Are emerging markets about to experience a credit crunch? Slowing growth in China and other emerging market economies (EMEs) does not bode well. Nor does the prospect of rising interest rates in the USA and the resulting increase in the costs of servicing the high levels of dollar-denominated debt in many such countries.
According to the Bank for International Settlements (BIS) (see also), the stock of dollar-denominated debt in emerging market economies has doubled since 2009 and this makes them vulnerable to tighter US monetary policy.
Weaker financial market conditions combined with an increased sensitivity to US rates may heighten the risk of negative spillovers to EMEs when US policy is normalised. …
Despite low interest rates, rising debt levels have pushed debt service ratios for households and firms above their long-run averages, particularly since 2013, signalling increased risks of financial crises in EMEs.
But there is another perspective. Many emerging economies are pursuing looser monetary policy and this, combined with tighter US monetary policy, is causing their exchange rates against the dollar to depreciate, thereby increasing their export competitiveness. At the same time, more rapid growth in the USA and some EU countries, should also help to stimulate demand for their exports.
Also, in recent years there has been a large growth in trade between emerging economies – so-called ‘South–South trade’. Exports from developing countries to other developing countries has grown from 38% of developing countries’ exports in 1995 to over 52% in 2015. With technological catch-up taking place in many of these economies and with lower labour and land costs, their prospects look bright for economic growth over the longer term.
These two different perspectives are taken in the following two articles from the Telegraph. The first looks at the BIS’s analysis of growing debt and the possibility of a credit crunch. The second, while acknowledging the current weakness of many emerging economies, looks at the prospects for improving growth over the coming years.
Articles
‘Uneasy’ market calm masks debt timebomb, BIS warns The Telegraph, Szu Ping Chan (6/12/15)
Why emerging markets will rise from gloom to boom The Telegraph, Liam Halligan (5/12/15)
Questions
- How does an improving US economy impact on emerging market economies?
- Will the impact of US monetary policy on exchange rates be adverse or advantageous for emerging market economies?
- What forms does dollar-denominated debt take in emerging economies?
- Why has south–south trade grown in recent years? Is it consistent with the law of comparative advantage?
- Why is growth likely to be higher in emerging economies than in developed economies in the coming years?
The Federal Reserve chair, Janet Yellen, has been giving strong signals recently that the US central bank will probably raise interest rates at its December 16 meeting or, if not then, early in 2016. ‘Ongoing gains in the labor market’ she said, ‘coupled with my judgement that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2%.’ This, as for many other central banks, is the target rate of inflation.
In anticipation of a rise in US interest rates, the dollar has been appreciating. Its (nominal) exchange rate index has risen by 24% since April 2014 (see chart below).
In the light of the sluggish eurozone economy, the ECB president, Mario Draghi, has been taking a very different stance. He has indicated that he stands ready to cut interest rates further and increase quantitative easing.
At the meeting on 3 December, the ECB did just that. It announced a further cut in the deposit rate, from –0.2 to –0.3 and an extension of the €60 billion per month QE programme from September 2016 to March 2017 (bringing the total by that time to €1.5 trillion – up from €1.1 trillion by September 2016).
Stock market investors had been expecting more, including an increase in the level of monthly asset purchases above €60 billion. Consequently stock markets fell. Both the German DAX and the French CAC 40 stock market indices fell by 3.6%. The euro also appreciated against the dollar by 2.7% on the day of the announcement. Nevertheless, since April 2014, the euro exchange rate index has fallen by 13%. Against the US dollar, the euro has depreciated by a massive 31%.
So what will be the consequences of the very different monetary policies being pursued by the Fed and the ECB? Are they simply the desirable responses to a lack of convergence of the economic performance of the US and eurozone economies? In other words, will they help to bring greater convergence between the two economies?
Or will the desirable effects of convergence be offset by other undesirable effects for the USA and the eurozone and also for the rest of the world?
