The Group of 20 finance ministers are meeting this weekend in South Korea, in the southern port city of Busan. True, such meetings do not of themselves change much but they give a moment to pause, a time for the rest of us to take stock of what is happening to the world economy and what the policy-makers might do next. Come to the big point in a moment, which is that we are not through this yet by any means, and focus on some of the smaller ones.
For a start, note that this is the G20, not the G7. The forum is global; no longer the club of the old developed world. That shift of course reflects the changing balance of power in the world economy, and rightly so. But it means that policy will be determined by a much wider group of people and there is already an example of that.
It is the idea of a global levy on bank transactions to help fund any future government support. The Germans and the French like it, and it is possible that in the old G7 line-up it might have got legs. But Canada is opposed, I suspect largely because its banks have been well-managed and escaped the whole banking crisis, and it is none too keen on having its banks taxed to support weaker ones elsewhere. Now, writing ahead of the meeting, it is clear that China is against the idea too, and China is home to the largest banks in the world. So too is India against it, whose banking system is pretty sound.
If neither China nor India come on board, this global bank levy is not going to happen. Individual governments can tax their own banks but the idea won't go global. Indeed, to many people in the emerging world the banking crisis was created by Western greed and stupidity. Why should their banks be taxed when they have done nothing wrong?
But the biggest issue facing the finance ministers is whether the recovery is secure, and what might abort it. Here it is Europe that is giving most concern, a concern reflected in the continuing fall of the euro, a fall that in the view of the market has some way yet to go.
It is strange, isn't it, how fashions change in currencies. For several years the pound was remarkably stable, while the dollar and the euro swung up and down around it. Then, understandably in the context of what was to happen to the British economy, it plunged. But just as sterling was reasonably stable between the mid-1990s and a couple of years ago, the euro had a period of stability from 2003 onwards on its trade-weighted measure – the dollar/euro swings gave an exaggerated idea of its volatility, as you can see from the large graph.
Now that it is back to something like "fair value", the obvious next questions are – to what extent is it likely to fall below fair value, and what are the consequences of that?
The market view, that there will be a prolonged period of weakness, feels right. Europe needs a period of undervaluation if it is to boost demand, which remains very weak. But there is a problem. It is that a weak euro tends to help the stronger European economies more than the weaker ones. I had not fully appreciated this until I saw some research by the economics team at ING Bank. As you can see from the right-hand graph, Germany exports some 35 per cent of its GDP and, while Ireland exports even more, Portugal exports only 18 per cent of its output, Spain 15 per cent and Greece only 5 per cent. True, these three countries are big tourist destinations, unlike Germany, and tourism does respond quickly to exchange-rate movements, but the general picture – that a weak euro helps boost demand in Germany more than in Spain or Greece – is still valid.
This is troubling. If the weaker euro does not help Spain or Greece much, then the fiscal squeeze both have been forced to impose becomes all the more painful. The extreme nervousness about Greek debt has receded a little but the weakness of the Spanish banking system has brought into focus the huge shift that has to take place in the Spanish economy too. A small bank had to be rescued and there are fears that more rescues are on the way. The country faces austerity, starting from a base of 20 per cent unemployment. As a result the market seriously questions whether Spanish debt is worth the full 100 cents in the euro, and if not, why take the risk? We have reached a situation where the only purchaser of Greek, Spanish or Portuguese public debt, at least in any quantity, has been the European Central Bank.
Ireland also had a huge property crash, but thanks to its strong export sector can dig its way out. Indeed, the first signs of growth there are starting to come through. But the prospects for Greece, Spain and Portugal – and even Italy – don't look good. Strange as it may seem, given what we know will happen in our emergency Budget on 22 June, sterling is starting to look like a safe haven for spare cash. Or if not a haven, it could at least be a bargain-basement parking place. At least UK banks are now secure; unfortunately the same cannot be said for eurozone ones.
The weakness of Europe's banks will hold back the recovery there. There is a possibility of some sort of emergency happening – further big bank rescues – in the next few weeks. Add in the disturbingly low private-sector job creation in the US and it is clear that we are not, as noted above, though this one yet. The question that all this raises is whether there will be a second downward leg to this cycle, the W-shaped recession. That is the thought at the back of the mind of every finance minister and central banker in the developed world, including those at the G20 meeting.
My own feeling is that some sort of pause in the developed world is very likely. We will get a pause here and if the housing market is anything to go by, that might come quite soon. It is hard to see the eurozone extracting itself from its present difficulties until well into next year. And the US remains fragile. The rest of the world economy, however, will continue to grow.
So a full-scale second leg to recession is unlikely. We are not going back down to the depths of mid-2009, here or anywhere else. But expect several months of uneven news, and quite possibly a three-month period of negative growth in several of the main economies in the developed world. But as this G20 meeting should remind us, there is another world beyond.
We risk Seventies' misery if inflation is used to tackle debt
So will we try to inflate our way out of our debts? It has been tried before, with the long post-war inflation cutting the real value of Britain's Second World War debt. While the present burden will not see anything like those debt levels, the idea has been gaining ground with investors. The international outlook helps, for other countries, including the US, are accumulating similar debts – while the emerging nations, though they have much lower debt levels, do in general have higher levels of inflation.
But there is a problem. The most difficult period of the post-war era was in the 1970s and early 1980s, when inflation threatened the entire market economy of the developed world. It took two full cycles, the recessions of the 1980s and 1990s, to crush it, with all the misery they caused.
Charlie Bean, a deputy governor of the Bank of England, has just warned of the dangers of such an approach, and while you might respond, "he would say that, wouldn't he?", no one who went through the misery of that time would want to repeat it.
For the moment, the financial markets, representing global savers, believe the central banks will hold the line. But the soaring price of gold says something different and it would be easy for confidence to slither away. What is happening to confidence in the Spanish government shows how fragile things are. The investors who are losing faith with the Club Med countries could turn on the UK. With the RPI running at more than 5 per cent, we are on a knife edge.
There is one simple thing we could do to boost confidence – go back to the former measure of inflation as an anchor for monetary policy. Instead of using the consumer price index, the European measure adopted against the Bank's wishes, we could use the retail price index, less mortgage interest rates. And we could fix the central rate, as before, at 2.5 per cent.
No one is fooled by the CPI as we all know it understates inflation. The only reason for switching was the possibility that the UK might join the euro, something that is no longer on the radar. Everyone knows and trusts the RPI. So why not go back to the Bank's preferred measure?Reuse content