Showing posts with label Europe. Show all posts
Showing posts with label Europe. Show all posts

Monday, July 19, 2021

Reality is catching up with our freeloading, populist climate deniers

Don’t be taken in by the Morrison government’s outraged cries of “protectionism” against the EU plan to impose a carbon tariff on our exports to Europe. It’s we who are in the wrong, failing to do what we should have to reduce emissions, in favour of politicking and populism.

What we’re seeing is just the reality of the world’s need to act to limit climate change catching up with a government and federal party which, since Tony Abbott used denialism to seize the party’s leadership from Malcolm Turnbull in 2009, decided to make global warming a party-political football: a way to beat your opponents, not a need to tackle the nation’s biggest problem.

It’s a condemnation of our business people that, when their own side of politics offered them a way to postpone the inevitable costs of adjusting to a low-carbon world, they happily embraced it.

It’s a condemnation of Australian voters that they were willing to allow their preferred party to tell them whether they cared or didn’t care about their children’s future. It should have been the other way round. “It’s all too hard; you do my thinking for me.”

But the game has moved on since those bad days, and now it’s not just the rest of the world that’s realised there’s no future in denying the reality of climate change and the need to act. As each day passes, we see more evidence that our own financial regulators, banks, investors and businesses are accepting the inevitable and modifying their behaviour.

All our state governments – most notably the Berejiklian Coalition government of NSW – have embraced the target that all other rich nations have embraced, net-zero emissions by 2050. Everyone can see that our refusal to take climate change seriously is wrong-headed and unsustainable.

So, apart from being a national embarrassment – we’re the person stopped for not wearing a mask, so to speak – it’s no bad thing that even other countries have stepped in to oblige our national government to shoulder its responsibilities.

As part of their plan to reduce their emissions by 55 per cent by 2030, the Europeans are toughening up the emissions trading scheme they introduced in 2005, which imposes a price on the carbon emissions of European industries.

To prevent this putting their industries at a disadvantage against imports from countries that don’t impose a similar carbon price on their own industries, the Europeans plan to use a “carbon border adjustment mechanism”, a tax on imported cement, fertilisers, aluminium and iron and steel to bring their carbon costs up to those faced by local producers.

This not only levels the playing field for local industry, it eliminates the incentive for producers to move their production to countries without carbon pricing.

These problems are ones we ourselves worried about when designing Kevin Rudd’s original carbon pollution reduction scheme (which the Coalition and the Greens voted down in 2010) and Julia Gillard’s carbon pricing scheme of 2012 (which was repealed by Abbott in 2014).

So what the Europeans want to do can’t honestly be called protectionism. It bears no similarity with the new import duties China’s imposing on some of our exports.

What’s true is that it’s a messy but necessary way of solving the “wicked” problem of climate change which, being global, can only be fixed by all of the world’s big emitting countries doing their bit. This is why we can expect many other big countries – starting with America, and maybe extending to Japan − to impose similar carbon border taxes on those countries that try to freeload on those doing the right thing, while helping to sabotage the good guys’ efforts in the process.

So there’s no reason for any of us who believe climate change is real and must be countered to have any sympathy for the Abbott-Turnbull-Morrison government. All its sins of expedience and populist politicking are finding it out. It took a bet that the rest of the world wouldn’t get serious, and we lost.

The point is, had we stuck with either the first or the second version of our own emissions trading scheme – which were actually designed to fit with the Europeans’ scheme – we wouldn’t have this problem.

By now our exporters would be paying our carbon tax to our government (or, if they weren’t yet, we could easily fix it) rather than paying the same tax to foreign governments. Why’s that a good idea?

From the beginning, this government has used climate change as nothing more than an opportunity to attack the other side of politics by pushing populist delusions that taxes are always and everywhere a bad thing. Bad for the economy. Yeah, sure.


Monday, March 12, 2018

How we could gang up against a Trump trade war

A possible trade war looms and, as always, an adverse overseas development has caught poor little Oz utterly unprepared. Well, actually, not this time.

Just as Treasury had been war-gaming the next big world recession well before the global financial crisis of late 2008, so the Productivity Commission began thinking about our best response to a trade war soon after the election of Donald Trump.

In July last year it published a research paper, Rising protectionism: challenges, threats and opportunities for Australia, to which Dr Shiro Armstrong, co-director of the Australia-Japan Research Centre, at the Australian National University, made a major contribution. (During a visit to ANU last week I also benefited from discussion with Professor Jenny Corbett.)

Trump's tariffs (import duties) on steel and aluminium were never a great threat to our economy. It'll be only when he decides to take a crack at the Chinese that there'll be a lot to worry about.

But the chest-thumping by our pollies (on both sides) over steel is a demonstration of the way populism can crowd out clear-headed self-interest where protectionism is involved.

Trade wars happen by accident. They start out in a small way, the perceived victims feel their manhood demands they stand up to a bully by retaliating, the bully hits back and pretty soon everyone in the bar is throwing chairs and punches.

As the research paper puts it, "significant worldwide increases in protection would cause a global recession."

Economic modelling by Armstrong estimates that, for every extra dollar by which our revenue from import duties rose, economic activity in Australia would fall by 64¢.

In total, the level of real gross domestic product would be 1 per cent lower each year. This would equate to a loss of about 100,000 jobs. (As with all modelling, take these figures as, at best, roughly indicative.)

A full-blown global trade war would take many months, even years to build up, so how should we respond to the provocative actions of others? What could we do to minimise the damage we'd suffer?

The research paper proposes what economists call a "first-best" response (here I'd call it the What-would-Jesus-do? cheek-turning response): not only should we resist the temptation to retaliate in any way, we should also cut what few remaining protective barriers we have.

If you think that would be plum crazy, you don't know as much about protection as you should. But you've demonstrated why any politician would find such advice almost impossible.

That's why I'm attracted by the paper's second-best suggestion: "working with a coalition of countries to keep their markets open is a strategy that would make it easier for Australia to resist protectionist pressures".

Good thinking. Our leaders want to be seen to be acting to defend our economy, and this response – "let's form our own gang and fight back" - is active rather than passive, and harder to portray as appeasing the bullies.

Oh yeah, what gang? What coalition of countries? That's obvious. We're already a member of a gang that, depending on how you measure it, is bigger than Trump's, or the Europeans'. And our gang's by far the fastest growing.

We do almost three-quarters of our two-way trade (exports plus imports) with Asia – in descending order, China, ASEAN, Japan, South Korea, New Zealand, India, Hong Kong and Taiwan. Europe accounts for only about 15 per cent and Trumpland​ for little more than 10 per cent.

Although it's true Asia needs to trade with North America and Europe, it's also true there's huge trade within our region. Just imagine the damage we'd suffer if we Asians started jacking up tariffs against each other. Or all of us against the rest of the world.