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Will huge amounts of dollar-denominated debt held by many emerging economies make it harder to service these debts with an appreciating dollar? |
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How much will US exporters suffer from the dollar’s rise and what will the US authorities do about it? |
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Will currency volatility lead to currency wars and, if so, what will be their economic effects? |
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Will the time lags involved in the effects of the continuing programme of QE in the eurozone eventually lead to overheating? Already euro money supply is rising, on both narrow and broad measures. |
The following articles address these issues.
Articles
The Fed and the ECB: when monetary policy diverges The Guardian, Mohamed El-Erian (2/12/15)
European stocks slide after ECB dashes hopes of major QE expansion The Guardian, Heather Stewart and Graeme Wearden (3/12/15)
Mario Draghi riles Germany with QE overkill The Telegraph, Ambrose Evans-Pritchard (3/12/15)
How the eurozone missed its shot at a recovery The Telegraph, Peter Spence (3/12/15)
Yellen Signals Economy Nearly Ready for First Interest-Rate Hike Bloomberg, Christopher Condon (3/12/15)
Exchange rate data
Effective exchange rate indices Bank for International Settlements
Exchange rates Bank of England
Questions
- What would be the beneficial effects to the US and eurozone economies of their respective monetary policies?
- Explain the exchange rate movements that have taken place between the euro and the dollar over the past 19 months. How do these relate to the various parts of the balance of payments accounts of the two economies?
- Is it possible for the USA to halt the rise in the dollar while at the same time raising interest rates? Explain.
- Why are some members of the ECB (e.g. the German and Dutch) against expanding QE? Assess their arguments.
- What will be the impact of US and eurozone monetary policies on emerging economies?
- What will be the impact of US and eurozone monetary policies on the UK?
- Why did the euro appreciate after the Mario Draghi’s press statement on 3 December? What has happened to the dollar/euro exchange rate since and why?
George Osborne in his recent Autumn Statement, once again stressed that ‘the government is committed to strong, sustainable and balanced growth’. But while he plans to reduce government debt as a percentage of GDP, consumer debt is rising, both absolutely and as a percentage of household disposable income. The rise in household borrowing, and the resulting rise in consumer expenditure, has been the main factor driving economic growth. It has not been exports nor, until recently, investment, as the Chancellor had hoped. Indeed, investment in new housing is falling.
The Office for Budget Responsibility in its latest Economic and Fiscal Outlook forecasts that gross household debt will reach 163 per cent of household disposable income by 2021, up from 146% at the end of 2015.
Consumer gross debt includes both secured debt and unsecured debt. Secured debt is essentially debt secured on property (i.e. mortgages), while unsecured debt is largely in the form of credit card debt, overdrafts and personal loans.
The chart shows that from 2008 to 2013, gross debt fell as a percentage of personal disposable income. Following the financial crisis, banks were more cautious about lending as they sought to increase their capital and liquidity ratios. And consumers were more cautious about borrowing as the uncertainty made many people keen to reduce their debts. This decline in credit reversed the massive growth in household debt from 2000 to 2008: one of the contributing factors to the financial crisis. (Click here for a PowerPoint of the chart.)
But since late 2013, household debt – both secured and unsecured – has been rising. In absolute (nominal) terms, individuals’ debt is now £1.43 trillion, slightly above the previous high in 2008. And as the chart shows, the OBR forecasts that it will continue rising. This makes consumers more vulnerable to adverse economic shocks, such as a downturn in emerging markets, another crisis in the eurozone or financial crises in other parts of the world.
And as consumer debt has been rising, the personal saving ratio (the ratio of saving to personal disposable incomes) has been falling and is now lower than before the financial crisis.
The rise in consumer borrowing has been of some concern to the Bank of England. Andy Haldane, the Bank’s Chief Economist, appearing before the Treasury Select Committee, warned that consumer credit, and in particular personal loans, had been ‘picking up at a rate of knots. That ultimately might be an issue that the Financial Policy Committee might want to look at fairly carefully.’
