GLOBAL Macq-ro insights - jrj.com.cnpg.jrj.com.cn/acc/Res/CN_RES/MAC/2016/4/14/6d5... · Macquarie Research Macq-ro insights 14 April 2016 3 Global consumption growth Over 2016-18,

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GLOBAL

Why this issue matters to investors 1) Entitlement program promises are under pressure. Politicians and policymakers are looking to boost global growth

2) Global fiscal easing is highly unlikely to happen, such that the debate appears to have moved towards supporting global consumption

3) UNCTAD estimates that global growth could be boosted by 1% with full global macro coordination. Perhaps a tenth of that is currently possible

4) This report supports a focus on global consumption growth beneficiaries

Our forecasts:

Please see the 14 March 2016 The Global

Macro Outlook: Post the deleveraging

twister

Online access to our global macro

forecasts is available on request

Analyst(s) Macquarie Capital Securities (Japan) Limited Peter Eadon-Clarke +81 3 3512 7850 [email protected] Nara Song +81 3 3512 7878 [email protected] Macquarie Capital (Europe) Limited Matthew Turner +44 20 3037 4340 [email protected]

14 April 2016

Macq-ro insights Global policy coordination dreams The political consequences of ‘the long grinding cycle’ of 2.5-3.0% global real

GDP growth, and 1.0-1.5% global inflation are intensifying. Entitlement program

promises are under pressure. Politicians and policymakers are looking to boost

global growth, somehow. The private sector is less robust beyond the US,

suggesting the ongoing need for cyclical policy support.

From fiscal stimulus to boosting consumption

On 26-27 February 2016, the G20 finance ministers and central bankers met in

Shanghai amid turbulent markets. The then preferred policy, global fiscal easing,

is highly unlikely to happen, page 14. Subsequently, the debate appears to have

moved towards supporting global consumption, pages 3-5.

Global real private consumption growth, US$, YoY, 4Q moving average

Source: Oxford Economics, Macquarie Research, April 2016

To make a substantial difference, policies would need to be almost revolutionary:

upping the minimum wage rate, reducing the tax burden on households,

introducing income redistributive policies and increasing the returns on savings

(a reduction in financial repression). Whilst the probability of their adoption is

low, they have long been advocated by UNCTAD, and the IMF is now

recommending modest steps in this direction.

UNCTAD estimates that global growth could be boosted by 1% with full global

macro coordination, pages 7-9. Perhaps a tenth of that is currently possible.

The G7 meets 26-27 May 2016 at Ise-Shima, Japan. With a developing global

push to support consumption, it will be difficult for PM Abe and Japan, as hosts,

to proceed with the consumption tax rate increase (from 8% to 10%) legislated

for April 2017. A postponement is now in our best case, 6 April 2016 PEC’s

Japan strategy; Grinding out minimal growth.

This report supports a focus on global consumption growth beneficiaries.

Suggested Macquarie research reports

Laurent Vasilescu & Dan Isaacson

Looking at the US consumer names through an international lens (PowerPoint) 8-04-2016

Daniele Gianera et al Global luxury goods – time to price in the new normal 8-12-2015

Viktor Shvets What caught my eye: Launching global portfolios 04-02-2016

Source: Macquarie Research, April 2016

-2

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0

1

2

3

4

5

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

(%) World - Consumption

Ma

cq

ua

rie R

es

ea

rch

M

acq

-ro in

sig

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14

Ap

ril 201

6

2

Fig 1 G20 real GDP growth softened over 3Q and 4Q 2015, YoY based on quarterly data

2011 2012 2013 2014 2015 2016

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

G20 4.8 4.3 3.8 3.5 3.4 3.2 3.0 2.7 2.7 2.8 3.2 3.6 3.5 3.4 3.3 3.2 3.2 3.3 3.1 3.0 NA

Argentina 10.6 8.0 7.7 7.3 3.9 -1.1 0.0 0.6 1.5 4.9 3.4 1.8 0.5 0.7 0.0 0.6 2.2 1.9 3.5 0.9

Australia 2.0 2.5 3.1 3.1 4.4 3.9 3.2 2.7 1.8 2.1 2.0 2.3 3.0 2.7 2.6 2.2 2.2 2.0 2.7 3.0

Brazil 5.1 4.6 3.5 2.5 1.6 1.0 2.6 2.6 3.0 3.8 2.8 2.4 2.5 -0.3 -1.0 -0.7 -2.1 -2.9 -4.5 -6.0

Canada 3.1 2.8 3.5 3.1 2.4 2.6 1.4 0.7 1.7 1.8 2.3 3.1 2.2 2.7 2.5 2.4 2.1 1.0 1.1 0.5

China 10.2 9.9 9.4 8.7 8.0 7.5 7.4 8.0 7.8 7.5 7.9 7.6 7.3 7.4 7.1 7.2 7.0 7.0 6.9 6.8

France 2.9 2.2 1.8 1.5 0.4 0.2 0.3 0.0 0.1 1.1 0.8 1.0 0.7 -0.2 0.1 0.1 1.0 1.1 1.2 1.4

Germany 5.6 3.7 3.3 2.4 0.9 0.8 0.6 0.1 -0.5 0.3 0.5 1.3 2.3 1.4 1.2 1.5 1.1 1.6 1.7 1.3