Australia and New Zealand are already members of various Asian trading clubs. And what greater incentive for Asians to pack down more closely than a threat from Trumpland, or from a Europe trying to repel boarders?

Nor is it presumptuous for Oz to take a (quiet) leadership role. Despite all their trade, there's a lot of mistrust between China, Korea, Japan and other countries. China and Japan, for instance, find it easier to work with us than with each other.

After all, we played significant roles in the formation of the Asia-Pacific Economic Co-operation group and in improving the governance arrangements for China's new Asian Infrastructure Investment Bank. We worked behind the scenes with Japan to keep the Trans-Pacific Partnership alive despite Trump's dummy-spit.

And guess what? Malcolm Turnbull will host a summit of the 10 leaders of the Association of Southeast Asian Nations in Sydney next weekend.

Saturday, July 26, 2014

Why we're still not free of the GFC

Almost six years since the global financial crisis reached its height, it's easy to forget just how close to the brink the world economy came. To someone like Reserve Bank governor Glenn Stevens, however, those events are burnt on his brain.

Which explains why he thought them worth recalling in a speech this week. And also why, so many years later, the major developed economies of the North Atlantic are still so weak and showing little sign of returning to normal growth any time soon.

When those key decision-makers who lived through 2008 and 2009 say that there was the potential for an outcome every bit as disastrous as the Great Depression of the 1930s, "I don't think that is an exaggeration", he says.

"Any account of the events of September and October 2008 reminds one of what an extraordinary couple of months they were. Virtually every day would bring news of major financial institutions in distress, markets gyrating wildly or closing altogether, rapid international spillovers and public interventions on an unprecedented scale in an attempt to stabilise the situation.

"It was a global panic. The accounts of some of the key decision-makers that have been published give even more sense of how desperately close to the edge they thought the system came and how difficult the task was of stopping it going over."

But, despite the inevitable "mistakes and misjudgments", the authorities did stop it going over. Stevens attributes this to their having learnt the lessons of the monumental mistakes and misjudgments that that turned the Great (sharemarket) Crash of 1929 into the Great Depression.

Economic historians (including one Ben Bernanke) spent decades studying the Depression and, in Stevens' summation, they came up with five key lessons: be prepared to add liquidity – if necessary, a lot of it – to financial systems that are under stress; don't let bank failures and a massive credit crunch reinforce a contraction in economic activity that is already occurring – try to break that feedback loop; be prepared to use macro-economic policy aggressively.

So far as possible, maintain dialogue and co-operation between countries and keep markets open, meaning don't resort to trade protectionism or "beggar-thy-neighbour" exchange rate policies. And act in ways that promote confidence – have a plan.

There was a lot of action and a lot of international co-operation, and it worked. As a result, we talk about the Great Recession, not the Great Depression Mark II.

"We may not like the politics or the optics of it all – all the 'bailouts', the sense that some people who behaved irresponsibly got away with it, the recriminations, the second-guessing after the event and so on," he says. "But the alternative was worse."

With collapse averted, the next step was to fix the broken banks. Their bad debts had to be written off and their share capital replenished, either by them raising capital from the markets or accepting it from the government.

Fixing the banks' balance sheets was necessary for recovery, but not sufficient. A sound financial system isn't the initiating force for growth, so stimulatory macro-economic policies were needed to get things moving.

On top of all the government spending to recapitalise the banks came a huge amount fiscal (budgetary) stimulus spending. Stevens says a financial crisis and a deep recession can easily add 20 or 30 percentage points to the ratio of public debt to gross domestic product.

Then you've got the weak economic growth leading to far weaker than normal levels of tax collections. Add to all that the various North Atlantic economies that had been running annual budget deficits for years before the crisis happened.

"So fiscal policy has not had as much scope to continue supporting recovery as might have been hoped," Stevens says. "Policymakers in some instances have felt they had little choice but to move into consolidation mode [spending cuts and tax increases] early in the recovery."

He doesn't say, but I will: this crazy, counterproductive policy of "austerity" has helped to prolong the agony.

With fiscal policy judged to have used up its scope for stimulus, that leaves monetary policy. Central banks cut short-term interest rates hard, but were prevented from doing more because they soon hit the "zero lower bound" (you can't go lower than 0 per cent).

But long-term interest rates were still well above zero and, in the US and the euro area, long-term rates play a more central role in the economy than they do in Oz. Hence the resort to "quantitative easing".

Under QE, the central bank buys long-term government bonds or even private bonds and pays for them merely by crediting the accounts of the banks it bought from. Adding to the demand for bonds forces their price up and yield (interest rate) down. And reducing long-term rates is intended to stimulate borrowing and spending.

Has it worked? It's intended to encourage risk-taking, but are these risks taken by genuine entrepreneurs producing in the real economy, or are they financial risk-taking through such devices as increased leverage?

Stevens' judgment is that it always takes time for an economy to heal after a financial crisis [because it takes so long for banks, businesses and households to get their balance sheets back in order - they've borrowed heavily to buy assets now worth much less than they paid] so it's too soon to draw strong conclusions.

For Stevens, the lesson is that there are limits to how much monetary policy can do to get economies back to healthy growth after financial crises. "If people simply don't wish to take on new business risks, monetary policy can't make them," he says.

Perhaps the answer is simply subdued "animal spirits" – low levels of confidence, he thinks. But, at some stage, sharemarket analysts and the investor community will ask fewer questions about risk reduction and more about the company's growth strategy.


Saturday, July 28, 2012

OK gloomsters, let's run some worst-case scenarios

In the long boom before the global financial crisis, when economists convinced themselves they'd achieved the Great Moderation and everyone was confident the good times would roll on forever, anyone who thought they saw a problem looming was either ignored or dismissed as a fool.

In the North Atlantic economies' continuing agonies since the crisis, it's been roughly the reverse. Excessive optimism has swung to excessive pessimism and anyone who thinks they see a problem looming gets a microphone and loud speaker stuck in front of their face.

Now it's the people who don't think the end is nigh who tend to be ignored. Our cyclical switch to pessimism is being compounded by the media's natural bias in favour of bad news and the tendency of people who dislike the Gillard government to believe everything in the economy has gone to hell.

One person who thinks things aren't as bad as they're being painted is Glenn Stevens, governor of the Reserve Bank. He gave a speech this week in which he begged to differ with the doomsayers. The cogent arguments he advanced deserve more attention than they've been given.

When it comes to dark forebodings, first prize goes to fears of a break-up of the euro. But worries about a hard landing in China are now coming second. Stevens examines the figures and concludes they show "Chinese growth in industrial output of something like 10 per cent, and gross domestic product growth in the 7 to 8 per cent range. To be sure, that is a significant moderation from the growth in GDP of 10 per cent or more that we have often seen in China in the past five to seven years."

