is not possible to make fundamental institutional moves [in Europe] without the agreement of the people.”

We need a fully loaded and full-fledged banking union, meaning a single supervisory mechanism and a single resolution rule.”

It must be reminded that the Eurozone is still a credit-based economy. It is not yet – not yet – a capital market based economy.”

[The European banking] regulation is mainly made for a capital-market based economy – But this is not the state of the art [in Europe] and we need a transition.”


If you work for a member institution and register with the Institute of International Finance, you can watch or download the speeches here.