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The US Economy’s Dirty Secret

The US Economy’s Dirty Secret

Relatively strong US growth amid sluggishness elsewhere is not what economics textbooks would predict. But persistently low interest rates and weak inflation bring multiple benefits to American firms and consumers, while the adverse impact of the global slowdown on US exports should not be overstated.

SAN DIEGO – There is a dirty little secret in economics today: the United States has benefited – and continues to benefit – from the global slump. The US economy is humming along, even while protesters in the United Kingdom hurl milkshakes at Brexiteers, French President Emmanuel Macron confronts nihilist yellow-vested marchers, and Chinese tech firms such as Huawei fear being frozen out of foreign markets.

Last year, the US economy grew by 2.9%, while the eurozone expanded by just 1.8%, giving President Donald Trump even more confidence in his confrontational style. But relatively strong US growth amid sluggishness elsewhere is not what economics textbooks would predict. Whatever happened to the tightly integrated world economy that the International Monetary Fund and the World Bank have been advocating – and more recently extolling – since World War II?

The US economy is in a temporary but potent phase in which weakness abroad lifts spirits at home. But this economic euphoria has nothing to do with Trump-era spite and malice, and much to do with interest rates.

Borrowing costs are currently lower than at any time since the founding of the US Federal Reserve in 1913, or in the UK’s case since the Bank of England was established in 1694. The ten-year US Treasury bond is yielding about 2.123%, and in April, the streaming service Netflix issued junk bonds at a rate of just 5.4%.

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Time for a True Global Currency

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Time for a True Global Currency

The International Monetary Fund’s global reserve asset, the Special Drawing Right, is one of the most underused instruments of multilateral cooperation. Turning it into a true global currency would yield several benefits for the global economy and the international monetary system.

NEW YORK – This year, the world commemorates the anniversaries of two key events in the development of the global monetary system. The first is the creation of the International Monetary Fund at the Bretton Woods conference 75 years ago. The second is the advent, 50 years ago, of the Special Drawing Right (SDR), the IMF’s global reserve asset.

When it introduced the SDR, the Fund hoped to make it “the principal reserve asset in the international monetary system.” This remains an unfulfilled ambition; indeed, the SDR is one of the most underused instruments of international cooperation. Nonetheless, better late than never: turning the SDR into a true global currency would yield several benefits for the world’s economy and monetary system.

The idea of a global currency is not new. Prior to the Bretton Woods negotiations, John Maynard Keynes suggested the “bancor” as the unit of account of his proposed International Clearing Union. In the 1960s, under the leadership of the Belgian-American economist Robert Triffin, other proposals emerged to address the growing problems created by the dual dollar-gold system that had been established at Bretton Woods. The system finally collapsed in 1971. As a result of those discussions, the IMF approved the SDR in 1967, and included it in its Articles of Agreement two years later. 

Although the IMF’s issuance of SDRs resembles the creation of national money by central banks, the SDR fulfills only some of the functions of money. True, SDRs are a reserve asset, and thus a store of value. They are also the IMF’s unit of account.

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The Sorry State of the World Economy

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The Sorry State of the World Economy

Data released in January paint a bleak picture of advanced-economy prospects. Even if some emerging economies – which face serious challenges of their own – manage to pick up some of the slack, the world economy will remain encumbered by the combination of economic interconnectedness and political balkanization.

NEW YORK – January is traditionally a time for assessing the developments of the previous year, in order to anticipate what the new one has in store. Unfortunately, even though we may be at a turning point for the better politically, the data that have emerged in the last month do not paint a promising picture of the global economy’s short-term prospects.

The tone was set early in the month by the World Bank’s Global Economic Prospects, along with the accompanying articles. The report paints a picture as bleak as its subtitle – “Darkening Skies” – and cuts the growth forecast for the advanced economies in 2020 to 1.6% (down from 2.2% in 2018).

