What It Means For Global Economies & Corporates
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AUSTERITY ON THE ROPES
Still other observers believe the ongoing debt renegotiations between the ECB, EU and the IMF, collectively known as the Troika, and the new anti-austerity government in Greece could help change the climate in Europe. Even if Greece compromises, its electoral success and pointed criticism of austerity could influence the outcome of elections in other countries, including Spain, Portugal and Ireland. “With austerity proving detrimental to growth,” notes McCormick, “the appetite to get reforms through is clearly diminishing.”
And that could scare Germany into backing off from demands for more austerity measures, which critics contend are self-defeating. “You end up cutting your nose off to spite your face if you end up with deflation,” McCormick points out, since countries’ ability to pay off their debts falls with declining economic activity. He adds that European policymakers have forgotten the lessons of the Great Depression by failing to realize that.
As Odendahl sees it, “We’ve been talking a great deal about competitiveness, but much less so about demand. That shift should have happened already.” He worries that the ECB has awakened too late to that reality. But he says he’s more optimistic than most that the resulting devaluation of the euro as a result of QE will help.
Odendahl contends that fears of a global currency war are overstated, given that most countries aren’t pursuing truly mercantilist policies but merely trying to stimulate demand, and that the US economy still isn’t tied so deeply into world trade to make the resulting increase in the dollar’s value a threat to the US recovery. In sharp contrast, Ashmore’s Dehn thinks the dollar is hugely overvalued.
But even if less austerity would help reverse the course of prices in the eurozone, many observers doubt it’s politically possible. “It’s politically unlikely for all sorts of reasons,” says Kevin Logan, chief US economist for HSBC. “That’s one reason rates are so low.” Adds McCormick of DBRS: “I don’t see any way out of making labor and product markets more competitive.”
Until that happens, the economy remains dependent on monetary policy to keep deflation at bay. And while much of the financial markets reacted with glee to Draghi’s announcement of QE, prices of futures contracts on sovereign bonds barely budged. By that measure, says Dehn, “inflation expectations didn’t change much.”
For that reason, Odendahl believes Draghi should increase the ECB’s inflation target to 4% from 2%, although Germany is likely to complain loudly over such a move. But how can a central bank generate confidence that it will create inflation when its toolkit is so noticeably depleted? “That’s exactly the problem,” says Odendahl.
In normal times, he notes, all a central bank has to do to stimulate demand is lower its short-term interest rate. But these aren’t normal times. Adds the economist: “It’s very dangerous when a central bank loses that ability.”
HSBC contends that a new global accord like the so-called Plaza and Louvre Accords of the mid-1980s, in which currency interventions were used to try and stabilize markets, is necessary to correct the imbalances dogging growth. Ideally, the bank’s economists say, a successful accord would do three basic things: The United States would reprise its former role as consumer of last resort by agreeing to offset a stronger dollar with domestic monetary and fiscal stimuli, including a decision to keep policy rates lower for longer. China would attempt to grapple with an excessively high level of domestic household savings by opening up capital markets and, in the process, boosting consumer demand. Germany would raise its retirement age considerably to encourage Germans to save less, paving the way to a sustained reduction in the German current-account surplus.
But HSBC contends such an accord is unlikely in the current political climate. That leaves the world hoping Draghi and his counterparts elsewhere can regain their ability somehow to conjure higher inflation.