But not even China can grow that fast indefinitely and there were clearly problems building up. It's far better the moderation occurs, he argues, if this increases the sustainability of future expansion.

What's more, the Chinese authorities have been taking well-calibrated steps in the direction of easing macro-economic policies, as their objectives for lower inflation look like being achieved and as the likelihood of slower global growth affecting China has increased.

Next he responds to the pessimists' greatest fear of disaster in the domestic economy: a collapse in house prices. He's not convinced they're overvalued by our historical standards. And while, expressed as multiples of annual household disposable income, they seem very high compared with American prices, they are within the pack of other developed countries. It's the US that seems out of line.

But Stevens emphasises he's not saying there's no possibility house prices will fall. "It is a very dangerous idea to think that dwelling prices cannot fall," he says. "They can, and they have." But the ingredients you'd look for as signalling an imminent crash seem even less in evidence now than five years ago.

"Even though we don't face immediate problems, we should ask: what if something went wrong?"

OK, so let's look at some worst-case scenarios. If the thing that goes wrong is a "major financial event" emanating from Europe, he says, the most damaging potential transmission channel would be if there were a complete retreat from risk, capital market closure and funding shortfalls for financial institutions.

This would be a problem for many countries, of course, not just us. But in that event the Aussie dollar might decline, perhaps significantly.

"We might find that, in an extreme case, the Reserve Bank - along with other central banks - would need to step in with domestic currency liquidity, in lieu of market funding. The vulnerability to this possibility is less than it was four years ago; our capacity to respond is undiminished and, if not actually unlimited, is not subject to any limit that seems likely to bind."

An alternative version of this scenario, if it involved the sort of euro break-up about which some people speculate, could be a flow of funds into Australian assets. In that case our problem might be not being able to absorb that capital. But that means the banks would be unlikely to have serious funding problems.

If the thing that went wrong was a serious slump in China's economy, the Aussie would probably fall, Stevens says, which would provide expansionary impetus to the Australian economy. But more importantly, we could expect the Chinese authorities to respond with stimulatory measures.

"Even if one is concerned about the extent of problems that may lurk beneath the surface in China - say in the financial sector - it is not clear why we should assume that the capacity of the Chinese authorities to respond to them is seriously impaired.

"And in the final analysis, a serious deterioration in international economic conditions would still see Australia with scope to use macroeconomic policy, if needed, as long as inflation did not become a concern, which would be unlikely in the scenario in question."

Next, what if house prices did slump after all? In such a scenario people typically worry about two consequences. The first is a long period of very weak construction activity, usually because an excess of housing stock resulting from previous over-construction needs to be worked off. But we've already had a long period of weak residential construction and it's hard to believe it could get much weaker at the national level.

The second common worry is about what a slump in house prices would do to the balance sheets of the banks and other lenders. But this scenario is regularly covered by the Australian Prudential Regulation Authority in its "stress-testing" of the banks.

"The results of such exercises always show that even with substantial falls in dwelling prices, much higher unemployment and associated higher levels of defaults, key financial institutions remain well and truly solvent."

Stevens points out that a lot of the adjustments we're complaining about at present - including households' higher and more normal rates of saving, a more sober attitude towards debt, the reorientation of the banks' funding away from short-term foreign borrowing, and weak house prices - are strengthening our resilience to possible future shocks.

"The years ahead will no doubt challenge us in various ways, including in ways we cannot predict. But what's new about that? Even if the pessimists turn out to be right on one or more counts, it doesn't follow that we would be unable to cope.

"Acting sensibly, with a long-term focus, has as good a chance as ever of seeing us through," Stevens concludes.

Monday, June 11, 2012


June 2012

If you’re not quite sure what’s happening in the economy at present, don’t feel bad. Some people are saying the economy’s in bad shape; others are saying it’s doing pretty well. The reason for the confusion is that the economy’s being hit by three different factors, at present: one expansionary, one contractionary and one that sounds worse than it actually is - so far, at least. These conflicting factors are affecting different industries differently and different states differently. This is because they’re bringing about a change in the structure of our economy, and structural change is often painful. The three factors are: first, the resources boom; second, the high exchange rate the resources boom has brought about and, third, the problems in the developed economies of the North Atlantic, particularly the Europeans’ debt crisis and worries about the survival of the euro. Let’s start with the troubles in the North Atlantic, then move to the boom then on to the high exchange rate.

Problems in America and Europe

The mighty US economy is recovering only very slowly from the Great Recession of 2008-09. But the problems are much more severe in continental Europe, as well as Britain. Europe’s basic problem of excessive levels of public debt is greatly complicated by the now-exposed structural weaknesses in the euro currency union. Most governments have resorted to the policy of ‘austerity’ - attempting to reduce budget deficits by slashing government spending and raising taxes at a time when their economic recoveries were still very weak. Unsurprisingly, this policy has proved counter-productive and has pushed various economies back into recession.

The media have given great publicity to Europe’s troubles and its tribulations have caused weakness in global sharemarkets, including ours. But the real question is the extent to which Europe’s problems affect our economy. They could do so via three main channels. First, the financial channel: they could cause certain global lending markets to seize up for a time, or increase the risk premiums paid by Australian banks or businesses borrowing in those markets. Second, the confidence channel: media reports of problems in Europe could damage the confidence of Australian consumers and business people. Third, the trade channel: weak growth or contraction in Europe could reduce our exports.

So what damage have we suffered so far? Europe’s tribulations have added a little to our banks’ costs of borrowing overseas. They do seem to have added to the uncertainty of our business people, helping to explain the weakness of non-mining business investment spending. But it’s hard to be sure Europe has had much effect on consumers because the household saving rate has been steady for more than a year and consumer spending has been growing at its trend rate. Europe accounts for less than 10 pc of our exports, so its weakness has had little direct effect on our export income.

However, Europe is a significant customer of our biggest export customer, China. So any adverse effect from Europe’s weakness could come to us via China - unless China were to offset the fall in its export income from Europe by stimulating its domestic demand, as it seems willing and able to do.

Bottom line: Europe’s problems have had some negative effect on us, but so far, not much. This could change, however, if the euro arrangement collapsed. Were something really bad to happen in Europe, the RBA would react quickly with big cuts in the official interest rate.

Resources boom

The big expansionary shock to the economy is coming from the resources boom, the biggest we have experienced since the gold rush. The rapid industrialisation of China and India has pushed prices for our exports of coal and iron ore to extraordinary heights, with our terms of trade only now starting to fall from their best level in 200 years. The improvement in the terms of trade represents a significant increase in the nation’s real income which, when spent, adds to demand. The boom has also added to demand by sparking a huge surge of investment spending on the construction of new mines and liquid-gas facilities. The emerging economies’ demand for the main components of steel is likely to stay strong for a decade or two. So, though the price of our exports of coal and iron ore is likely to fall back to less extreme levels, the volume of our exports is likely to continue growing for many years.