Moreover, last week, the European Central Bank sounded the alarm over the eurozone economy. Between the prospect of a disorderly Brexit and rising protectionism, exemplified by the trade war between the United States and China, Europe is subject to increasing uncertainty.

Making matters worse, Germany is facing a growth slowdown. According to its own official data, the economy contracted by 0.2% in the third quarter of 2018, while the Purchasing Managers Index for manufacturing sank to 49.9 – a four-year low. Given Germany’s role as the backbone of the eurozone economy, its economic struggles are likely to cascade beyond its borders.

This is particularly problematic, because, after more than a decade of fighting crisis and recession, the advanced economies have depleted their ammunition for countering a slowdown. With the ECB’s benchmark interest rate at zero, there is little room for a cut.

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Two Cheers for Population Decline

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Two Cheers for Population Decline

Eventual gradual population decline, provided it results from free choice, should be welcomed. Indeed, the greatest demographic challenge to human welfare is not low fertility and population aging, but rather the high fertility rates and rapid population growth still seen in Pakistan, much of the Middle East, and Africa.

LONDON – Since China abolished its one-child policy on January 1, 2016, annual births, after a temporary increase to 17.86 million that year, have actually fallen, from 16.55 million in 2015 to 15.23 million in 2018. The baby boom that wasn’t should surprise no one.

No other successful East Asian economy has ever imposed a one-child policy, but all have fertility rates far below replacement level. Japan’s fertility rate is 1.48 children per woman, South Korea’s is 1.32 and Taiwan’s 1.22. China’s fertility rate will almost certainly remain well below replacement level, even if all restrictions on family size are now removed.

Population decline will inevitably follow. According to the United Nations’ medium projection, East Asia’s total population will fall from 1.64 billion today to 1.2 billion in 2100. Nor is this simply an East Asian phenomenon. Iran’s fertility rate (1.62) is now well below replacement level, and Vietnam’s 1.95 slightly so. Across most of the Americas, from Canada (1.56) to Chile (1.76), rates are already well below two, or falling fast toward it.

The clear pattern is that successful economies have lower fertility rates: Chile’s rate is much lower than Argentina’s (2.27), and wealthier Indian states, such as Maharashtra and Karnataka, already have fertility rates around 1.8. In the poorer states of Uttar Pradesh and Bihar, fertility rates over three are still observed.

We should always be cautious about inferring universal rules of human behavior, but, as Darrel Bricker and John Ibbitson suggest in their recent book Empty Planet: The Shock of Global Population Decline, it seems we can identify one.

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Risks to the Global Economy in 2019

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Risks to the Global Economy in 2019

Over the course of this year and next, the biggest economic risks will emerge in those areas where investors think recent patterns are unlikely to change. They will include a growth recession in China, a rise in global long-term real interest rates, and a crescendo of populist economic policies.

CAMBRIDGE – As Mark Twain never said, “It ain’t what you don’t know that gets you into trouble. It’s what you think you know for sure that just ain’t so.” Over the course of this year and next, the biggest economic risks will emerge in those areas where investors think recent patterns are unlikely to change. They will include a growth recession in China, a rise in global long-term real interest rates, and a crescendo of populist economic policies that undermine the credibility of central bank independence, resulting in higher interest rates on “safe” advanced-country government bonds.

A significant Chinese slowdown may already be unfolding. US President Donald Trump’s trade war has shaken confidence, but this is only a downward shove to an economy that was already slowing as it makes the transition from export- and investment-led growth to more sustainable domestic consumption-led growth. How much the Chinese economy will slow is an open question; but, given the inherent contradiction between an ever-more centralized Party-led political system and the need for a more decentralized consumer-led economic system, long-term growth could fall quite dramatically.

Unfortunately, the option of avoiding the transition to consumer-led growth and continuing to promote exports and real-estate investment is not very attractive, either. China is already a dominant global exporter, and there is neither market space nor political tolerance to allow it to maintain its previous pace of export expansion. Bolstering growth through investment, particularly in residential real estate (which accounts for the lion’s share of Chinese construction output) – is also ever more challenging.

