Economic puzzles: the world, Europe, Brexit and renminbi Martin Wolf, Associate Editor & Chief Economics Commentator, Financial Times

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1 Economic puzzles: the world, Europe, Brexit and renminbi Martin Wolf, Associate Editor & Chief Economics Commentator, Financial Times FT-ANZ RMB Growth Strategy Series 24 th June Sydney

2 Economic puzzles 1. World 2. Eurozone 3. Brexit? 4. Renminbi 2

3 1. World Developed countries are in a managed depression : Real interest rates are zero Monetary policy is hyper-accommodative Inflation is ultra-low and falling Emerging economies also face big challenges: They did well in the crisis But emerging economies have been slowing since China s growth model is in the middle of a risky transition But the world economy continues to grow 3

4 1. World RATES AS LOW AS THEY WILL GO 8 CENTRAL BANK INTERVENTION RATES (per cent) Fed BoE Buba/ECB BoJ 4

5 1. World SPAIN BECOMES JAPAN 4.0% CORE INFLATION RATE (year-on-year, less food and fuel) 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% Jan-2009 Jan-2010 Jan-2011 Jan-2012 Jan-2013 Jan-2014 Jan-2015 Eurozone Germany Italy Japan (less consumption tax increase) UK US Spain 5

6 1. World THE FALL OF PRODUCTIVITY GROWTH 2.5% GROWTH OF OUTPUT PER WORKER (trend annual rate) (Source: Conference Board) 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% United Kingdom United States Canada Germany France Japan Italy Spain

7 1. World PROGRESSIVE DECELERATION 8 SUCCESSIVE 5-YEAR AHEAD GROWTH FORECASTS (Source: IMF WEO) World Advanced economies Emerging market economies Fall 2011 Fall 2012 Fall 2013 Fall 2014

8 2. Eurozone The eurozone is a special case of a general story: Huge credit expansions creating huge imbalances Collapse in credit flows Financial crises and deep recessions Slow recovery Big role of the European Central Bank Additional role of reform But heavy reliance on external demand This greater Germany model will fail 8

9 2. Eurozone 9 EUROZONE BECOMES JAPAN EUROZONE AND US REAL GDP AND DOMESTIC DEMAND 90.0 Q Q Q Q Q Q Q Q Eurozone GDP Eurozone Demand US GDP US Demand

10 2. Eurozone IMBALANCES AND REBALANCING 4.0% EUROZONE IMBALANCES ON CURRENT ACCOUNT (as per cent of Eurozone GDP) 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% Germany Other creditors Vulnerable countries France Others Eurozone 10

11 2. Eurozone A LOST DECADE OR MUCH MORE REAL GDP IN THE CRISIS Q Q Q Q Q Q Q Q Eurozone Germany Italy Spain Greece Ireland Portugal UK 11

12 3. Brexit? The UK has always been uncomfortable in the European Union This has now got far worse, because of: Immigration, including from the EU The eurozone crisis and Rise of populist forces The Conservative party is split and worried by UKIP The prime minister must do a very complex dance 12

13 3. Brexit? Likely outcome: Almost impossible to know what will happen Cameron s problem is that any deal he can reach is very unlikely to change the UK s position in any fundamental way The argument that the UK can only stay in a reformed EU would then backfire But most parties and business want the UK to stay in And there is no clear alternative. Also Scotland might leave 13

14 3. Brexit? So the no vote would be a leap into the dark UK voters will probably be too cautious Also alternatives all worse: The European Economic Area (Norway) The Customs Union (Turkey) EFTA (Iceland) EFTA plus bilateral treaties (Switzerland) WTO membership WTO plus new FTAs 14

15 4. Future of the renminbi Will the renminbi become a major reserve currency? Should the Chinese authorities want the RMB to become a major reserve currency? Should the rest of the world want the RMB to become a major reserve currency? My tentative answer to all three questions is: no. 15

16 4. Future of the renminbi Will the renminbi become a major reserve currency? Arguments in favour: China wants the RMB to become a reserve currency, by inclusion in the International Monetary Fund s Special Drawing Right basket, together with the dollar, euro, yen and pound China has a huge and rapidly growing economy, likely to be the largest in the world, on all measures, in the 2020s China is already the world s largest exporter of goods and second largest importer China s public finances seem to be in decent shape 16

17 4. Future of the renminbi Arguments against the RMB becoming a major reserve currency: China holds huge foreign currency reserves, which suggest the Chinese authorities do not believe the RMB is an adequate reserve asset The RMB is not now freely usable According to PBoC governor Zhou Xiaochuan in April, China will adopt a concept of managed convertibility. So the RMB may never be freely usable - or at least not for a very long time 17

18 4. Future of the renminbi CHINA S ACTUALLY HOLDS RESERVES $14,000 GLOBAL FOREIGN CURRENCY RESERVES ($bn) $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 18 China Rest of Asia Other developing countries Industrial countries

19 4. Future of the renminbi So what might happen? The RMB is already an important settlement currency in world trade According to SWIFT, On average, 31 per cent of payments in Asia Pacific with China and Hong Kong are now made in RMB, up from 7 per cent in April China has itself promoted greater use of the renminbi for such purposes Balances for transactions are also becoming substantial 19

20 4. Future of the renminbi Yet even all this would not necessarily make the RMB a major reserve asset: A reserve asset must be safe and liquid in all circumstances, and particularly in times of crisis Inevitably, such reserve currencies have been supplied by open, law-governed market economies with deep and liquid capital markets At present China cannot credibly promise to create such a currency It would require a revolution 20

21 4. Future of the renminbi Should the Chinese authorities want the RMB to become a reserve currency? The value of having a reserve currency is exaggerated China risks losing control over the domestic financial system That would make the economy somewhat crisis-prone It might well make sense to retain restrictions on convertibility, instead And so limit the possibility of becoming a dominant reserve asset 21

22 4. Future of the renminbi Should the rest of the world want the RMB to become a reserve currency? If China were to abandon controls on convertibility, it might create substantial instability at home and abroad China already has much the largest flow of savings in the world If unregulated, the impact on world markets might be destabilising It is normal for the opening of a previously closed economy to the world financial system to finish up in a crisis 22

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