High exchange rate

The big contractionary shock to the economy is coming from the still very high exchange rate caused by the resources boom. An improvement in our terms of trade almost always leads to a rise in our exchange rate. Our dollar is likely to stay unusually high for some years, even as commodity prices fall back, because of the significant net inflow of foreign capital needed to finance the expansion of our mining sector. The high exchange rate helps to prevent the resources boom from leading to inflation by, first, directly reducing the price of imports and, second, reducing the international price competitiveness of our export and import-competing industries, thus reducing their production and so working in the direction of diminishing demand.

Structural change

The public is used to thinking about the economy in cyclical terms: it’s either booming or turning down. At present, however, because these two big shocks to the economy - the resources boom and the high dollar - are working on opposite directions, the economy is neither booming nor busting. It’s easier to understand what’s going on in the economy if you think of it in structural terms: the interplay of the two conflicting forces bearing on the economy is causing some industries to expand while others contract. The mining industry and mining-related parts of the construction industry and the manufacturing industry - accounting in total for up to 20 per cent of GDP - is expanding rapidly, whereas most of the other trade-exposed industries (manufacturing and service export industries such as tourism and education) are likely to get relatively smaller. The other industry that’s suffering from structural change is retailing. The pressures it’s facing have little to do with the high dollar, however. It’s being affected by the digital revolution and the rise of e-commerce.

Outlook for the economy

Over the year to March, the economy grew by an exceptional 4.3 pc, lead by strong consumer spending and the boom in mining investment. But now the economic managers are expecting growth to return to its trend rate of 3.25 pc for the coming financial year, 2012-13, as a whole. But this is expected to involve quite disparate growth in the components of GDP: another very big increase in mining investment spending and trend growth in consumer spending, but no growth in new home building and a small contraction in public sector spending as federal and state governments seek to return to operating surplus.

And note that the other economic indicators are looking pretty good at present. The latest figures say underlying inflation is running at 2.2 pc - almost down to the bottom of the RBA’s 2 to 3 pc inflation target. The latest figures say unemployment is running at about 5 pc - which economists say is down very close to our NAIRU - the non-accelerating-inflation rate of unemployment, which is the lowest point to which unemployment can fall before labour shortages start causing wage and price inflation. That is, unemployment is very close to its lowest sustainable rate.

Monetary policy

Monetary policy - the manipulation of interest rates to influence the strength of demand - is conducted by the RBA independent of the elected government. It is the primary instrument by which the managers of the economy pursue internal balance - low inflation and low unemployment. MP is conducted in accordance with the inflation target: to hold the inflation rate between 2 and 3 pc, on average, over the cycle. The primary instrument of MP is the overnight cash rate, which the RBA controls via market operations.

Aware the unemployment rate was only a little above the NAIRU and concerned the resources boom could lead to excessive wage growth, the RBA stood ready to tighten monetary policy throughout most of 2011. But, partly because of the lingering effect of the Queensland floods in early 2011, the economy did not accelerate as the RBA had forecast. Instead, the outlook for growth in the North Atlantic economies worsened, business and consumer confidence weakened and inflation continued to improve. So the RBA cut the cash rate by a click in both November and December of 2011, lowering it to 4.25 pc. In May it cut by 0.5 points in June by a further 0.25 points, taking the cash rate down to 3.5 pc, more than offsetting the banks’ efforts to preserve their profit margins, and producing a net fall in the interest rates actually paid by households and businesses. With market interest rates a little below their long-run average, the stance of monetary policy is now mildly expansionary.

Fiscal policy

Fiscal policy - the manipulation of government spending and taxation in the budget - is conducted according to the Gillard government’s medium-term fiscal strategy: ‘to achieve budget surpluses, on average, over the medium term’. This means the primary role of discretionary fiscal policy is to achieve ‘fiscal sustainability’ - that is, to ensure we don’t build up an unsustainable level of public debt. However, the strategy leaves room for the budget’s automatic stabilisers to be unrestrained in assisting monetary policy in pursuing internal balance. It also leaves room for discretionary fiscal policy to be used to stimulate the economy and thus help monetary policy manage demand, in exceptional circumstances - such as the GFC - provided the stimulus measures are temporary.

After the onset of the GFC, tax collections fell heavily, and they have yet to fully recover. The Rudd government applied considerable fiscal stimulus to the economy by a large but temporary increase in government spending.

The government’s ‘deficit exit strategy’ requires it to avoid further tax cuts and limit the real growth in government spending to 2 pc a year until the budget has returned to a surplus equivalent to 1 pc of GDP. The delay in returning to surplus is caused not by continuing high spending but by continuing weak revenue.

In this year’s budget the government shifted its spending plans around to allow it to keep its election promise to budget for (then actually achieve) a tiny budget surplus in 2012-13. After allowing for unimportant changes in the timing of spending and the effect on demand of particular budget measures, the stance of fiscal policy is much less contractionary than it appears to be, with the Treasury secretary estimating the effect to be less than 1 pc of GDP, which is still significant.


Should the contractionary stance of fiscal policy combine with other factors to weaken aggregate demand, the RBA has scope to counter this by further loosening monetary policy from its present stance of ‘mildly expansionary’.

Saturday, February 11, 2012

How fiscal policy does and doesn't work

It's remarkable that the politicians of Europe and America are making things much worse for themselves and their people because they've unlearnt the economic lessons of the past 70 years.

Economists spent many years studying what policymakers did wrong in the Great Depression of the 1930s, making it much worse than it needed to be. One well-understood lesson was not to try to get the government budget back into balance too quickly.

This is counter-intuitive to many people. The government's tax revenues have collapsed, its spending has increased, it has a yawning budget deficit and government debt is piling up. Surely it's obviously right to get spending and your income back into line as quickly as you can.

Not if you're a national government. Why not? Because governments are so big that what they do affects the rest of the economy. Remember, governments can borrow more for longer than the richest individual or corporation, since they represent the whole community and have the power to pay their bills by levying taxes.

Economic downturns, recessions or depressions almost always manifest themselves in consumers and businesses cutting their spending. The more they cut, the more people lose their jobs and their businesses and the greater the decline in spending.

In such circumstances, it's not possible for the private sector to lift itself up by its bootstraps. Clearly, the government needs to do something that helps the private sector get back on its feet.

One thing the central bank can do is cut interest rates to encourage borrowing and spending. In normal times this is usually effective, but in really bad times a lot of people are too uncertain about the future to want to borrow and expand, no matter how low rates are. And if interest rates are already very low - as they are in the advanced economies at present - you can't cut them below zero.