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An Optimist’s Guide to Climate Change

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An Optimist’s Guide to Climate Change

Grim environmental news is nothing new, but 2018 brought a deluge of it, and some now argue that the world has reached the point of no return for climate change. But new research shows that it is not too late to change course.

WASHINGTON, DC – During a recent commute to work, as my car inched along in rush-hour traffic, I watched a heron stalk the banks of the Potomac River. The majestic bird was a timely reminder that nature and beauty can be found in the unlikeliest of circumstances. And yet, even for optimists like me, it is getting harder to be hopeful about the fate of our planet.

Grim environmental news is nothing new, but 2018 brought a deluge of it. One report noted that vertebrate populations have declined by 60% in the last four decades, and less than a quarterof the Earth’s land has escaped the effects of human activity. By 2050, less than 10% of the planet’s land area will be untouched by anthropogenic change.

Perhaps most sobering was a study from the United Nations Intergovernmental Panel on Climate Change (IPCC), which warned that the world is not on track to meet emissions targets needed to keep global warming to 1.5° Celsius above pre-industrial levels, the threshold set by the 2015 Paris climate agreement. The consequences of this failure grow more extreme with every fraction of a degree by which the mark is missed.

Amid these negative trends, some now argue that the world has reached the point of no return for climate change. But, as new findings from The Nature Conservancy indicate, it is not too late to change course.

Last year, we collaborated with the University of Minnesota and 11 other leading academic and research institutions to assess how the world’s future food, water, and energy needs might affect environmental health.

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Central Bankers’ Fiscal Constraints

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Central Bankers’ Fiscal Constraints

With policy interest rates near zero in most advanced economies (and just above 2% even in the fast-growing US), there is little room for monetary policy to maneuver in a recession without considerable creativity. But those who think fiscal policy alone will save the day are stupefyingly naive.

CAMBRIDGE – If you ask most central bankers around the world what their plan is for dealing with the next normal-size recession, you would be surprised how many (at least in advanced economies) say “fiscal policy.” Given the high odds of a recession over the next two years – around 40% in the United States, for example – monetary policymakers who think fiscal policy alone will save the day are setting themselves up for a rude awakening.

Yes, it is true that with policy interest rates near zero in most advanced economies (and just above 2% even in the fast-growing US), there is little room for monetary policy to maneuver in a recession without considerable creativity. The best idea is to create an environment in which negative interest-rate policiescan be used more fully and effectively. This will eventually happen, but in the meantime, today’s overdependence on countercyclical fiscal policy is dangerously naïve.

There are vast institutional differences between technocratic central banks and the politically volatile legislatures that control spending and tax policy. Let’s bear in mind that a typical advanced-economy recession lasts only a year or so, whereas fiscal policy, even in the best of circumstances, invariably takes at least a few months just to be enacted.

In some small economies – for example, Denmark (with 5.8 million people) – there is a broad social consensus to raise fiscal spending as a share of GDP. Some of this spending could easily be brought forward in a recession.

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Climate Change Action Cannot Ignore Social Issues

floods pakistanGideon Mendel For Action Aid/ In Pictures/Corbis via Getty Images

 Climate Change Action Cannot Ignore Social Issues

Despite a series of troubling new reports and studies, the world has yet to respond adequately to the threat posed by global warming. One reason is that policymakers have not made the connection between climate action and the social and political challenges their countries face.

PRINCETON/VIENNA – Climate scientists are sounding the alarm about global warming, but the world is not responding. In October, the United Nations Intergovernmental Panel on Climate Change warned of catastrophic risks to health, livelihoods, water supplies, and human security if global warming is not limited to 1.5° Celsius relative to the pre-industrial level, a target set by the 2015 Paris climate agreement. At the moment, however, we are on track for a 3°C increase.

