Measures to buoy western economies are making some progress while the search for yield feeds the pace of development of emerging markets, HSBC Bank UK’s senior global economist Karen Ward told The Sunday Times.
Europe’s crisis may not be over by next year as economies react to very aggressive fiscal plans, while quantitative easing (QE) – the measure to stimulate economies with monetary boosts – is slowly producing the desired, albeit subtle, results in the US and UK, she added. Elsewhere, emerging markets will ensure their sustainability if they are able to channel capital flowing in from the west into sound investments.
Ms Ward was in Malta last week to address a business breakfast on “The World in 3D: debt, deflation and deleveraging”. More than 130 professionals attended and contributed to an interesting debate at the Hilton Malta.
“The European crisis will not be over by next year because there are some very aggressive fiscal plans in place in Europe and we need to see how these economies react,” Ms Ward explained. “If growth is maintained through exports, or the private sector does not buckle under fiscal tightening, then the debt-to-GDP ratios are improved. If it does buckle, we are back to square one.
“If all the government has managed is a cutback in spending and a cut in nominal GDP and therefore a cut in tax revenue, then nothing has been achieved. It is in danger of getting caught in a vicious cycle: the government tries to make more cutbacks to repair its position and the economy falls deeper.”
Ms Ward believed this could be where the much talked about double dip might happen. In some parts of the periphery, like in Greece, the fiscal cuts were so significant that a considerable impact on the economy was almost inevitable.
As the eurozone faced its latest crisis in the summer with its most troubled economies, the euro weakened, opening a window for the export sector to compensate for the government sector.
But the euro (the European Central Bank has not opted for QE) was now rising against QE currencies and the window was closing. Ms Ward explained this scenario would lead to structural reform in parts of Europe that will pave the way for a very long-term growth outlook. For Greece to realign its balance sheet, Ms Ward pointed out, tax reforms and significant cutbacks were necessary. Its recovery hinged partly on politicians’ willpower to see the process through, a notion that made financial markets particularly nervous.
With exiting the eurozone – and consequently the European Union – practically unthinkable, Ms Ward believed Greece will work hard at its recovery; northern economies would show leniency and the International Monetary Fund would continue to be supportive to ensure debt was rolled over and refinanced.
Ms Ward added it was in the northern economies’ interest to support the south: German imports were upbeat thanks, to some extent, to significant trade within the eurozone. It was imperative to bring the struggling economies back on track through trade and through the banking system: considerable sovereign debt was held by the northern economies’ banking systems, which was why collaboration was in the common interest.
Would eurozone states ever come to an agreement on centralisation?
“The past 18 months have shown that monetary union without some clear fiscal union is a problem,” Ms Ward replied. “There were very large underlying differences, which meant the common interest rate did not result in a credit boom in Germany, but did in Spain. The development of those imbalances within the region, and their prevention, needs to be examined. There is still a lot of work for European policy makers drawing up the monetary and fiscal architecture.”
In the US and the UK, QE was doing what it was supposed to through subtle channels. Ms Ward conceded that central banks explained the concept in different ways, causing confusion. She explained that new, periodic boosts were necessary because confidence was inspired very slowly: the first cycles often resulted in debt repayment, subsequent cycles led to cautious spending. The challenge for central banks lay in striking a balance, injecting just the right ‘measure’ of inflation into the system.
Ms Ward outlined the four main channels through which QE worked: “First of all, it depresses the currency and helps exports. There are limits to what a central bank can say it is trying to achieve because this growth is at the expense of neighbouring countries. The second channel is the support to the government bond markets: ensuring governments can fund very large deficits and keep fiscal options open – or at least not talk about fiscal cuts. That provides some underlying support to the economy.
“This is the main distinction between what is happening in the eurozone and what is happening in the UK, which has much larger fiscal deficits but the lowest interest rates ever. That is because so much of the new supply of government bonds has been taken up by the central bank, so there is not a huge amount of supply to the private investor.
“The third way QE works is to boost expectation. When we reached zero interest rates, there was immediate panic as people believed there was nothing more that could be done. QE is infinite: money can continue to be printed until the problem is sorted out. Boosting expectation leads to people thinking there could be some inflation down the road.
“The final channel is through asset markets. As investors are risk- averse, they try to buy government bonds. But by making the yield on government bonds so unattractive, investors are forced to buy risk assets. There is no doubt this channel is working. Pushing investors into risk to keep some type of yield helps the economy as corporates are financing with no difficulty at all.”
Ms Ward is a firm believer in the long-term structural story that sees emerging markets continue to grow. Their developing economic infrastructure was fostering long-term growth: they were expanding their capital markets, opening themselves up to trade, and developing financial systems, enabling them to reach the west’s levels of financial wealth.
She added that the west’s problems might accelerate the process. Western policy makers were facing a scenario where as stimulus money searched for yield, it ventured east and south, feeding the development of emerging markets. There was evidence of this trend in portfolios, but Ms Ward cautioned that emerging economies had to ensure that capital inflows were channelled into productive, long-term investment.
Currency wars, such as that between the US and China, would continue, as the developed world fought to gain momentum for its exports. An interesting factor will be the euro’s reaction: the single currency had retained its value as the ECB was reluctant to go down the QE route to expand supply.
Asked whether economies were prepared for when interest rates began to rise, Ms Ward replied that would be an indication that problems were finally being solved.
“Interest rates will only rise when we are absolutely on the road to recovery,” she stressed. “Inflationary pressures will come through the system when unemployment is much lower and the economy is back on track.”
If 2009 was the year of the rescue package and 2010 the year of the austerity measure, 2011 was the year of...?
“Politics,” Ms Ward replied. “The austerity packages are ongoing, unemployment is still high. Politicians will be really tested as they move through election cycles. The political economy is back and will be the key feature of 2011.”
Ms Ward graduated from University College London in 2003 with a distinction awarded for her Master’s in Economics. She joined the Bank of England and provided supporting analysis for the Monetary Policy Committee, focusing on the impact of the housing and financial markets for the macro economy.
In 2006, she joined HSBC as chief UK economist and was one of the first economists to warn of the potential problems that would arise from a bubble in the property market in 2007.
She appeared as a witness for the UK’s Treasury Select Committee to provide an independent assessment of the Chancellor’s Budget in 2009.
Last July, Management Today listed her among the UK’s most successful professional women under 35.