Robert Fauver, former US G7 sherpa, shares with editor John Kirton his perspective on the global economy – from what is making it tick to short- and long-term threats to growth
What is the current state of the global economy?
Putting aside for the moment the Middle East oil problem, nothing looks like it would bring anything other than a very modest slowdown, if that. In general, the global economy is on a steady growth path.
For the United States, consumption spending and private investment spending look solid enough to support 3% annual growth. Net exports are always an unknown factor, but from the domestic side it is solid 3% growth.
The big unknown in Europe is, of course, Brexit. It is still upsetting expectations, so consumption in some parts of Europe is being held back. Italy is still a weak spot, but it has survived weaker conditions, and its little-talked-about black economy continues to bring the population a decent standard of living. France is still going through a reaction to Emmanuel Macron’s presidency. His early initiative on changing labour laws backfired with unrest and it is still holding growth down. Germany is trying to figure out what is going to happen in the post-Merkel era, so expectations are a little shaky there. Europe is on the weaker side of the G7; nothing disastrous, but nothing optimistic either.
Japan’s first quarter was below expectations, but it is coming into a growth spurt because of the summer Olympics next year. That huge influx of tourist dollars will sustain significant growth – maybe almost 2% over the next 18 months. That is a bright spot in the outlook that most econometric forecasters do not consider.
What are you most worried about?
Two things. First, the trade situation led by the United States’ continual bombastic approaches to trade negotiations unsettles markets. Regardless of the anxious wait for passage of the new NAFTA, the final product is a significant improvement. I think the same will come from China when the dust settles, but in the meantime it does upset markets.
Second, if the oil crisis in the Middle East and the Iranian situation continue, we could see uncertainty in the financial market. The longest growth of the markets in modern US history could end, not for underlying economic factors but for geopolitical tensions and global factors. But if you put energy markets in the Middle East and the Suez Canal area to the side, there is plenty of room for upward growth for 18 months, perhaps with a modest correction.
Will inflation reappear?
It is far too early to worry about a return of rapid inflation. We have gone for 14 years with almost none, which is not a long-term path that anybody would expect. Increased labour mobility and wage flexibility are beginning to enter into the US market. We are seeing wages and lower and middle incomes rising, finally. That will put some upward pressure on prices. There is not much slack within the domestic economy. Excess capacity is relatively tight, so I would not be surprised to see 2% inflation.
At what point should markets worry about mounting debts and deficits and quantitative easing?
It will be a medium-term concern in the next year or two. I am worried about the current move in the United States about putting a two-year cap on expenditures, leaving a $1 trillion deficit for the next two years. That is an outrageous number – nowhere near some of the Europeans, but we do not have the slack that they have.
It is taking a very long time to come out of the crisis. Monetary policy has been excessively cautious in returning to positive real interest rates. If the US Federal Reserve cuts rates again, we may return to negative interest rates, which are never good over any length of time. But the Fed will come back around. I am a little concerned about the European Central Bank, with new leadership from somebody with no financial market experience or economic training. The new ECB leader is an astute politician and very good at working with diverse groups, but that does not necessarily make for a good central banker.
Should the G7 leaders at Biarritz take a stance on interventions in exchange rate policy for competitive purposes?
There is a non-market-determined exchange rate in China but not by purchase and sale by the central bank. Constraints on capital movements are much more significant in reducing demand for the renminbi in international markets, which has a more significant effect on creating a non-market determined exchange rate than direct market intervention. Within the G7 there is not much evidence of direct market intervention other than smoothing.
Should the G7 leaders focus on structural reforms?
Yes, structural rigidities continue to hinder the efficient allocation of resources within Europe and, to some extent, in Japan. There is a lot in labour mobility that is hindered by rules and regulations and labour market arrangements. There are product price determinations still unable to take place in a market sense. There are institutional rigidities – pension schemes being one, which is a significant concern given ageing populations in most of the G7 countries. Underfunding pensions both public and private is a significant overhang on medium- and long-term growth. There needs to be a significant discussion by leaders, central bankers and finance ministers. Japan is leading us down that path because its ageing population and underfunded liabilities are comparatively more significant.