A GLOBAL OUTLOOK
the economy of the European Union (EU) has dominated the news in the past few years, and continues to register on the radar. Although other global issues, such as slower growth in emerging economies like China, and the United States federal policy, have risen to a level of concern recently.
On the European front, Germany seems to be the fulcrum of much of the debate, as it is both part of the solution and part of the problem. Many policy makers and economists alike agree that a short term solution to the EU dilemma would involve fiscal consolidation through Eurobonds. In other words, issuing debt investments whereby banks lend money for a fixed term, at a fixed interest rate, providing national governments with liquidity and thereby helping national governments lower their debt to GDP ratio.
The banks spread the risk by lending to the entire seventeen member team at an interest rate lower than lending at an individual rate to lower and higher risk players. It is clear that such a move would benefit the high debt-stricken countries like Greece, Italy and Portugal who already have difficulties servicing their debt at the current interest rates. However, this plan would leave better performing countries like Germany worse off, as they would be forced to endure higher interest levels than those currently established.
Germany’s position against the Eurobond has been found on the grounds of moral-hazard: a joint guarantee of liquidity to Eurozone members at more attractive rates would provide national governments with incentive to spend beyond their means, again.
In either case, the global economy, and the German economy in particular, would be better off than having individual EU members exit the party and return to their national currency. This would lead to a devaluation of the Euro, or worse, a total Eurozone collapse. A collapse would not only hurt investors and governments who hold euros, but will severely impact the German economy which is co-dependent on its export sector. Germany sells an estimated 60% of its products to various parts of Europe.
In a recent conference, CIBC deputy chief economist, Benjamin Tal, painted a picture in various shades of grey of the current economic climate and shared his short term outlook. His overall view is that monetary policy will be conservative in the years to come for the Bank of Canada and the US Federal Reserve. From a fiscal perspective, countries employing spending cuts are likely to underperform and take a longer road to recovery because of a reduced spending multiplier.
In the case of the EU, a majority of the member countries have large real estate exposure and are at higher risk of fluctuations in the exchange markets. More importantly, EU banks have grown to be the type of institution considered to be “too-big-to-fail”.
China is experiencing a housing market slowdown with a real estate to GDP ratio nearly twice in magnitude to that of the US at the peak of the bubble. The slowdown is significant given a majority of the investment component in China’s GDP is in physical capital.
The US economy appears to be closing the gap with a healthier disposable income to house debt ratio, and improved real wages. The US housing market is recovering as well as the margin with more flow of investors. A critical and bold statement made by Tal during his presentation is the notion that the manufacturing sector is the future of the US economy. We have witnessed the severe blow the automotive sector endured during the recession years in one form or another, whether it’s the flood of job losses, the demise of the Pontiac brand or the media coverage of the events that followed both US and Canadian government interventions. In any case, the big-three were shaken severely and hopes of rebounding seemed unlikely until recently. Tal’s statement is not without controversy and time will only tell.
Canada is not investing enough according to Tal. The private sector is sitting on cash rather than finding new venues to spend it. The stronger loonie is making the manufacturing sector less competitive. The Canadian economy is becoming less sensitive to low interest rates, leaving monetary policy less effective. The issue of debt to income ratio is important, but more importantly is the composition of the debt according to Tal. The majority of the contribution of growth in household debt since the recession has been from heavy debt load borrowers – those the bank characterizes with a debt to gross income ratio equal or greater than 1.6. The event of a housing bubble seems unlikely as it requires sudden events of large magnitude, like large growth of interest rates in a short span or a subprime delinquency. Canada seems clear of such contaminations. •