Sparks fly in economic divergence debate

Experts at an AsianInvestor forum voice wildly differing views on the drivers of global economics and whether the US Federal Reserve will raise rates next year.
Sparks fly in economic divergence debate

Divergence has become a buzzword in global economic circles of late and it was out in force yesterday at a forum organised by industry body Asia IRP in partnership with AsianInvestor.

But while it was used in reference to the speed of recovery in developed markets, it could equally have described panelists’ views on whether the US Federal Reserve would start raising interest rates next year. For the record, the panel of four was evenly split.

In the opening debate at Asia’s Independent Research Summit entitled Is the global economy broken?, the most balanced (consensus) view came from Arnab Das, strategist for Trusted Sources.

He noted that while the US was in recovery mode, construction had not taken off and there was no wage pressure even as headline unemployment was falling.

“So deflationary pressures are fairly rigid and this recovery is still in many respects a shadow of all former [US] recoveries,” he said. “Our take is that rates will move up, but slowly and with continued forward guidance.”

He argued that while US policymakers were agreed on the need to rebalance their economy – to make it more production and investor-led rather than credit-fuelled – there were factors that would weigh on the speed of recovery.

Although deleveraging had taken place in various sectors, in the household segment this had been primarily through default rather than an increase in savings and payback of debt, meaning gross national debt had barely been reduced.

Moreover the Fed would be constrained in its tightening actions because the other major central banks of Europe and Japan were at differing stages of monetary easing.

“Because of this divergence, the risk of a very strong dollar is very much there,” said Das. “That will constrain how far and fast the Fed is going to tighten.

“It does imply that although we will have rate hikes, it will not be a shocking process because it would derail this weak recovery.”

In agreement on Fed rate rises, but employing different logic, was Diana Choyleva, head of macroeconomic research at Lombard Street Research.

She observed that while the US was ready for rate hikes, Europe and emerging markets were not. On the back of growing labour competitiveness, lower energy costs and deleveraging, the US no longer had a debt problem, she argued.


This caused Jim Walker (pictured), founder and managing director of Asianomics, to look quizical. Das subsequently pointed out that US gross national debt stood at 347% of GDP – a fraction below its historical peak.

But Choyleva’s argument was that deleveraging had taken place in the household sector through default and that debt was now affordable, even if interest rates returned to historical norms.

She pointed to OECD forecasts that the primary budget deficit in the US would reach a level this year consistent with a stable public-debt-to-GDP ratio if nominal GDP growth was at 4% and the nominal effective rate at 2%.

“There has not been much visible fall in debt in the US economy overall, but all the sectors have now adjusted and can afford that,” she said. “It is a very different story to almost everywhere else in the world.”

Walker responded by noting that the US was 81 months into recovery and by this time should be running a huge surplus. “We are on the cusp of where we are supposed to slow down and go back into bust,” he said. “Yet we are talking about a recovery that has not even got rid of the deficit.”

Walker noted the current US unemployment rate of 5.9% was at its 40-year average. But while the average Fed Funds rate was 4.4%, today it stands at 0.25%. “What is that telling you? That the unemployment rate is garbage,” he said.

The only jobs created in the US over the past 14 years had been in health, education and social services sectors, said Walker. But for productive or high-paid services industries, there was negative job creation in the US.

He noted, too, that while 232,000 jobs were created in September this year, some 248,000 of them were for over 65-year-olds. This was forcing young and married people out of the labour market.

The bottom line was that the US labour market was exceptionally weak, he said. As it is unemployment figures that Fed chairman Janet Yellen is focusing to determine when to hike rates, he argued they would not go up next year. “This is a global economy in recession, folks,” he said.

Also in the no camp for Fed rate rises, again for different reasons, was Chen Zhao, chief strategist for BCA. He pointed to three reasons.

Firstly, the US was still dealing with a serious over-saving problem. Secondly, with inflation so low – his research shows that of 22 OECD nations, two-thirds have an inflation rate below 1% – there is no need for higher rates.

And thirdly he is bullish on the US dollar, with an expectation it will strengthen 10-15% from the current level. “Given that, do you think the Fed is going to raise rates? Forget about it.”

He subsequently argued that the reason the global economy had difficulties moving from economic recovery to boom was that the private sector had been delevering. “If you don’t lever up, your spending will be confined by your income growth,” he said.

He also dismissed economic consensus that the public sector needed to retrench, return to surplus and balance its books.

“The private sector has cut debt and created over-saving in the whole economy; that will require the public sector to come in and spend money for the private sector,” he said.

In Japan, Chen argued there was no problem with public sector spending because it was entirely offset by private sector over-saving.

Explaining his view on why the Fed could not raise rates, he said that governments around the world had bought into the need to balance their books “This is very dangerous,” he said.

“It’s a policy that may trigger another recession because we are dealing with a system of over-saving. You want the public sector to save more on top of the private sector over-saving? That is a recipe for falling prices and falling output.”

Das questioned Chen as to whether there was any such thing as too much public debt, to which he replied: “I don’t think so.”

That left Walker at a loss. “I have never heard anything so nutty in my life,” he spluttered.

Both he and Das pointed to the need for structural reform, while Walker said households get out of their debt problems historically by defaulting. Japan relied on hyperinflation in 1946-47, while Asian nations devalued their currencies and defaulted during the Asian financial crisis of 1997-98.

With his socialist dander up, Walker said that using central bank bailouts as a solution to the debt problem was about maintaining the wealth of the rich.

“What we are building into the global economy, what we are seeing on the streets of Hong Kong today, are people who cannot get a foot on the ladder towards being able to afford a property and a decent lifestyle, because we have adopted policies to protect the wealth of the rich and the wealth of banks,” said Walker. “That is a disastrous social policy going forwards.”

In response to Chen’s suggestion that there was no limit to public debt in a domestic currency, Das said there had to be because there was a speed at which economies were able to grow and generate income and wealth.

“It is inconsistent over the long run to think you can exceed that speed limit for your growth rate and your income and wealth indefinitely,” he said. “There will come a point when you need to pay the piper, at which time either you default or you default in a de facto manner by inflating the value of your currency.”

He said Japan had got away with it for so long because it was a net creditor to the rest of the world, but that was changing, given that its current account surplus had been virtually eliminated due to importing more hydrocarbons and turning off nuclear power. “There will come a time when Japan has to deal with its debt problem,” he warned.

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