Then, in November, the Fourth National Climate Assessment in the United States predicted that without swift action to reduce greenhouse-gas emissions, the US economy would suffer “substantial damages.” But President Donald Trump’s administration appears utterly unconcerned.

How is it possible that the slow-motion threat of climate devastation has not yet been halted?

Insights from the social sciences can help answer this question. In a recent report and companion book, the International Panel on Social Progress (IPSP), where we serve as committee members, analyzed social justice and equality across a number of sectors. One conclusion stands out: the only way to tackle the threat posed by climate change is by simultaneously addressing social and political challenges.

When ignored, social issues can trigger political turmoil, which can undermine the political will to fight climate change. For example, despite the implementation deal that was reached on December 15 in Poland, the Paris agreement remains in jeopardy, owing to political upheaval in many countries. In the US and Brazil, voters angry over socioeconomic issues elected leaders who are hostile to climate action.

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Europe’s Year of Living Defensively

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Europe’s Year of Living Defensively

With the future of the EU-UK relationship shrouded in uncertainty and crises brewing in France, Italy, and elsewhere, 2019 will be another difficult year for Europe. And if populist forces prevail in the European Parliament election in May, it could be an impossible one.

BERLIN – From a European perspective, 2019 promises to be another difficult year, dominated by large challenges that could easily turn into menacing crises. Barring a major reversal, the United Kingdom will withdraw from the European Union on March 29. A brewing economic and financial crisis in Italy will intensify, threatening the stability of the eurozone. And France will likely remain beset by populist protests, diminishing its potential to take a lead role in the pursuit of EU-level reforms.

Moreover, the European Parliament election in May could well deliver a nationalist majority or near-majority, which would then the next members of the European Commission, the leaders of the European Council and European Central Bank, and the High Representative for Foreign Affairs and Security Policy. Needless to say, a nationalist victory would be a disaster for the EU, because it would derail necessary reforms and further divide member states.

Whatever happens, Europe’s internal political drama will play out against a backdrop of international turmoil. At the same time that Russia is its aggression in eastern Ukraine, US President Donald Trump is waging a trade war against China, and could expand it to the EU (which he has deemed a “foe”). And, more broadly, the global economy is weakening, and growth will continue to slow in the months ahead.

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The Biggest Emerging Market Debt Problem Is in America

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The Biggest Emerging Market Debt Problem Is in America

A decade after the subprime bubble burst, a new one seems to be taking its place in the market for corporate collateralized loan obligations. A world economy geared toward increasing the supply of financial assets has hooked market participants and policymakers alike into a global game of Whac-A-Mole.

CAMBRIDGE – A recurrent topic in the financial press for much of 2018 has been the rising risks in the emerging market (EM) asset class. Emerging economies are, of course, a very diverse group. But the yields on their sovereign bonds have climbed markedly, as capital inflows to these markets have dwindled amid a general perception of deteriorating conditions.

Historically, there has been a tight positive relationship between high-yield US corporate debt instruments and high-yield EM sovereigns. In effect, high-yield US corporate debt is the emerging market that exists within the US economy (let’s call it USEM debt). In the course of this year, however, their paths have diverged (see Figure 1). Notably, US corporate yields have failed to rise in tandem with their EM counterparts.

What’s driving this divergence? Are financial markets overestimating the risks in EM fixed income (EM yields are “too high”)? Or are they underestimating risks in lower-grade US corporates (USEM yields are too low)?

Taking together the current trends and cycles in global factors (US interest rates, the US dollar’s strength, and world commodity prices) plus a variety of adverse country-specific economic and political developments that have recently plagued some of the larger EMs, I am inclined to the second interpretation.

In what is still a low-interest-rate environment globally, the perpetual search for yield has found a comparatively new and attractive source in the guise of collateralized loan obligations (CLOs) within the USEM world.

