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The recent G-20 summit has marked a defining moment.  We know the rise of Asia is shifting the global landscape, politically and economically.  But the summit has made it clearer than ever to the western public that Asian countries have the means and weight to support their own national interests.  In a new multi-polar world, the forces at play are more complex and nuanced.  Most economic problems are now unlikely to be solved with magic bullets, or unilateral shoving or bullying. 

In the field of economics, much uncertainty lies ahead.  There is a great deal of disparity in economic prospects amongst the large trading blocks of Asia, Europe and the Americas.  Scenarios about growth, inflation and long term interest rates, and notably exchange rates, keep changing every quarter.  While many countries have so far resisted the siren call of protectionism, policies and politics have in the short term ruthlessly focused on exchange rates.  Exports are deemed to be an important key to the exit strategy out of the financial crisis.   In a slow motion deployment, countries are still responding to this prolonged financial crisis:  Quantitative easing (QEII) in the USA, debt restructuring and budget cuts in Europe, and tackling overheating in Asia.  At this stage of the crisis, we are only sure that it is setting the stage for further episodes.

QE II is the second response from the Federal Reserve in this financial crisis.  The short term impacts of QE II were well anticipated by the markets:  a drop in the US dollar, a lower interest curve, a stock market rally and a rebound in commodities.  Yet it remains speculative to predict the likely outcome of QE II in the medium term.  A string of renown economists (among others Krugman, Stieglitz, Brittan, Roach, Roubini…) have voiced concerns about the effectiveness of QE II to jump start the American economy.  Moreover, other countries will not remain idle to this American policy.  So what can we expect about the American economy?

One of three scenarios is likely to take hold in the next couple of years:  1. The American economy gets back on its feet and cures its financial system, 2. The USA falls into a decade long pattern somehow similar to Japan in the 1990s, 3. The USA experiences a steady decline from now on.

SCENARIO 1:  Resilience trumps the doubters

The resilience of the American economy has long made the envy of other nations.  Several factors have underpinned this capacity to spring back after major setbacks:  Inventive minds giving birth to new technologies, a power to attract the best brains, a financial system backing entrepreneurs, a mobile and educated workforce, a bevy of competitive companies, a large domestic market to induce scale, and a military force to sustain security and national interests.  Now, this past recession was no ordinary slow down.  It deeply hurt federal institutions, states budgets, industries and flagship companies.  The central question is about whether the financial crisis has permanently damaged the American model and its intrinsic resilience?   Whatever the answer, the coming back will require hard work, sacrifice and deft fingers to manage the right balance between short term stimulus and  a credible medium term fiscal plan.  It is thus quite possible that the USA will regroup politically, pull economically ahead (albeit slowly) and manage enough growth to tackle the extended deleveraging phase.   This is the wish of the several key trading partners to the USA.  Much is at stake in this recovery.

SCENARIO 2:  Muddling through for a while, Japanese style

It is equally possible that things will not move so fast and so positively for the American economy.  The headwinds are strong.  Economic growth has in the past ten years shifted away from the axis of Europe-America, to Asia and other emerging blocks.  Technology and innovation are spreading fast to other nations.  Healthcare and education standards will suffer in the near term at state levels.  Household mobility is hampered by the real estate mess.  In fact, the American middle class ended up the first decade of the 21st century in pretty bad shape.  Paul Volker recently commented on the largest ever wealth transfer in America, taking place in the same decade, from the middle class to the rich class. 

The Japanese went through a similar financial crisis in 1990. The post-bubble headache lasted a good ten years: Low growth, high indebtedness, bouts of deflation, deep social changes, etc.  The pillars of the Japanese model, which had so much frightened the West for a couple of decades, were irreparably weakened as a result. But as much as the Japanese economy finally recovered around 2003-2005, the ageing curve was catching up with the country.  GDP per capita has now started to fall in Japan. 

For America, this is a scenario of relative decline, for a period of 5 to 10 years, but with the strength to remain a top tier power across the board. 

SCENARIO 3:  Past the tipping point?

Are we now possibly witnessing TWO earth shaking moments in this generation?  The first, anchored in the fastest and largest industrial revolution of all times, is the return of China as a world economic power. And the second could be the recent peak of American power, slowly and steadily evaporating before our eyes.   We should by no means jump to pessimistic conclusions just because a country is going through a very tough patch.  But the words of Paul Kennedy, in his seminal work of 1988 (The rise and fall of the great powers; P. 533) have a ring of truth that such a scenario should not be discarded too lightly either:

“For it has been a common dilemma facing previous ‘number-one’ countries that even as their relative economic strength is ebbing, the growing foreign challenges to their position have compelled them to allocate more and more of their resources into the military sector, which in turn squeezes out productive investments and, over time, leads to the downward spiral of slower growth, heavier taxes, deepening domestic splits over spending priorities, and weakening capacity to bear the burdens of defence. “

There is a sense of vulnerability clouding the American economy, shared by many observers.  We hope it recovers ground and strength, but we cannot be certain that it will in the current global context.  We can only be sure that QE II will bring its share of unpredictable events in the next few years, as they unfold and possibly take us by surprise. 

This is not what companies wish for, accustomed to deal with macroeconomic variables only once a year, at budget time.  But that is the picture they will face:  A certain level of global uncertainties, driven by competing geopolitics, trade imperatives, glowing bubbles, and shifting alliances.  

Boards, CEOs and CFOs will need to track on a regular basis (monthly or quarterly) those fundamental changes as they affect interest rates, exchange rates, patterns of trade and investments, etc.   Macroeconomics is moving up to the strategic level:  Turning points, potential crises, growth opportunities or market destruction will stray the path ahead.

André Du Sault

Posted in CFO & treasury, World economy.

Tagged with , , .

2 Responses

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  1. René Miglierina says

    Mes plus vives félicitations à André Du Sault pour un texte très fouillé et à point.

    • Cornelia says

      Good point. I hadn’t thoguht about it quite that way. 🙂

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