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A new approach to growth and money

The US, China and Europe are all desperate for more growth – but all have constraints on how much more action they think they can take. But they should muddle through.

by
John Redwood

in Features

31.10.2019

This week, Mario Draghi passed the job of President of the European Central Bank over to Christine Lagarde, whilst trespassing into fiscal policy territory in search of more economic growth. In the US, the Federal Reserve continued its monetary expansion, with a bigger balance sheet and a further interest rate cut. In China, the more-secretive Central Committee held a plenary to discuss how it can support Chinese growth and make progress on the trade war with the US.

These three big economies of the world share some common problems. Growth has slowed more than they would like. World trade is damaged by the US tariff war but also by other tariff and trade conflicts from Iran to Kashmir and from South Korea to the Airbus/Boeing disputes in the EU and the US. It is also hit by the sharp decline in traditional diesel and petrol vehicle output as a result of the big regulatory and tax push to get people to buy electric vehicles before they are ready to do so in big enough volumes. The grounding of the Boeing 737 Max, the majority of Boeing’s order book, also hits sales and deliveries in world aviation manufacture, whilst the general weakness of investment cuts demand. Manufacturing has been in a recession in many places.

The problem with euro

Mr Draghi drew attention to a fundamental weakness of the Euro-area system. He said: “National policies cannot always guarantee the right fiscal stance for the Euro-area as a whole”. He probably had Germany in mind in particular, where the country will not run a deficit even though the economy is close to recession and the zone as a whole would like more German spending. He asked for “Euro-area fiscal capacity of adequate size design, large enough to stabilise the monetary union, but not to create excessive moral hazard”. The Draghi solution is a larger Euro-level budget with a larger aggregate budget deficit around the zone. He is trying to balance the forces, reassuring the Germans that he does not have in mind a big budget deficit expansion in weak economies such as Italy or Greece, whilst backing some fiscal expansion. He pondered that work on climate change might create the route to a larger EU level of budget with a fiscal stimulus coming from more green investment and spending.

Mrs Lagarde may well wish to intervene in this sensitive politics of the zone. Some think her first task is to calm disagreements around the ECB table, where Mr Draghi has overridden the views of those – often led by Germany – who oppose additional quantitative easing and lower negative interest rates. She may be able to work with Ursula Von der Leyen, the new President of the Commission. She herself has talked of a bigger green budget at EU level, and of the need for some fiscal relaxation. Given the balance of forces and the entrenched Maastricht state debt and deficit criteria, it is unlikely there will be a large fiscal relaxation anytime soon. The countries that want a fiscal expansion most are the ones most constrained from borrowing more by the controls. We expect a modest increase in budgets around a green theme.

The Chinese government is likely to endorse current Chinese strategy of trying to achieve a limited deal with the US to avoid the tariff and trade problem becoming worse. China is likely to confirm offers of more financial market opening, less onerous technology transfer terms for inward investors, and some more purchases of US food. They would like to lift the spectre of more tariffs. They will also doubtless reinforce the more muscular approach to government of Hong Kong which has led to the disruptions there, whilst examining how to change the local management.

Hong Kong flashpoint

The government has always been more interested in the One Country part of the One Country, Two Systems mantra, and does not accept two systems where they think the Hong Kong system is some kind of challenge or weakness to the mainland approach. The government seems to want to muddle through on growth, offering occasional modest stimulus through tax cuts, spending and borrowing increases and monetary action whilst continuing to bear down on weak balance sheets in industry and banking. The latest figures for Chinese orders and outlook are weak, implying the need for a further boost. The Central Bank, meanwhile, is worried about the current headline inflation figure at 3% and the extent of borrowing is some areas.

It is the US that has applied most stimulus. The President wants every lever for expansion to be fully pulled, and regularly chides the Central Bank for not doing more. For its part, the Fed is desperately trying to catch up with events. Late last year it tightened too much, and it has taken time to adjust its stance this year. Now it is creating liquidity and passing it on at the short end of the market, and gradually bringing interest rates down. The Fed is saying they have now cut interest rates enough, but markets still think there could be a bit more to come.

The US is not immune

The President has put through large tax cuts and a big fiscal expansion and will be unable to do much more given the attitudes of the Democrat controlled House of Representatives. This is why he is turning to trade policy and is seeking to influence monetary policy. His tariff policy is not helping, though he thinks it will. He sees he can spend the tariff revenue and believes more businesses will onshore their activities into the US and more domestic production will meet consumer needs as foreign competitors have to take a tariff hit. So far, US industry has not been protected from the general world downturn.

All three areas of the advanced world economy have governments and Central Banks that want more GDP growth, but all have constraints on how much more action they think they can take. It means we are likely to muddle through with slower growth and occasional market alarms about the state of economies. The bullish things to watch out for are further monetary easing in the US and China, and some EU level investment and spending.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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