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?
The International Monetary Fund has just published its six-monthly World Economic Outlook (WEO). The publication assesses the state of the global economy and forecasts economic growth and other indicators over the next few years. So what is this latest edition predicting?
Well, once again the IMF had to adjust its global economic growth forecasts down from those made six months ago, which in turn were lower than those made a year ago. As Larry Elliott comments in the Guardian article linked below:
Every year, economists at the fund predict that recovery is about to move up a gear, and every year they are disappointed. The IMF has over-estimated global growth by one percentage point a year on average for the past four years.
In this latest edition, the IMF is predicting that growth in 2015 will be slightly higher in developed countries than in 2014 (2.0% compared with 1.8%), but will continue to slow for the fifth year in emerging market and developing countries (4.0% in 2015 compared with 4.6% in 2014 and 7.5% in 2010).
In an environment of declining commodity prices, reduced capital flows to emerging markets and pressure on their currencies, and increasing financial market volatility, downside risks to the outlook have risen, particularly for emerging market and developing economies.
So what is the cause of this sluggish growth in developed countries and lower growth in developing countries? Is lower long-term growth the new norm? Or is this a cyclical effect – albeit protracted – with the world economy set to resume its pre-financial-crisis growth rates eventually?
To achieve faster economic growth in the longer term, potential national output must grow more rapidly. This can be achieved by a combination of more rapid technological progress and higher investment in both physical and human capital. But in the short term, aggregate demand must expand sufficiently rapidly. Higher short-term growth will encourage higher investment, which in turn will encourage faster growth in potential national output.
But aggregate demand remains subdued. Many countries are battling to cut budget deficits, and lending to the private sector is being constrained by banks still seeking to repair their balance sheets. Slowing growth in China and other emerging economies is dampening demand for raw materials and this is impacting on primary exporting countries, which are faced with lower exports and lower commodity prices.
Quantitative easing and rock bottom interest rates have helped somewhat to offset these adverse effects on aggregate demand, but as the USA and UK come closer to raising interest rates, so this could dampen global demand further and cause capital to flow from developing countries to the USA in search of higher interest rates. This will put downward pressure on developing countries’ exchange rates, which, while making their exports more competitive, will make it harder for them to finance dollar-denominated debt.
As we have seen, long-term growth depends on growth in potential output, but productivity growth has been slower since the financial crisis. As the Foreword to the report states:
The ongoing experience of slow productivity growth suggests that long-run potential output growth may have fallen broadly across economies. 
Persistently low investment helps explain limited labour productivity and wage gains, although the joint productivity of all factors of production, not just labour, has also been slow. Low aggregate demand is one factor that discourages investment, as the last World Economic Outlook report showed. Slow expected potential growth itself dampens aggregate demand, further limiting investment, in a vicious circle.
But is this lower growth in potential output entirely the result of lower demand? And will the effect be permanent? Is it a form of hysteresis, with the effect persisting even when the initial causes have disappeared? Or will advances in technology, especially in the fields of robotics, nanotechnology and bioengineering, allow potential growth to resume once confidence returns?
Which brings us back to the short and medium terms. What can be done by governments to stimulate sustained recovery? The IMF proposes a focus on productive infrastructure investment, which will increase both aggregate demand and aggregate supply, and also structural reforms. At the same time, loose monetary policy should continue for some time – certainly as long as the current era of falling commodity prices, low inflation and sluggish growth in demand persists.
Articles
Uncertainty, Complex Forces Weigh on Global Growth IMF Survey Magazine (6/10/15)
A worried IMF is starting to scratch its head The Guardian, Larry Elliott (6/10/15)
Storm clouds gather over global economy as world struggles to shake off crisis The Telegraph, Szu Ping Chan (6/10/15)
Five charts that explain what’s going on in a miserable global economy right now The Telegraph, Mehreen Khan (6/10/15)
IMF warns on worst global growth since financial crisis Financial Times, Chris Giles (6/10/15)
Global economic slowdown in six steps Financial Times, Chris Giles (6/10/15)
IMF Downgrades Global Economic Outlook Again Wall Street Journal, Ian Talley (6/10/15)
WEO publications
World Economic Outlook, October 2015: Adjusting to Lower Commodity Prices IMF (6/10/15)
Global Growth Slows Further, IMF’s latest World Economic Outlook IMF Podcast, Maurice Obstfeld (6/10/15)
Transcript of the World Economic Outlook Press Conference IMF (6/10/15)
World Economic Outlook Database IMF (October 2015 edition)
Questions
- Look at the forecasts made in the WEO October editions of 2007, 2010 and 2012 for economic growth two years ahead and compare them with the actual growth experienced. How do you explain the differences?
