Bloomberg News

Europe Tops U.S. as Global Growth Locomotive: Cutting Research

September 26, 2013

While Europe struggles to raise its economic growth rate, when it does it provides a more powerful boost to the world economy than the U.S., says Barclays Plc in a challenge to conventional wisdom.

A 1 percent increase in aggregate demand in Europe’s developed nations gives 33 of 39 international economies a bigger lift in their gross value added, a proxy for gross domestic product, than if the higher demand had occurred in the U.S., Barclays strategists including London-based Jim McCormick said in a Sept. 25 report.

The impact of the European demand rise on the entire world is more than 0.25 percent, three times the U.S. effect. The explanation is that that Europe has a bigger economy with greater trade links and its banks are more exposed globally, McCormick, Barclays’ global head of asset allocation research, told reporters in London yesterday.

Europe’s positive spillovers were calculated using historical relationships between economies. The ripples extend as far as emerging Asian economies and to some in Latin America.

“While it is often believed that the U.S. cycle is a bigger source of global growth shocks, statistics suggest otherwise,” the Barclays report said.

The observation was contained in a study suggesting “the evolution of the European recovery could well be the most important factor for financial markets in the months ahead.”

Among other reasons for that analysis: The euro region’s eight-quarter recession may have hurt asset markets abroad too. Barclays noted that assets typically linked to growth have underperformed the Standard & Poor’s 500 Index by almost 20 percent since Europe’s slump began in the middle of 2011. Since the rebound started this year, growth assets have started to gain against the S&P.

* * *

Central banking may be a laughing matter.

A Federal Reserve policy-setter tends to elicit more laughter if he or she anticipates faster inflation, according to a study of transcripts by Kevin W. Capehart, a Ph.D. student at American University in Washington.

Laughter, often mentioned in the transcripts of Federal Open Market Committee meetings, occurred 372 times across the 18 sessions for which economic forecasts are available, Capehart said in a paper for a forthcoming copy of the publication “Economic Inquiry.” He found a one percentage point increase in a member’s inflation projection is linked with a 75 percent rise in the amount of laughter their humorous observations attract in meetings at about that time.

“The laughter elicited by FOMC members may therefore reflect serious concerns about threats to the economy, rather than any lack of concern or sense of complacency,” said Capehart.

* * *

The increasing longevity of the world’s population -- in which we currently gain 5 hours a day of life expectancy every day -- will prove a challenge for money managers.

That’s the warning of Michael Bret, head of thematic research at AXA Investment Managers. In a Sept. 19 report, he said while older populations previously created disinflation, now they will threaten high inflation because of fiscal unsustainability in the programs that support them and the economy.

In many countries, Bret says, half the babies born today could well live to more than 100 with leading economies on track to reach that mark by 2075. Japanese women, for example, already have a life expectancy at birth of 86.4 years, compared with 70.1 years in 1960.

As populations age and the ratio of older people to young climbs, the weight on public finances will rise, creating strong inflationary pressures. That will offset the normal trend in which retirees dislike inflation because it eats into their savings, influencing policy makers to keep control of prices, said Paris-based Bret.

Now governments will have little option but to respond to higher health-care spending, helping to undermine the ability of central banks to control inflation even if they want to, he said.

“The past trend of an aging population associated with lower inflation could well be reversed,” he said.

With bond yields now so low, Bret said increasing investment in equities by pension funds could compensate, as could private equity investing. In Japan, pension funds already look overseas for yield, he said.

“In a world of free moving capital, we should be prepared to witness a significant impact of aging on global markets,” he said.

The report was published just days after the International Monetary Fund produced a paper in which economist Patrick Imam said the shift to an older society could blunt the effectiveness of monetary policy over time.

* * *

When it comes to countries defaulting on their bonds, there is strength in numbers, according to a study released by the Federal Reserve Bank of Minneapolis.

A bankruptcy in one nation should prompt others to follow because they are often borrowing and renegotiating with the same investors, be they other countries or in the private sector, said Cristina Arellano of the regional Fed bank and the University of Rochester’s Yan Bai.

If one country defaults, the incentive for others to do the same increases because the original declaration pushes up bond yields elsewhere, making borrowing more expensive, they said. Defaulting is also made less costly if countries renegotiate simultaneously, Arellano and Bai said in their paper, published this month.

It found about 25 percent of defaults happened only because another nation was defaulting, adding that almost all Latin America’s nations defaulted in the 1980s.

The model also can “rationalize” some of the recent behavior by European governments, five of which accepted bailouts, beginning with Greece, Arellano and Bai said. It showed about half the correlation of bond spreads between Italy and Greece can be attributed to linkages in their debt markets.

* * *

Central banks can pay a price in the form of higher unemployment if they undershoot their inflation target, according to Lars E.O. Svensson, a former deputy governor of Sweden’s Riksbank.

In a paper published this week by the National Bureau for Economic Research, Svensson detailed how unemployment will mount if investors’ inflation expectations shadow a central bank’s inflation target yet inflation deviates from it.

In Sweden, for example, he found that from 1997 to 2011 expectations were anchored at the Riksbank’s goal of 2 percent, but average inflation fell 0.6 percentage point below it. Svensson calculates that means average unemployment has been 0.8 percentage point higher than if the Riksbank had allowed average inflation to run on target.

Svensson often sought laxer monetary policy in Sweden, stepping down in May after failing to persuade colleagues to cut interest rates to support the labor market. In March, he derided as “poor” the bank’s efforts to reach its 2 percent inflation goal.

“I believe the main policy conclusion to be that if one wants to avoid the average unemployment cost, it is important to keep average inflation over a longer period in line with the target,” Svensson said in the paper. He is now at The Institute for Financial Research at the Stockholm School of Economics.

* * *

Higher wages may be a curse as well as a blessing for emerging markets, according to a PricewaterhouseCoopers LLP report. The salaries that boost consumption may also discourage production.

Average wages in India may quadruple over the next two decades while those in the U.S. and U.K. gain just a third, reducing the labor cost advantage that has lured business to emerging markets, economist John Hawksworth said in a report released yesterday.

India’s current average monthly wage is now 25 times smaller than the U.K.’s but could be only 7.5 times smaller by 2030. Wages in Mexico and the Philippines are also set to rise faster than those in developed economies, while China’s average monthly wage could rise to around half that of Spain’s, PwC said.

Countries such as Turkey, Poland, China and Mexico will become more valuable as consumer markets and low-cost production could shift to relatively lower-cost locations such as the Philippines, Hawksworth said.

To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net


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