The next tool available to help the private sector is "fiscal policy" - the budget. The first way to help is do nothing: when fewer people paying tax and more people on the dole cause the budget deficit to blow out, don't do anything to counter it.

This process happens automatically when the private sector turns down, and the fact that some people are paying out less money to the government while others are getting more money from it means the government is helping to cushion the private sector's fall, stopping it from falling further. Thus economists say budgets contain "automatic stabilisers".

If you try to counter the effect of these stabilisers by cutting spending or increasing taxes, you'll push the private sector down further and, because of that, probably won't succeed in getting the budget closer to balance in any case.

The second way to help is more active: stimulate the private sector by cutting taxes or increasing spending. If you were to do this when the economy was strong, you'd just worsen inflation. But if you do it when the economy is flat on its back, it will probably be effective, particularly if you increase spending rather than cutting taxes (which would allow some people to save their tax cuts).

Once you get the economy growing again, tax collections will improve and people will go off the dole, thus causing the deficit to reduce. This is the automatic stabilisers working the other way. Keep it up and the budget balance will turn to surplus, which you can then use to repay government debt.

See the point? Exercise enough discipline and patience and eventually the budget problem will fix itself.

All this had been well understood by economists and politicians for many years. It was how governments responded to the global financial crisis in 2008. But governments in Britain and the euro zone, and the US Congress, are now doing pretty much the opposite.

Their economies are still quite weak but they want to increase taxes or - more commonly - slash government spending to get their big budget deficits down in a hurry. In consequence of this policy of "austerity", the European economies are heading back into recession and their deficits getting worse.

Why are they doing something so counter-productive? Because their stock of government debt is so unsustainably high. Whereas sensible policy involves running surpluses and reducing debt during the good years, they kept running deficits and piling it up in the noughties.

When the global financial crisis struck in 2008, many had to borrow heavily to rescue their banks and then borrow even more to kick-start their economies. Their debt is now so high the financial markets have started wondering whether they'll be able to repay it.

But the flighty financial markets are an unreliable guide to good policy: though they seemed to approve when governments announced their austerity programs, they started disapproving when they saw those programs were causing economies to weaken.

Of course, when a country's sovereign debt gets so high that markets will soon refuse to lend more to it at any price, it has no choice but austerity. You can renege on your debts, but you can't run a deficit if no one will finance it.

Even if some international institution bails you out, it will punish you for your profligacy by insisting on austerity. Will this make things worse long before it makes them better? Inevitably.

That's the case of Greece. But most of the European countries aren't in those dire straits, so why are they slashing spending?

What they should be doing is promising and laying plans to reduce their spending down the track, as their economies recover and can take it in their stride.

Why don't they? Because, after decades of fiscal indiscipline, they don't have much credibility when making promises to be good tomorrow.

But that doesn't change economic reality: cut when the economy's weak and you make it weaker. The answer is to find ways of making their promises more credible.

As for the Americans, they too have years of fiscal indiscipline and a way-too-high level of debt. But though it suits President Obama's critics to claim the US has a "debt crisis", it doesn't. The world is still so anxious to lend to the US government that the yield (effective interest rate) on its long-term debt is down to 2 per cent.

It has plenty of time to get its budgetary house in order but, at present, a hostile Congress has the budget set up to crunch the US economy next year. These guys have learnt nothing.

Monday, January 30, 2012

Europe has serious troubles, but we don’t

The economic news from Europe in recent days hasn’t been good. And it could get worse as the year progresses. Those guys have big problems. But let’s not spook ourselves by imagining it to be any worse than it is.

Unfortunately, there’s been a tendency in parts of the media to convey an exaggerated impression of how bad things are and of the extent to which Europe’s problems translate into problems for us.

Take last week’s downwardly revised forecast for the world economy in 2012 from the International Monetary Fund. We heard a lot about the fund’s dire warnings of what could happen if the Europeans didn’t get their act together, but what wasn’t made clear was that the fund’s actual forecast was for global recession to be avoided.

Though the forecast for growth in the world economy this year WAS cut significantly from the forecast in September, at 3.3 per cent it’s below the long-run average rate of about 4 per cent, but still comfortably above the 2 per cent level generally regarded as representing a world recession.

No one thought it necessary to tell us - even though Wayne Swan reminded journalists of it at his press conference - that, from our perspective, the fund’s revisions were old news. They were surprisingly similar to the revised forecasts the government adopted in its mid-year budget review last November.

The fund has the United States growing by 1.8 per cent this year; Treasury had it at 2 per cent. The fund has the euro area contracting by 0.5 per cent; Treasury had it contracting by 0.25 per cent. For China, the fund has growth of 8.2 per cent, whereas Treasury had 8.25 per cent. For India it’s the fund’s 7 per cent versus Treasury’s 6.5 per cent.

Bottom line? The fund has the world growing by 3.3 per cent, whereas Treasury had it at 3.5 per cent.

Journalists are always criticising politicians for repeatedly re-announcing new spending programs, thus leaving the public with an inflated impression of how much is being spent. But journos aren’t above doing much the same thing.

We get a fuss when the government revises down its forecasts in November, then another fuss when the fund announces essentially the same revisions. And in between we get a fuss when the World Bank announces its revisions. Three for the price of one.

Actually, you can understand why the uninitiated got excited about the bank’s revisions. Whereas Treasury had forecast world growth of 3.5 per cent, the bank revised its forecast down to just 2.5 per cent. But no one remarked on that, just as they didn’t seem to notice when, only a week later, the fund put its prediction at a seemingly healthier 3.3 per cent.

So which one is right? They all are. That’s to say, they’re all saying the same thing. I find it hard to understand how anyone who knew their business could bang on about how low the bank’s forecast was without pointing out that it does its forecasts on a different and inferior basis to everyone else.

Whereas our Reserve Bank and Treasury, and the fund, add each country’s gross domestic product together using exchange rates that take account of the US dollar’s widely differing purchasing power in each country, the World Bank doesn’t bother. It uses market exchange rates.

So it perpetually understates the rate of growth in the emerging economies of Asia, thereby understating world growth, since most of it has for quite some years come from Asia. But not to worry. If you took the fund’s country-by-country forecasts and added them together the same misleading way the bank does, what would you get? Growth of 2.5 per cent. Same forecast on either basis.

The trouble with all these forecasts and pronouncements from international agencies is it’s hard for the public to assess what they amount to by the time they reach our shores. These pronouncements rarely mention Australia. And shock waves from Europe have to come to us via China, India and the rest of Asia.

I think the media could try harder to bridge this gap rather than leaving us with the vague impression disaster for Europe means disaster for Australia. Actually, what matters for us is not world growth so much as the growth in our major trading partners, with each partner’s contribution weighted according to its share of our exports.

