UBS at Davos: ‘We’ve swapped global imbalances for domestic disequilibrium’; Your guide to EM compartmentalisation

UBS at Davos: ‘We’ve swapped global imbalances for domestic disequilibrium’

FT Alphaville | Jan 24 09:01 | 2 comments | Share

According to a white paper released by UBS for this week’s World Economic Forum in Davos, the world economy remains as unbalanced today as it has been over the past quarter century – with big implications for the global economic recovery.

The authors argue that the adjustment of current account imbalances in the world economy was mostly a function of recession, not shifts in competitiveness. Large current account deficit countries restored external equilibrium at the cost of domestic disequilibrium, so output plummeted and unemployment soared.

One of the consequences of shifting imbalances is changes in capital flows and hence financing conditions, particularly for sovereigns. A related point concerns the role of central banks. For instance, a different buyer of US Treasuries had to step in, which during quantitative easing has been the Federal Reserve.

A second consequence is that the unwinding of external imbalances and the ensuing sluggish global recovery have taken their toll on global trade.

One of the authors of the white paper, Stephane Deo, global head of asset allocation and macro strategy at UBS Investment Bank, will be joining FT Alphaville at 11am on Friday for a session of Markets Live.

Deo’s bullet points:

Over the past five years there has been a clear inverse relationship between changes in domestic demand and changes in the external balance.

With the advent of smaller US external deficits, the rise in foreign official holdings of Treasuries (from $600bn in 2000 to $4,000bn in 2013) has slowed and may even be reversing (with a decline of roughly $125bnbetween March and August 2013).

The trade intensity of the global recovery has fallen. Prior to the crisis, a 1 percentage point increase in global GDP growth boosted world trade by roughly 2 percentage points. In the past five years, the trade multiplier has collapsed. Trade is growing in line with sluggish world GDP growth.

With domestic demand still skewed towards the US, the UBS paper concludes conclude that:

The US is still the sole major economic region capable of driving up its rate of growth via increased domestic demand.

If the US is to restore full employment, it will have to do so without much help from the rest of the world.

Given that the US economy does not have the same vitality that it did before the crisis, the exported recoveries elsewhere will remain correspondingly weaker for longer.

 

Your guide to EM compartmentalisation

Izabella Kaminska

| Jan 24 16:50 | 4 comments | Share

It’s been a tough day for EM. But just in case you were tempted to bundle the whole region together to make a sweeping generalisation about future performance, it’s worth reading through the following note from Capital Economics on Friday.

As they explain, EM is no longer the place it used to be. There are clear divisions emerging, and understanding which countries influence into each other more directly than others matters now more than ever:

Market turbulence in Turkey, Ukraine and now Argentina has led to talk of a new crisis sweeping emerging markets (EMs). But the emerging world has become a far more diverse place over the past decade. The real lesson from recent events is that the need for investors to discriminate between individual EMs has never been greater.

In the past, financial crises have indeed tended to sweep from one EM to another, primarily because they shared many of the same vulnerabilities. The financial crisis that began in Thailand in 1997 swept through the rest of Asia, hit Russia and also caused a wobble in parts of Latin America. Today, the emerging world is a very different place.

Readers wanting to know more might like to ask about our Emerging Markets services. But at the risk of generalising, there are perhaps five separate groups among the 56 EMs that we now cover.

1) The first is those countries where serial mismanagement by the authorities is now posing a risk to economic stability. Of the countries that have been in the spotlight recently, Argentina and Ukraine fall into this category. So too does Venezuela.

2) The second is those countries that have lived beyond their means and that now face a period of weaker growth. These countries are generally the ones that are most vulnerable to Fed tapering and the shift towards tighter global monetary conditions over the next couple of years, Turkey falls into this category, but so too does South Africa, parts of South East Asia and some countries in Latin America (such as Chile and Peru).

3) The third group is those where the legacy of previous booms continues to cloud the outlook. These are mainly in Emerging Europe, where a combination of the hangover from last decade’s credit bubble and strong financial ties to the euro-zone means that banking sectors are still fragile.Hungary stands out in this regard, but so too does Romania.The big risk for these EMs is a re-escalation of financial stress in the euro-zone.

4) The fourth (and by far the largest) grouping is of countries facing domestic structural problems, with the BRICs being the most important in this regard. Their prospects will be shaped by the extent to which policymakers implement economic reform, rather than events in Europe or the actions of the Fed.

5) The fifth and final group of countries is those where the outlook is brightening. This includes Korea (where the improving performance of key export markets should pull up growth), the Philippines (where economic reforms should lift growth) and Mexico(which should benefit from both economic reform and faster growth in export markets).

So there you have it. Don’t go mixing your Group 1 crisis with a Group 5 crisis.