There are signs that the US economy may resume growth in the current quarter: The fall in economic activity in the second quarter was just 1 per cent at an annualised rate, and unemployment in July has dropped from 9.5 per cent to 9.4 per cent. There are some other positive signs for the economic outlook: The household savings rate has increased from zero to 7 per cent and this, together with a fall in oil prices, has led to a sharp drop in the external account deficit. There are also some indications that housing prices have bottomed out. Some major players in the financial services sector have reported a strong growth in profits in Q2. Besides, compensation levels in the financial services sector are soaring once again. Last week, the Federal Reserve kept interest rates unchanged, expressing the hope that the worst could be over and that the economy is levelling out. It would surely have been re-assured by the reversion of the Libor-OIS spread to normal levels, suggesting a liquid interbank market.
However, the economy is still not out of the woods. Retail sales fell 0.1 per cent in July, and, by one estimate, the banking system may need to write off another $600 billion of bad debts to corporate and consumer segments (the IMF’s estimate is much higher). The corporate mortgage-backed securities market is experiencing defaults of the order of $2 billion a month (gross outstandings are $600 billion). In recent weeks, Nobel laureates Joseph Stiglitz and Paul Krugman have opined that another stimulus package would be needed before the economy comes back to a level of self-sustaining growth. Krugman, in particular, is looking at a W-shaped recovery — in other words, another dip in economic activity after some time. This is, of course, quite possible, if only because, somewhere down the line, the monetary authorities would need to start reversing the flood of money they have poured into the economy over the last 18 months or so. And, it remains to be seen whether this can be done without affecting recovery.
Meanwhile, there does not seem to be any consensus among analysts as to whether the beginning of economic recovery would lead to a stronger or a weaker dollar.
Elsewhere in the developed world, both France and Germany recorded 1.3 per cent per annum GDP growth in Q2, but Japan and Germany are still expected to record GDP falls of 6 per cent in 2009, and the UK economy also looks weak despite both monetary and fiscal stimuli more or less exhausted. To be sure, industrial orders with German manufacturers have gone up sharply, as have most commodity prices. On the other hand, the Baltic Dry Cargo Index recently dropped further, indicating that global trade remains in the slow lane.
China recorded a growth rate close to 8 per cent in the second quarter of 2009, even as exports, one of the major drivers of the economy for the last several decades, fell sharply. Surely this is the result of the huge domestic stimulus package of the order of $600 billion announced by China some time ago. Here again, the key question is whether growth will be sustained once the stimulus is over, and whether domestic demand, rather than exports, would become the engine of growth. As it is, the possibility of losing a significant part of the value of its dollar reserves in the medium term must be concentrating the Chinese policy makers’ minds on domestic demand-driven growth. One recent measure is the CNY (Chinese Yuan) 650 billion currency swap lines that the People’s Bank of China has exchanged with its Asian trading partners: The objective is to persuade them to invoice bilateral trade in the Chinese currency, perhaps as the first step to globalising it. It is a moot factor as to whether this would do muchto the growth in China’s reserves and the vulnerability of the central bank’s balance sheet to a sharp fall of the dollar.
Again, while the dollar-yuan rate has been held steady for a little more than a year now, the possibility of a resumption in the yuan’s appreciation in dollar terms can hardly be discounted. In this situation, why would importers from China prefer to switch the invoicing currency to the yuan, despite the availability of swap facilities? In a broader sense, artificial measures to promote the use of a currency for invoicing rarely succeed: Remember how countries in southern Asia tried to promote the use of the Asian Currency Unit for intra-regional rate, but had to give up?
Meanwhile, the gap in growth rates between emerging Asia and the developed countries is likely to be the highest ever in the current year, close to double digits.
Tailpiece: In an article in this newspaper last month (July 28), Deepak Lal described China’s exchange rate policies as ‘foolish’. Surely, there is something to commend in foolish policies if they can help an economy grow at double digit-levels for three decades, and bring hundreds of millions of dirt-poor people above the poverty line in a generation, a feat none of today’s developed economies have ever managed to achieve!