Articles
The UK economy may be growing, but in a highly unbalanced way The Guardian, Phillip Inman (27/11/15)
UK growth hit by biggest drag from net trade on record The Telegraph, Szu Ping Chan (27/11/15)
Surge in consumer lending could prompt Bank of England intervention The Guardian, Patrick Collinson and Jill Treanor (30/11/15)
Consumer spending rise troubles Bank of England The Guardian, Heather Stewart (24/11/15)
Between Debt and the Devil by Adair Turner review – should the government start printing money? The Guardian, Tom Clark (25/11/15)
Lending rises as Bank of England ponders new curbs Financial Times, Ferdinando Giugliano (30/11/15)
Carney indicates BoE’s willingness to rein in credit Financial TImes, Chris Giles (5/11/15)
FCA sounds alarm at rising credit card debt Financial Times, Emma Dunkley (3/11/15)
Interest rates will stay low for longer – but household debt is a worry, says BoE The Telegraph, Szu Ping Chan (24/11/15)
Seven years after the crisis, Britain is still addicted to the drug of debt Independent, James Moore (1/12/15)
Vince Cable: Former Business Secretary warns that ‘severe economic storms’ are on the way Independent, Ben Chu (14/11/15)
The risks stalking the UK economy BBC News, Kamal Ahmed (1/12/15)
OBR publications
Economic and fiscal outlook Office for Budget Responsibility (25/11/15)
Economic and fiscal outlook charts and tables (Excel file) Office for Budget Responsibility (25/11/15)
Questions
- Does it matter if economic growth is driven by a rise in consumer demand, in turn driven by a risen in consumer credit?
- Is there an inflation risk from growth being driven by a rise in consumer credit?
- What is the precise relationship between the household saving ratio and the household debt ratio? (Which of these ratios is a stock and which is a flow?)
- What might cause a fall in consumer borrowing? Would this be a good thing?
- Why did consumer borrowing fall following the financial crisis of 2007–8?
- What could the Bank of England’s Financial Policy Committee do to curb consumer borrowing?
- If banks were forced to hold more reserves, how could aggregate demand be maintained? Would ‘helicopter money’ be a good idea?
- What are ‘countercyclical buffers for banks’? What are the arguments for raising them at the current time?
The Paris Climate Change Conference (COP21) is under way. At the opening on November 30, 150 Heads of State gathered in Paris, most of whom addressed the conference. With representatives from 195 countries and observers from a range of organisations, the conference is set to last until 11 December. Optimism is relatively high that a legally binding and universal agreement will be reached, with the aim of keeping global warming below 2°C – what is generally regarded as a ‘safe’ limit.
But although it is hoped that a successor to the Kyoto Protocol of 1997 will be put in place, there are many problems in getting so many countries to agree. They may all wish to reduce global warming, but there is disagreement on how it should be achieved and how the burden should be shared between countries.
There are several difficult economic issues in the negotiations. The first is the size and impact of the external costs of emissions. When a country burns fossil fuels, the benefits are almost entirely confined to residents of that county. However, the environmental costs are largely external to that country and only a relatively small fraction is borne by that country and hardly at all by the polluters themselves, unless there is a carbon tax or other form or penalty in place. The problem is that the atmosphere is a common resource and without collective action – national or international – it will be overused.
The second problem is one of distribution. Politicians may agree in principle that a solution is necessary which is equitable between nations, but there is considerable disagreement on what is meant by ‘equitable’ in this context. As the third Guardian article below puts it:
The most important hurdle could be over whether industrialised countries like the US, UK and Japan, which have contributed the most to the historical build-up of emissions, should be obliged to cut more than developing countries. India, on behalf of many poor countries, will argue that there must be “differentiation” between rich and poor; but the US wants targets that are applicable to all. A collision is inevitable.