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From Economic Crisis to World War III

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From Economic Crisis to World War III

The response to the 2008 economic crisis has relied far too much on monetary stimulus, in the form of quantitative easing and near-zero (or even negative) interest rates, and included far too little structural reform. This means that the next crisis could come soon – and pave the way for a large-scale military conflict.

BEIJING – The next economic crisis is closer than you think. But what you should really worry about is what comes after: in the current social, political, and technological landscape, a prolonged economic crisis, combined with rising income inequality, could well escalate into a major global military conflict

The 2008-09 global financial crisis almost bankrupted governments and caused systemic collapse. Policymakers managed to pull the global economy back from the brink, using massive monetary stimulus, including quantitative easing and near-zero (or even negative) interest rates.

But monetary stimulus is like an adrenaline shot to jump-start an arrested heart; it can revive the patient, but it does nothing to cure the disease. Treating a sick economy requires structural reforms, which can cover everything from financial and labor markets to tax systems, fertility patterns, and education policies.

Policymakers have utterly failed to pursue such reforms, despite promising to do so. Instead, they have remained preoccupied with politics. From Italy to Germany, forming and sustaining governments now seems to take more time than actual governing. And Greece, for example, has relied on money from international creditors to keep its head (barely) above water, rather than genuinely reforming its pension system or improving its business environment.

The lack of structural reform has meant that the unprecedented excess liquidity that central banks injected into their economies was not allocated to its most efficient uses. Instead, it raised global asset prices to levels even higher than those prevailing before 2008.

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The Makings of a 2020 Recession and Financial Crisis

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The Makings of a 2020 Recession and Financial Crisis

Although the global economy has been undergoing a sustained period of synchronized growth, it will inevitably lose steam as unsustainable fiscal policies in the US start to phase out. Come 2020, the stage will be set for another downturn – and, unlike in 2008, governments will lack the policy tools to manage it.

NEW YORK – As we mark the decennial of the collapse of Lehman Brothers, there are still ongoing debates about the causes and consequences of the financial crisis, and whether the lessons needed to prepare for the next one have been absorbed. But looking ahead, the more relevant question is what actually will trigger the next global recession and crisis, and when.

The current global expansion will likely continue into next year, given that the US is running large fiscal deficits, China is pursuing loose fiscal and credit policies, and Europe remains on a recovery path. But by 2020, the conditions will be ripe for a financial crisis, followed by a global recession.

There are 10 reasons for this. First, the fiscal-stimulus policies that are currently pushing the annual US growth rate above its 2% potential are unsustainable. By 2020, the stimulus will run out, and a modest fiscal drag will pull growth from 3% to slightly below 2%.

Second, because the stimulus was poorly timed, the US economy is now overheating, and inflation is rising above target. The US Federal Reserve will thus continue to raise the federal funds rate from its current 2% to at least 3.5% by 2020, and that will likely push up short- and long-term interest rates as well as the US dollar.

Meanwhile, inflation is also increasing in other key economies, and rising oil prices are contributing additional inflationary pressures. That means the other major central banks will follow the Fed toward monetary-policy normalization, which will reduce global liquidity and put upward pressure on interest rates.

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The Turkish Emerging Market Timebomb

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The Turkish Emerging Market Timebomb

As the Turkish lira continues to depreciate against the dollar, fears of a classic emerging-market crisis have come to the fore. Turkish President Recep Tayyip Erdoğan’s populist economic policies have finally caught up to him, and sooner or later, he will have to make nice with his country’s traditional Western allies.

LONDON – Turkey’s falling currency and deteriorating financial conditions lend credence, at least for some people, to the notion that “a crisis is a terrible thing to waste.” I suspect that many Western policymakers, in particular, are not entirely unhappy about Turkey’s plight.

But more to the point, Turkey has a large, persistent current-account deficit, and a belligerent leader who does not realize – or refuses to acknowledge – that his populist economic policies are unsustainable. Moreover, Turkey has become increasingly dependent on overseas investors (and probably some wealthy domestic investors, too).