- Why is forecasting even two years ahead fraught with difficulties?
- What factors would cause a rise in (a) potential output; (b) potential growth?
- What is the relationship between actual and potential economic growth?
- Explain what is meant by hysteresis. Why may recessions have a permanent negative effect, not only on trend productivity levels, but on trend productivity growth?
- What are the current downside risks to the global economy?
- Why have commodity prices fallen? Who gains and who loses from lower commodity prices? Does it matter if falling commodity prices in commodity importing countries result in negative inflation?
- To what extent can exchange rate depreciation help commodity exporting countries?
- What is meant by the output gap? How have IMF estimates of the size of the output gap changed and what is the implication of this for actual and potential economic growth?
The second largest economy in the world, with a record expansion to its current economic status: China. With a phenomenal population, massive migration to the cities and incredible infrastructure development, China has fast become a key economic player, with environmental and pollution problems to match.
The price of China’s economic development may be too high for some people. Increases in incomes, growth and employment may be good news, but is the cost too high? Do economic growth and progress mean poor health and if so, is this a price worth paying
Another big topic within China is the impact on inequality. With growth accelerating in urban areas, population movement from the rural to the urban has been a common feature across China, but this has also created greater inequality. This population movement has separated families and played a role in creating barriers of access to health and education.
The following article from the BBC considers a range of indicators within China and you may also want to review some earlier blog postings on the Sloman News Site which analyse the Chinese economy.
Cement and pig consumption reveal China’s huge changes BBC News (21/9/15)
Questions
- What are the key drivers of China’s development?
- What are the costs and benefits of rural-urban migration?
- To what extent do you think there may be a trade-off between quality and quantity when it comes to infrastructure projects? Or is Chinese labour simply more efficient relative to countries such as the UK?
- How should we measure economic development? If access to education and health care is limited in the more rural areas, but widely available in the larger cities, does this suggest a country that is developing?
- What are the main externalities that China must tackle? Are they domestic issues or global ones? What about the solutions?
- If a key driver of Chinese growth and development is government investment in infrastructure projects, is this true and sustainable growth or do you think it might slowly disappear if the government doesn’t continue to invest?
- Do you think the relative success of China can be replicated in other emerging nations and in particular in nations within Africa?
Interest rates are the main tool of monetary policy and have a history of being an effective tool in creating macroeconomic stability. There has been much discussion since the end of the financial crisis concerning when interest rates would rise in the US (and the UK) and for the US, the case is stronger, given its rate of growth, which has averaged at 2.2% per annum since June 2009.
As in the UK, the question of ‘will rates rise?’ has a clear and certain answer: Yes. The more challenging question is ‘when?’. Much of the macroeconomic data for the US is promising, with positive economic growth (and relatively strong in comparison to the UK and Eurozone), a low unemployment rate and inflation of 0.3%. This last figure is ‘too low’, but it comes in at a much more attractive 1.2% if you exclude food and energy costs and there is an argument for doing this, given the price of oil. The data on unemployment and growth might suggest that the economy is at a stage where a rate rise could be managed, but the inflation data indicates that low interest rates might be needed to keep inflation above 0%. Furthermore, there are concerns that the low unemployment figure is somewhat misleading, given that under-employment is quite high at 10.3% and there are still many who are long-term unemployed, having been out of work for more than 6 months.
Interest rates can be a powerful tool in affecting the components of aggregate demand (AD) and hence the macroeconomic variables. If interest rates fall, it can help to stimulate AD by reducing borrowing costs for consumers and businesses, reducing the incentive to save, cutting variable rate mortgage payments and depreciating the exchange rate. Collectively these effects can stimulate an economy and hence create economic growth, reduce unemployment and push up prices. However, interest rates have been at almost 0% since the financial crisis, so the only way is up. Reversing the aforementioned effects could then spell trouble, if the economy is not in a sufficiently strong position.
For many, the strength of the US economy, while relatively good, is not yet good enough to justify a rate rise. It may harm investment, growth and unemployment and none of these variables are sufficiently high to warrant a rate rise, especially given the slowdown in the emerging markets. Karishma Vaswani, from BBC News said:
“The current global hand-wringing and head-holding over whether the US Fed will or won’t raise interest rates later has got investors here in Asia worried about what this means for their economies.