A third problem is that of uncertainty. Although there is general agreement among scientists that human action is contributing to global warming, there is less agreement on the precise magnitude of the causal relationships. There is also uncertainty over the likely effects of specific emissions reductions. This uncertainty can then be used by governments which are unwilling to commit too much to emissions reductions.
A fourth difficulty arises from the intertemporal distribution of costs and benefits of emissions reductions. The costs are born immediately action is taken. Carbon taxes or charges, or subsidies to renewables, or caps on emissions, all involve higher energy prices and/or higher taxes. The flows of benefits (or lower costs), however, of reduced emissions are not likely to be fully experienced for a very long time. But governments, whether democratic or dictatorships, tend to have a relatively short time horizon, governed by the electoral cycle or the likelihood of staying in power. True, governments may not be solely concerned with power and many politicians may have genuine desires to tackle climate change, but their political survival is still likely to be a major determinant of their actions.
Of course, if there is strong public opinion in favour of action to reduce emissions, governments are likely to respond to this. Indeed, all the expressions of public support for action ahead of the conference from all around the world, do give some hope for a strong agreement at the Paris conference. Nevertheless, there is still widespread scepticism in many countries over the relationship between human action and climate change, and many argue that the costs of policies to tackle climate change exceed the benefits.
Game theory can shed some insights into the difficulties ahead for the negotiators. The global optimum may be for a strong agreement, binding on all countries. The Nash equilibrium, however, may be a situation where countries push for their own interests at the expense of others, with the final agreement being much more minimalistic.
There do, however, seem to be more reasons to be cheerful at this summit that at previous ones. But negotiations are likely to be hard and protracted over the coming days.
Videos and webcasts
Paris Climate Conference: The Big Picture Wall Street Journal on YouTube, Jason Bellini (30/11/15)
Why is the Paris UN climate summit important? PwC, Leo Johnson (14/10/15)
Paris climate change summit 2015: ‘the near impossible task’ Channel 4 News on YouTube, Tom Clarke (30/11/15)
COP21: Rallies mark start of Paris climate summit BBC News, David Shukman (29/11/15)
With climate at ‘breaking point’, leaders urge breakthrough in Paris Reuters, Bruce Wallace and Alister Doyle (1/12/15)
COP21: Paris conference could be climate turning point, says Obama BBC News (30/11/15)
Leaders meet to reach new agreement on climate change BBC News, David Shukman (30/11/15)
Poll: Growing Doubts Over Climate Change Causes Sky News, Thomas Moore (30/11/15)
Paris climate protesters banned but 10,000 shoes remain The Guardian (29/11/15)
Articles
COP-21 climate deal in Paris spells end of the fossil era The Telegraph, Ambrose Evans-Pritchard (29/11/15)
Is there an economic case for tackling climate change? BBC News, Andrew Walker (28/11/15)
World Leaders in Paris Vow to Overcome Divisions on Climate Change Wall Street Journal, William Horobin and William Mauldin (30/11/15)
Experts discuss how to build a carbon-free energy industry The Guardian, Tim Smedley (25/11/15)
Africa could lead world on green energy, says IEA head The Guardian, Anna Leach (11/11/15)
Climate change talks: five reasons to be cheerful or fearful The Guardian, John Vidal (30/11/15)
The Paris climate change summit, explained in 4 charts The Washington Post, Philip Bump (30/11/15)
Why This Goal To Curb Climate Change ‘Is Not Ideal’ Huffington Post, Jacqueline Howard (30/11/15)
Paris climate change talks: What the different groups attending expect from these crucial meetings Independent, Tom Bawden (29/11/15)
UN Climate Change Conference: World Leaders Call For Price On CO2 Emissions Despite Uphill Battle At Paris Summit International Business Times, Maria Gallucci (30/11/15)
World Bank, six nations call for a price on carbon SBS (Australia) (1/12/15)
Uruguay makes dramatic shift to nearly 95% electricity from clean energy The Guardian, Jonathan Watts (3/12/15)
Questions
- Why is COP21 considered to be so significant?