Given these slowly gestating factors, markets have long assumed that Turkey was headed for a currency crisis. In fact, such worries were widespread as far back as the fall of 2013, when I was in Istanbul interviewing business and financial leaders for a BBC Radio series on emerging economies. At that time, markets were beginning to fear that monetary-policy normalization and an end to quantitative easing in the United States would have dire consequences globally. The Turkish lira has been flirting with disaster ever since.

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Learning from America’s Forgotten Default

​President Franklin D. Roosevelt​ signs the Gold Bill (also known as the Dollar Devaluation Bill) ​Bettmann/Getty Images

Learning from America’s Forgotten Default

One of the most pervasive myths about the United States is that the federal government has never defaulted on its debts. There’s just one problem: it’s not true, and while few people remember the “gold clause cases” of the 1930s, that episode holds valuable lessons for leaders today.

LOS ANGELES – One of the most pervasive myths about the United States is that the federal government has never defaulted on its debts. Every time the debt ceiling is debated in Congress, politicians and journalists dust off a common trope: the US doesn’t stiff its creditors.

There’s just one problem: it’s not true. There was a time, decades ago, when the US behaved more like a “banana republic” than an advanced economy, restructuring debts unilaterally and retroactively. And, while few people remember this critical period in economic history, it holds valuable lessons for leaders today.

In April 1933, in an effort to help the US escape the Great Depression, President Franklin Roosevelt announced plans to take the US off the gold standard and devalue the dollar. But this would not be as easy as FDR calculated. Most debt contracts at the time included a “gold clause,” which stated that the debtor must pay in “gold coin” or “gold equivalent.” These clauses were introduced during the Civil War as a way to protect investors against a possible inflationary surge.

For FDR, however, the gold clause was an obstacle to devaluation. If the currency were devalued without addressing the contractual issue, the dollar value of debts would automatically increase to offset the weaker exchange rate, resulting in massive bankruptcies and huge increases in public debt.

To solve this problem, Congress passed a joint resolution on June 5, 1933, annulling all gold clauses in past and future contracts.

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Will Trump Launch a Currency War, Too?

A bank teller counts Chinese currency 100 yuan (or Renminbi) notes China Photos/Getty Images

Will Trump Launch a Currency War, Too?

Last month, Donald Trump personally announced a series of import tariffs and other measures to restrict the flow of Chinese goods and capital into the United States. Clearly, Trump views China as a significant economic threat, so it may be only a matter of time before he sets his sights on the renminbi as well.

SANTA BARBARA – In recent weeks, the Trump administration has rolled out a series of trade and investment measures that put China squarely in its crosshairs. Clearly, Trump and his advisers view China as America’s chief “economic enemy.” The question now is whether they will follow up with an attack on the renminbi, China’s increasingly popular currency.

So far, the US has imposed of 25% on steel and 10% on aluminum, which Trump personally announced early last month. Since then, the administration has carved out exemptions for certain US allies, while using the tariffs as a bargaining chip to extract concessions from others.

China, for its part, is not a major supplier of steel or aluminum to the United States. But Chinese overcapacity has been putting downward pressure on steel and aluminum prices globally, to the detriment of US producers. So, the Trump administration’s aim is to force China to reduce its own output sharply.

Even more dramatically, the Trump administration has unveiled plans to impose import tariffs on a wide range of Chinese goods, valued at up to $60 billion. It is also tightening restrictions on corporate acquisitions and investments by foreign firms; and it has signaled its intention to challenge China’s forced technology transfers at the World Trade Organization.

Moreover, the administration is moving to bar Chinese companies from investing in sensitive US sectors such as semiconductors and 5G wireless-communications technologies. Trump has already blocked a $117 billion bid by Broadcom – a Singapore-based firm with close ties to China – to acquire the US tech giant Qualcomm.

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Olduvai IV: Courage
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