A quick rundown on the global economy by Martin Wolf

Notes from a talk given on the global economy by Martin Wolf of the Financial Times

At the conference establishing the new Bretton Woods international system in 1944 - Keynes expressed concerns at the about how to manage global economic imbalances. Keynes wanted a monetary system that would automatically balance accounts and keep the interests of creditor and debtor nations more closely aligned.

Economic significance - as a result of the crisis, we are much poorer in aggregate than people expected ten years ago

United States

• In the USA actual real GDP has deviated from potential output by 18%
• More significant than the recession of 2008-09 has been that US growth has not returned to pre-crisis trend
• This is a big break point in the economic history of the USA

Euro Zone

• From a very slow growing trend, Euro Zone slowdown has taken the single currency area 14% below pre crisis levels
• What is remarkable about the Euro Zone since 2010 has been how slowly it has grown - barely a recovery at all

Intellectual significance

• Very few people expected a financial and economic crisis on this scale
• The policy-making orthodoxy did not think it can happen to the developed world built around lightly regulated finance and many years of macro stability
• Their belief in stable economies and stable growth has been truly shattered
• Recall one of the key Hyman Minsky ideas - in actual economies run by real people running real businesses, stability breeds instability.
• The simplest way to take on more risk is to increase the amount of leverage / debt and this is exactly what happened
• As the financial crisis engulfed most of the world in 2007, the banking system was leveraged at a rate of around 40. Leverage of 20 is frightening

Fundamental macro shifts causing the crisis

Combination of factors came together to bring about extraordinary fragility in the economic / financial system

A global savings glut and an investment dearth led to a steep decline in real interest rates

Drivers of the global savings glut:

(ii) Big shifts in income distribution towards the top end - towards savers and away from spenders

(iii) Post 1997 the emerging world became net capital exporters after they started to run up huge trade surpluses

As real interest rates fell, housing sectors in countries such as Spain, the UK and the USA started to rise

House price booms triggered credit booms in many countries

In the UK we don't build houses, in the USA and Spain - they do. We now live with the most expensive housing in the world (an almost permanent feature of our economy)

In the USA and Spain, lending against property came to an abrupt end when their markets became saturated with excess supply

2015: We now live in a world where the real interest rate on low risk assets is close to zero and has been for six years - this is a key depression indicator

Global imbalances

The world moved to more savings relative to investment

• Savings and investment need to balance
• Balance happens by looking at growing trade imbalances on the current account of the balance of payments
• Oil exporters, Germany & Japan, China and emerging Asia - these are the structural surplus countries
• United States, UK and others - trade deficit countries
• Emerging economies post 1997 crisis decided to go LONG dollars - i.e.build up rising / huge foreign currency reserves as a buffer stock against a future crisis

What Future for Greece?

• The external and the fiscal adjustment in Greece has already happened. Greece needs structural reforms.
• What is Greece breaks out of the system - e.g. brought about by ECB no longer supporting Greek banks - causing a run on deposits
• Greek central bank would create it's own money - the new money would devalue dramatically
• But how powerful would the effect of this?
• If social order is maintained, Greece might start growing very rapidly - but it has a very weak external sector
• Nobody really knows how the policy system would work in Greece outside the Euro - would they become another Argentina?

Can Monetary Union work without Fiscal Union?

• Yes - If the economies are very similar - i.e. similar structures, competitive advantage
• US is about diverse as Europe but that doesn't matter because they have many other institutions to help absorb shocks
• Even if countries are heterogeneous providing people are prepared to take adjustments via changes in relative wages and migration
• Modern welfare states make it very difficult to make this EU monetary union work in the long run
• One options is that a northern monetary union will spin off

Banks falling to lend to businesses

• Only 10% of the aggregate balance sheet of the UK retail banking system is lending to businesses
• Extraordinary asymmetry when compared to mortgage lending
• Banks don't lend to businesses because it is not sufficiently profitable

Central banks and interest rates

• This is an extraordinary era for monetary policy among the major central banks of the world
• Money from the central banks has been staggeringly cheap - this is completely abnormal
• Nobody seems to be frightened of inflation
• Enormous expansion of the central bank balance sheet arising from money creation
• People are lending money to national governments at (minus) one per cent for thirty years
• Even the governments of Italy and Spain can borrow for 30 years at 3% per annum
• For the UK government to be terrified of debt is to be terrified of shadows

Policy lessons from the crisis and the aftermath

1. We need to think more seriously about economic orthodoxy - monetary policy hasn't changed, in essence the financial sector is the same - just much more highly regulated
2. Will cheap money and regulated finance bring about a sufficient robust recovery? There are big doubts
3. Financial sector remains highly leveraged - they fund their assets with 96% of debt and 4% of equity - shocks will lender them insolvent
4. Chicago Plan for narrow banking - separating out the money and payments system run by banks
5. World system is one with massive deflationary bias because everyone wants to run surpluses (fiscal and trade) and US cannot run a big enough deficit to support the world