When Treasury did this sum in the mid-year review, growth in the world economy of 3.5 per cent translated to growth in our major trading partners of 4.25 per cent. All this despite Europe’s recession.

Fran Kelly of Radio Nation Breakfast did go to the trouble of asking the lead author of the fund’s World Economic Outlook, Jorg Decressin, what the revised forecasts meant for us. His reply deflated most of the hype we’ve been subjected to.

‘Australia will be affected by these downgrades only to a limited extent,’ he said. Oh. ‘At this stage, growth in output for Australia is still reasonably strong.

‘Growth in Australia is importantly driven by major investment projects that are in the pipeline and these are funded by strong multinationals that don’t have problems assessing funding.’ Oh.

‘There is no advanced economy - or maybe there are one or two - that is as well placed as Australia in order to combat a deeper slow down, were such a slowdown to materialise and that’s because, well, you still have room to cut interest rates if that was necessary and you also have a very strong fiscal [budgetary] position,’ he said.

Do you get the feeling you’ve heard all this before? Maybe it’s true.

Wednesday, January 25, 2012

Economic fixes must offer a fair go for all

When you listen to street interviews with people in the troubled countries of the euro zone, a common complaint emerges: whereas some people waxed fat in the boom that preceded the crisis, it's ordinary workers who suffer most in the bust, and they and even poorer people who bear the brunt of government austerity campaigns intended to fix the problem.

In other words, achieving a well-functioning economy is one thing; achieving an economy that also treats people fairly is another. Economists and business people tend to focus mainly on economic efficiency; the public tends to focus on the fairness of it all.

Fail to fix the economy and almost everyone suffers. But offend people's perceptions of fairness and you're left with a dissatisfied, confused electorate that could react unpredictably.

The trick for governments is to try to achieve a reasonable combination of both economic efficiency and fairness. Fortunately, but a bit surprisingly, the need for this dual approach has penetrated the consciousness of the Organisation for Economic Co-operation and Development - the rich nations' club which is expanding its membership to include the soon-to-be-rich countries.

New research from the organisation deals with ways governments can get their budgets back under control without simply penalising the vulnerable and ways they can improve the economy's functioning and increase fairness at the same time.

Much of the concern about fairness in the hard-hit countries of the North Atlantic has focused on bankers. In the boom these people made themselves obscenely rich by their reckless, greedy behaviour, eventually bringing the economy down and causing many people to lose their businesses and millions to lose their jobs.

But their banks were bailed out at taxpayers' expense - adding to the huge levels of government debt the financial markets now find so unacceptable - and few bankers seem to have been punished. Some have even gone back to paying themselves huge bonuses.

It's a mistake, however, to focus discontent on the treatment of a relative handful of bankers. The fairness problem goes much wider. In most developed countries, the long boom of the preceding two decades saw an ever-widening gap between rich and poor.

In the United States, almost all the growth in real income over the period has been captured by the richest 10 per cent of households (much of it going to the top 1 per cent), so that most Americans' real income hasn't increased in decades.

It hasn't been nearly as bad in Australia. Low and middle household incomes have almost always risen in real terms, even though high incomes have grown a lot faster.

Looking globally, a lot of the widening in incomes has come from the effects of globalisation and, more particularly, technological change, which has increased the wages of the highly skilled relative to the less skilled. But a lot of the widening is explained by government policy changes, such as more generous tax cuts for the well-off.

The euro zone countries need not only to get on top of their budgets and government debt, but also to get their economies growing more vigorously. So the organisation has proposed structural reforms - we'd say microeconomic reforms - which can foster economic growth and fairness at the same time.

One area offering a "double dividend" is education. Policies that increase graduation rates from secondary and tertiary education hasten economic growth by adding to the workforce's accumulation of human capital while also increasing the lifetime income of young people who would otherwise do much less well.

Promoting equal access to education helps reduce inequality, as do policies that foster the integration of immigrants and fight all forms of discrimination. Making female participation in the workforce easier should also bring a double dividend.

Surprisingly - and of relevance to our debate about Julia Gillard's Fair Work Act - the organisation acknowledges the role of minimum wage rates, laws that strengthen trade unions, and unfair dismissal provisions in ensuring a more equal distribution of wage income.

It warns, however, that if minimum wages are set too high they may reduce employment, which counters their effect in reducing inequality. And reforms to job protection that reduce the gap between permanent and temporary workers can reduce wage dispersion and possibly also lead to higher employment.

Systems of taxation and payments of government benefits play a key role in lowering the inequality of household incomes. Across the membership of the organisation, three-quarters of the average reduction in inequality achieved by the tax and payments system come from payments. Means-tested benefits are more redistributive than universal benefits.

Reductions in the rates of income tax to encourage work, saving and investment need not diminish the inequality-reducing effect of income tax, provided their cost is covered by the elimination of tax concessions that benefit mainly high income earners - such as those for investment in housing or the reduction in the tax on capital gains. Getting rid of these would also reduce tax avoidance opportunities for top income earners.

So it's not inevitable that the best-off benefit most during booms and the worst-off suffer most in the clean-up operations after the boom busts. It's a matter of the policies governments choose to implement in either phase of the cycle.

You, however, may think it's inevitable that governments choose policies that benefit the rich and powerful in both phases.

But we're talking about the government of democracies, where the votes of the rich are vastly outnumbered by the votes of the non-rich. So if governments pursue policies that persistently disadvantage the rest of us, it must be because we aren't paying enough attention - aren't doing enough homework - and are too easily gulled by the vested interests' slick TV advertising campaigns.

Saturday, December 17, 2011

Economy follows wherever our moods take us

To anyone but the economists and financiers, getting to the bottom of what the problem is in Europe is hellishly complicated. The more you read the more confused you get. But you can boil it down to the combination of the availability of credit and what Keynes called ''animal spirits''.

To anyone but the economists and financiers, getting to the bottom of what the problem is in Europe is hellishly complicated. The more you read the more confused you get. But you can boil it down to the combination of the availability of credit and what Keynes called ''animal spirits''.

Animal spirits refer to the tendency of the human animal to go through alternating waves of excessive optimism and excessive pessimism. Because we're a highly social animal, we tend to all be optimistic or pessimistic together. Animal spirits are contagious.

In principle, the availability of credit is a wonderful thing, allowing families to buy a home long before they could pay cash for it and businesses to expand beyond their owners' savings.

Taken separately, the existence of credit and animal spirits isn't a big problem. Taken in combination, however, they can be lethal. Animal spirits - also known as ''confidence'' and ''expectations'' - are the main factor causing the economy to speed up and slow down, speed up and slow down again.