The Fed has become the favourite whipping boy of Asia’s central bankers, with cries from India to Indonesia to “just get on with it”.”
There are many, including Professor John Taylor from Stanford University and a former senior Treasury official, a rate rise is well over-due. The market is expecting one and has been for some time and these expectations aren’t going away, so ‘just get on with it.’ Janet Yellen, the Chair of the Federal Reserve is in a tricky situation. She knows that whatever is decided, markets around the world will react – no pressure then! The following articles consider the interest rate debate.
Articles
FTSE slides ahead of Fed interest rates decision The Telegraph, Tara Cunningham (17/9/15)
US’s interest rate rise dilemma BBC News, Andrew Walker (17/9/15)
US interest rate rise: how it could affect your savings and your mortgage Independent (17/9/15)
All eyes on Federal Reserve as it prepares for interest rate announcement The Guardian, Rupert Neate (16/9/15)
Federal Reserve meeting: Will US interest rates rise and should they? The Telegraph, Peter Spence (16/9/15)
Markets push US rate rise bets into 2016 as China woes keep Fed on hold: as it happened The Telegraph, Szu Ping Chan (17/9/15)
Federal Reserve puts rate rise on hold The Guardian (17/9/15)
US central bank leave interest rates unchanged BBC News (17/5/15)
Fed leaves interest rates unchanged Wall Street Journal, Jon Hilsenrath (17/9/15)
Asian markets mostly rally, US Futures waver ahead of Fed interest rate decision International Business Times, Aditya Tejas (17/9/15)
Data
Selected US interest rates Board of Governors of the Federal Reserve System (see, for example, Federal Funds Effective rate (monthly))
Questions
- What happened to US interest rates in September?
- Present the main arguments for keeping interest rates on hold.
- What were the arguments in favour of raising interest rates and do they differ depending on whether interest rates rise slowly or very rapidly?
- How did stock markets around the world react to Janet Yellen’s announcement? Is it good news for the UK?
- Using a diagram to support your explanation, outline why interest rates are such a powerful tool of monetary policy and how they affect the main macroeconomic objectives.
- Do you think other central banks will take note of the Fed’s decision, when they make their interest rate decisions in the coming months? Explain your answer.
China has a key role in the global economy. Recording double digit growth for a number of years and posting impressive export figures, China’s has been an economy on an upward trajectory. But its growth has been slowing and this might spell trouble for the global economy, as was discussed in the following blog. For many, China is the pendulum and the direction it moves in will have a big influence on many other countries.
There are some suggestions that China’s rapid growth has been somewhat artificial, in particular following the financial crisis, where we saw massive investment by state-owner enterprises, banks and local government. This has led to a severe imbalance within the Chinese economy, with high levels of debt. One of the key factors that has enabled China to grow so quickly has been strong exports. China has typically had a large current account surplus, often balanced by large current account deficits in many Western countries.
The exchange rate is a key component in keeping strong export growth and the devaluation of the Chinese currency in August (see What a devalued yuan means to the rest of the world) is perhaps a suggestion that export growth in China is lower than desired. Devaluing the currency will boost the competitiveness of Chinese exports and this in turn may lead to a growth in the current account surplus, which had fallen quite significantly from around 10% to 2%.
The problem is that China is currently imbalanced and this is likely to create problems around the world. With globalisation, the free movement of capital and people, deflation in the West and falling world asset prices, the situation in China is crucial. Although you will find many articles about China and blogs on this site about its devaluation, its growth and policy, the BBC News article below considers the conflicts that exist between three key economic objectives:
1. currency stability
2. the free movement of capital
3. independent monetary policy
and the need for some international co-operation and co-ordination to enable China’s economy to return to internal and external balance.
China’s impossible trinity BBC News, Duncan Weldon (8/9/15)
Questions
- What is meant by internal balance?
- What is external balance?
- Would you suggest that China is suffering from an imbalanced economy? If so, which type of imbalance and why is this a problem for China and for the world economy?
- The article refers to the trilemma. Why can an country not achieve all 3 parts of the trilemma? You should explain why each combination of 2 aspects is possible, but why the third is problematic.
- Use a diagram to explain why a fall in the exchange rate will boost the competitiveness of exports and why this can create economic growth.
- Why is a devalued Chinese currency bad news for the rest of the world?
- How could international co-operation and co-ordination help China?