- For what reasons is there hope for a binding agreement to limit global warming to 2°C?
- What would be the effect on global warming of the commitments made by more than 180 countries prior to the conference?
- What market failings contribute towards the problem of global warming?
- Why, if all countries want to achieve a binding agreement at the Paris conference, is it likely to be so difficult to achieve?
- Explain what is meant by a ‘Nash equilibrium’ and how the concept is relevant to international negotiations.
- Why is China investing heavily in solar power?
- Could Africa lead the world in green energy?
- Is a ‘cap and trade’ (tradable permits) system (a) an effective means of reducing emissions; (b) an efficient system?
- What is the best way of financing investment in renewable energy?
- How does the structure/order of the Paris conference differ from previous COPs? Is such a structure more likely to achieve substantial results?
There is a select group of countries (areas) that have something in common: the USA, the UK, Japan and the eurozone. The currency in each of these places is one of the IMF’s reserve currencies. But is China about to enter the mix?
The growth of China has been spectacular and it is now the second largest economy in the world, behind the USA. It is on the back on this growth that China has asked the IMF for the yuan to be included in the IMF’s basket of reserve currencies. The expectation is that Christine Lagarde, the IMF’s Managing Director, will announce its inclusion and, while some suggest that the yuan could become one of the major currencies in the world over the next decade following this move, others say that this is just a ‘symbolic gesture’. But that doesn’t seem to matter, according to Andrew Malcolm, Asia head of capital at Linklaters:
“The direct impact won’t be felt in the near term, not least because implementation of the new basket won’t be until Q3 2016. However the symbolic importance cannot be overlooked…By effectively endorsing the renminbi as a freely useable currency, it sends a strong signal about China’s importance in the global financial markets.”
Concerns about the yuan being included have previously focused on China’s alleged under-valuation of its currency, as a means of boosting export demand, as we discussed in What a devalued yuan means to the rest of the world. However, China has made concerted efforts for the IMF to make this move and China’s continuing financial reforms may be essential. The hope is that with the yuan on the IMF’s special list, it will boost the use of the yuan as a reserve currency for investors. It will also be a contributor to the value of the special drawing right, which is used by the IMF for pricing its emergency loans.
Although the Chinese stock market has been somewhat volatile over the summer period, leading to a devaluation of the currency, it is perhaps this move towards a more market based exchange rate that has allowed the IMF to consider this move. We wait for an announcement from the IMF and the articles below consider this story.
Chinese yuan likely to be added to IMF special basket of currencies The Guardian, Katie Allen (29/11/15)
‘Chinese yuan set for IMF reserve status BBC News (30/11/15)
IMF to make Chinese yuan reserve currency in historic move The Telegraph, James Titcomb (29/11/15)
China selloff pressure Asia stocks, yuan jumpy before IMF decision Reuters, Hideyuki Sano (30/11/15)
IMF’s yuan inclusion signals less risk taking in China Reuters, Pete Sweeney and Krista Hughes (29/11/15)
Did the yuan really pass the IMF currency test? You’ll know soon Bloomberg, Andrew Mayeda (29/11/15)
Questions
- What is meant by a reserve currency?
- Why do you think that the inclusion of the yuan on the IMF’s list of reserve currencies will boost investment in China?
- One of the reasons for the delay in the yuan’s inclusion is the alleged under-valuation of the currency. How have the Chinese authorities allegedly engineered a devaluation of the yuan? To what extent could it be described as a ‘depreciation’ rather than a ‘devaluation’?
- Look at the key tests that the yuan must pass in order to be included. Do you think it has passed them given the report produced a few months ago?
- The weighting that a currency is given in the IMF’s basket of currencies affects the interest rate paid when countries borrow from the IMF. How does this work?