Add the availability of credit - which, once availed of, becomes debt - and the amplitude of the ups and downs is greatly increased to produce the business cycle of boom and bust.

The potentially toxic combination of credit and confidence can be a problem for households, businesses, banks or governments. The risk is they borrow too much while everyone's confident the present up-and-up will last forever, then get into trouble when the mood switches and everyone fears the end is nigh.

In Europe's case the main problem is with excessive borrowing by governments. As Ric Battellino, retiring deputy governor of the Reserve Bank, explained this week, government debt in the euro area has been growing faster than gross domestic product for the past 40 years.

The 17 countries' combined net public debt at the start of the global financial crisis equalled about 45 per cent of GDP. Since then it's jumped a third to 60 per cent. If those net figures don't impress you (most of those you see are gross, taking no account of the countries' financial assets), note that these euro-wide averages include Greece with a net debt of about 130 per cent of GDP and Italy with about 100 per cent.

The trouble with debt, of course, is it has to be ''serviced''. You have to pay the interest as it falls due and sometimes also repay part of the principle. Businesses and governments tend not to repay their borrowings but just roll them over (renew them)when they come to the end of their term.

You pay interest out of current income. This is rarely much of a problem while everyone's optimistic and your income keeps growing. But when the mood swings to pessimism and the economy turns down - or when the economy turns down and the mood swings to pessimism; it's often hard to be sure which causes which - it can get a lot harder to keep up your interest payments when your income isn't growing as fast or is falling.

The trouble with interest payments, of course, is they're not optional. Many households and firms have to cut back their other spending to make sure they can make their interest payments. When too many of them have to do that, the economy takes another lurch down, taking confidence with it.

Governments, on the other hand, tend merely to run bigger budget deficits. But when you're borrowing just to meet your interest payments, your debt and your interest payments grow rapidly.

And you find you've got another problem. The very people who lent to you so happily during the optimistic phase now turn on you. They say you're a hopeless money-manager, they worry about whether they'll get their money back, they'll only lend you more money at a much higher interest rate and may even press you to repay some principal.

Whereas during the optimistic phase they probably didn't charge you an interest rate high enough to adequately reflect their risk that you wouldn't be able to repay them, in the pessimistic phase - when you're at your most vulnerable - they probably charge you more than needed to cover that risk.

It's all terribly illogical, unfair and, worse, counterproductive. The people who shouldn't have lent you so much blame you, not themselves. They go from being too optimistic, to too pessimistic; too easy to too tough. And by doing so they threaten not only your survival, but their own.

Great system, eh? It's one of the great weaknesses of the generally highly beneficial capitalist system. It occurs because the humans who inhabit the system are emotional, herd animals, contrary to economists' happy assumptions that we're all rational and markets never get it wrong. It occurs when, as until recently, economists, regulators and politicians start believing their own bulldust.

All this helps explain why the governments of the euro area, having borrowed far more than they should have over many years, are now in so much trouble. Some, of course, have borrowed a lot more than others. These are the ones in the most trouble. But since they're all yoked together in the euro, they're all in trouble together.

Once the worst case - Greece - focused their attention, the financial markets began turning one by one on the other bad cases, as markets do. Trouble is contagious. Even the strong countries - Germany and France - are sus because their strength may not be sufficient to prop up all the others.

In the modern world, countries aren't allowed to go bankrupt. They always get bailed out, usually by the International Monetary Fund. In the case of the euro area, much of the bailing out will probably be done by the European Central Bank.

But salvation for sinners always comes with hefty punishment attached, to make sure they learn their lesson. Punishment comes in the form of ''austerity'' - big cuts in government spending and increases in taxes - which initially make things worse rather than better.

At present we're going through a drawn-out period of uncertainty while all the politicians involved argue about taking their medicine. I'm confident they'll eventually get their act together but, even if they do, Europe is in for an unpleasant decade.

Monday, December 12, 2011

Reserve has re-assessed outlook for world growth

Just as a stopped clock is right twice a day, so the financial markets' belief that Europe's sovereign debt problems are the primary factor influencing the Reserve Bank's decisions about interest rates, having been wrong for most of the year, has finally proved on the money.

A psychologist would say the financial markets have been suffering a "salience" problem. Their judgments about how the Reserve will adjust the official rate have been overly influenced by the factor sticking out in their minds and also on their minds most recently: Europe.

If Europe is on their front burner, it must also be on the Reserve's. Since the outlook for Europe is so worrying and so conducive to slower economic growth, the markets have for months been predicting that big falls in our official rate are imminent.

Month after month the markets have stuck to this view, ignoring the Reserve's twice-monthly explanations of its thinking, which, while acknowledging the worries and uncertainties over Europe, have repeatedly emphasised the state of the domestic economy and, in particular, the outlook for domestic inflation, as key considerations.

So when, on Melbourne Cup day, the Reserve acted for the first time in a year and chose to lower interest rates by a notch, the markets weren't surprised. But they were right for the wrong reason. As the Reserve made clear, it was able to ease a notch because the economy wasn't accelerating to the extent it had been expecting, thus making the Reserve more confident inflation would stay on track over the next year or two.

But all that changed last week, when the Reserve eased the rate another notch, this time making it clear its decision had been influenced by the changed prospects for the global economy.

So what exactly were its motivations? Was it taking out a little insurance, fearing the worst might come to the worst in Europe? No, nothing so dramatic.

It doesn't take many brain cells to get the wind up over Europe and assume the worst. It takes more brain power to quietly assess the probability of a complete disaster. And more again to assess the strength of any troubles in Europe by the time the ripples reach the Antipodes via China.

By now, the shape of the solution to Europe's problem is reasonably clear. The 17 member countries of the euro area (or, if they insist, almost all the members of the European Union) need to sign up to a new fiscal compact, which imposes limits on the size of their budget deficits and levels of public debt relative to gross domestic product, with automatic penalties for countries that breach these limits.

The pact would also impose timetables for countries presently well in excess of those limits to comply with them, again with penalties for breaches.

Once these strictures had been ratified - thus plugging the obvious hole in the euro currency union, as well as guaranteeing the errant borrowers would mend their ways - the European Central Bank would be willing to start buying up the bonds of member countries, thus forcing down their yields.

It would cut its official interest rate to next to nothing and engage in "quantitative easing" (buying government bonds to cover deficit spending and so, in effect, printing money). Thus all the budgetary contraction would be offset to some extent by monetary stimulus.

While it's painfully apparent the European leaders are having trouble getting their act together - thus increasing the risk of disaster occurring by accident - it's also apparent they're neither fools nor suicidal.

So to assume Europe is headed inevitably for an implosion - as many punters seem to - strikes me as nothing more than unthinking pessimism. Our more experienced observers put the probability of a complete disaster no higher than about one chance in three.

This says the chances are twice as high that Europe will muddle through. But it's clear that even if the full calamity of a collapse in the euro is averted, even if everyone dons their fiscal straitjacket, the financial markets calm down and ordinary life resumes, the outlook for the European economy is particularly weak.

All those economies committed to the fiscal austerity of tax increases and swingeing spending cuts - and it will be quite a few of them - face the dismal prospect of fiscal contraction leading to reduced revenue, reduced revenue leading to a need for more fiscal contraction, and so on and on.

If you wonder how any politician could agree to such an appalling exercise, you're starting to understand why Europe's politicians have had so much trouble getting themselves up to the barrier. They've had to reach the realisation the financial markets - which went for years happily lending them more money than was good for them - are now not going to tolerate any easier or more sensible work-out of their debt problems.

For our purposes, it's now clear the greatest likelihood is negative to flat growth in Europe for at least the next year or two (the forecast period) and probably far longer. It's also clear that, while the US economy has gained momentum recently, it too faces unavoidable fiscal contraction, if not next year then in 2013.

With evidence China's exports to Europe are already being hit, the Reserve decided last week to revise down its forecasts for world growth. This will change its forecasts for domestic growth and inflation only a little, but it was enough to raise the Reserve's confidence it could cut rates another notch without jeopardising achievement of its inflation target.

Meanwhile, the financial markets are betting the official rate will have fallen by another 1.5 percentage points by the middle of next year. I call that courageous.

Saturday, November 12, 2011

Storm clouds over Europe, but sun is shining elsewhere

If you're confused about what's happening in the European economies, why it's happening and what it means for the world economy, don't feel you're alone.

The media's great strength is the speed with which they can bring us myriad details about the latest happening in Greece, Italy or anywhere else. Unfortunately, their great weakness is their inability to digest all that information and summarise what it means. The closest they go is in relaying the opinions of 101 supposed experts from Greece, Britain, America or anywhere else. Listen to more than one or two and you're soon none the wiser.

But this week our own secretary to the Treasury, Dr Martin Parkinson, gave us his tight summary of what and why and what next.

He began by warning that ''the global economy is heading down a winding road, with twists and turns ahead that we can't predict''. Following the global financial crisis, it was expected that the global economy would recover at a modest pace as the financial excesses were worked out of national, business and household balance sheets.

Instead, we've seen events occur that threaten to derail this recovery. ''The unfolding saga of the European sovereign debt crisis sees events change on a daily (if not hourly) basis,'' Parkinson says.

''It's not just events in Europe either, with the unprecedented downgrade by Standard and Poor's of their US sovereign credit rating in August providing yet another twist.''

He says there are four ''proximate'' (immediate) causes of the present situation in Europe. The first is the unsustainable sovereign (government) debts of some economies in the euro area, which reflect a period of weak economic growth and big budget deficits. This suggests a need for microeconomic reforms to enhance the country's international price competitiveness (because membership of the euro prevents the country from gaining competitiveness by devaluing its currency) and for more competitive taxation and social welfare policies.

The second cause of Europe's problem is policy responses from governments that are inadequate considering the size of government debt. This raises the fear of ''contagion'' (spreading disease) throughout the European banking system.

Third, the markets' continuing fear that political institutions are incapable of implementing concrete and credible responses to the problem.

And finally, a growing recognition by markets that the economic recoveries in both the US and Europe will be weaker than previously expected, making it even harder to work down their already excessive levels of government debt.

Financial markets around the world have been gripped by uncertainty and aversion to risk because of the prospect of weak global growth and the European sovereign debt crisis. Volatility has become the new norm.

The euro-area leaders' summit late last month finally made some much-needed announcements, but though markets initially reacted positively to these measures - despite the absence of detail - this was very short-lived.

Political developments in Greece and Italy in the past fortnight have further undermined confidence in the commitment of governments to deal with the underlying problems. Europe will remain a source of market volatility until governments' commitments are seen as clear and credible.

Market participants have become very reluctant to hold the bonds of certain governments, which is reflected in the market yields (effective interest rates) participants require to hold the bonds of particular governments.

The yield required on Spanish and Italian bonds, for instance, is about 5 percentage points higher than that for German government bonds. For Irish bonds this ''spread'' got as high as 12 percentage points, but has since fallen to about 7 points. For Portuguese bonds it's 10 percentage points and for Greek bonds it's about 30 percentage points.

Across the Atlantic, growth in the US weakened significantly in the first half of this year. Though it's strengthened a bit since then, the recovery remains vulnerable to external shocks such as a re-intensification of the European debt crisis.

''In the longer term we can have confidence that the US economic system will drive the innovation and investment needed to spur competitiveness and growth,'' Parkinson says. ''The question is whether the US political system can mobilise itself to address its medium-term fiscal challenges.''

But while both Europe and the US face budgetary challenges, there are some crucial differences, he says. Critically, the US has its own currency and monetary policy and a fiscal (budgetary) union between its 50 states.

And with the yield on 10-year US Treasury bonds at about a 60-year low, there's zero pressure from the market to force political action - and a political compromise - on a substantial medium-term reduction in the US budget deficit.

But until such a plan is agreed and legislated, the US will remain at risk of a sudden shift in market sentiment, as Italy has discovered in recent months.

Parkinson remarks that, with economic commentary focused on the short term and the North Atlantic, it's easy to overlook the bigger picture. We are in the midst of a once-in-a-century global economic transformation as the world's centre of economic gravity shifts from the advanced economies to the emerging market economies.

We focus on the rapid growth of China and, to a lesser extent, India. But we shouldn't overlook the strong growth of Indonesia and Vietnam. With a population of almost 240 million, Indonesia is the world's fourth most populous country. If we measure it using purchasing-power parity (as we should), Indonesia's economy overtook Australia in size in 2005.

Parkinson also points out that the rise of the developing countries isn't limited to Asia. ''We see a similar story developing in other emerging economies,'' he says.

''For example, a young population and improvements in human capital will likely contribute to an expected doubling in South Africa's gross domestic product in the next 20 years and Nigeria is expected to increase three-fold to displace South Africa as the continent's largest economy by the late 2020s.

''Latin America also continues to surge forward, with Brazil and Chile leading the way - with both expected to double in size by 2030.''

Returning to Asia, despite rapid growth in living standards, China and India remain at the early stages of their economic development. Assuming broad trends continue, China and India's cities will be populated by an increasing wealthy and mobile middle class in the decades ahead. ''On some projections, there will be 1.7 billion middle-class consumers in the Asia-Pacific region by 2020 - more than the rest of the world combined.''

Remember, however, all these projections rest on the economists' de rigueur assumption that there's no way shortages of natural resources or environmental pressures could prevent the global economy from continuing to grow forever.