India 10.1 9.3 5.0 4.4 3.9 3.8 6.8 6.1 5.9 6.0 6.6 7.0 6.9 7.2 7.4 7.1 7.4 7.4 7.3 7.5

Indonesia 6.3 6.2 6.2 6.0 6.1 6.1 6.0 5.9 5.7 5.6 5.5 5.4 5.2 5.1 5.0 4.8 4.8 4.7 4.8 4.9

Italy 2.0 1.5 0.5 -1.1 -2.3 -3.2 -3.2 -2.7 -2.6 -2.0 -1.4 -0.9 -0.2 -0.2 -0.4 -0.3 0.2 0.6 0.8 1.0

Japan 0.1 -1.6 -0.4 0.3 3.3 3.5 0.3 0.0 0.1 1.1 2.1 2.1 2.4 -0.4 -1.5 -0.9 -1.0 0.7 1.7 0.8

Korea 4.8 3.7 3.4 2.9 2.6 2.4 2.1 2.1 2.2 2.7 3.2 3.5 3.9 3.5 3.3 2.7 2.4 2.2 2.8 3.1

Mexico 4.2 3.6 4.2 4.2 4.0 4.5 3.3 3.4 3.1 0.6 1.5 1.1 1.1 3.0 2.3 2.6 2.5 2.4 2.7 2.5

Russia 3.6 3.8 4.8 4.8 4.7 4.2 2.9 1.7 1.5 1.1 1.3 1.5 1.1 1.4 0.3 -0.8 -2.1 -3.8 -3.7 -3.8

Saudi Arabia .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. ..

South Africa 3.8 3.7 2.8 2.5 2.0 2.4 2.4 2.1 2.0 2.0 2.0 2.8 2.1 1.3 1.5 1.3 2.0 1.6 1.2 0.3

Turkey 11.9 9.1 9.2 5.2 2.3 2.9 1.9 1.4 3.4 4.3 4.3 4.7 4.7 2.3 2.3 2.9 2.4 4.0 5.1 4.4

United Kingdom 2.1 1.7 2.0 2.1 1.5 1.0 1.2 1.0 1.4 2.2 2.1 2.8 2.8 3.0 2.8 2.8 2.6 2.4 2.2 2.1

United States 1.9 1.7 1.2 1.7 2.8 2.5 2.4 1.3 1.1 0.9 1.5 2.5 1.7 2.6 2.9 2.5 2.9 2.7 2.1 2.0

European Union (28 countries) 2.8 1.9 1.6 0.9 -0.1 -0.4 -0.5 -0.7 -0.6 0.1 0.5 1.2 1.5 1.3 1.3 1.4 1.7 1.9 1.9 1.8

Euro area (19 countries) 2.8 1.9 1.4 0.5 -0.5 -0.8 -0.9 -1.1 -1.2 -0.4 0.0 0.6 1.1 0.8 0.8 1.0 1.3 1.6 1.6 1.6

Note: all data from the OECD with the exception of the pale green highlighted numbers which come from National Statistics sources

Aggregates above use PPP weights. Using market exchange rates would reduce the G20 real GDP growth numbers by 0.5-0.6%

“The G7 was established in 1976 as an informal forum of seven major industrial economies: Canada, France, Germany, Italy, Japan, the United Kingdom and the United States of America. It was re-named the G8 after the entry of Russia in 1998. In March 2014, the G7 voted to suspend Russia in response to escalating tensions with Ukraine that led to Russia's annexation of Crimea. However, the suspension is designed to be temporary. Where the G7 seeks agreement on current economic issues based on the interests of those countries, the G20 reflects the wider interests of both industrial and emerging-market economies. The G20 is made up of the finance ministers and central bank governors of 19 countries: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, the United States of America” - plus the EU (Source: the Telegraph newspaper)

Source: OECD, Macquarie Research, April 2016

Macquarie Research Macq-ro insights

14 April 2016 3

Global consumption growth Over 2016-18, national perspectives are expected to dominate: the US having achieved

domestic balance will slowly raise policy interest rates; the eurozone will nurture the revival of

its private sector; China will focus on the quality of its growth.

For more on the latter, please see the 8 April 2016 Macq-ro insights: What’s next for EM

economies? Larry Hu’s report: 8 April 2016 Debt/equity swap: What can we learn from the

past? discusses China’s debt restructuring issues.

Consumption is the key to global growth forecasts. At the global level, we are expecting

investment to be a mild headwind, whilst we are not expecting fiscal spending to be a material

growth driver. Trade growth is expected to remain modest and, therefore, we do not expect it

to be a material catalyst of efficiency gains. Please see the 14 March 2016 The Global Macro

Outlook: Post the deleveraging twister for more details on our global forecasts.

Fig 2 is illustrative of the current firmness in consumption, with an attribution of the growth

forecasts shown in Fig 3.

Fig 2 Global real private consumption, US$, YoY

Note: Forecasts Oxford Economics. Constant prices and exchange rate


Whilst consumption growth is expected worldwide, advanced economies remain important.

The 2018 blue highlighted cells below total 1.22%, the grey 0.93%.

Fig 3 Global real private consumption, US$, YoY, contributions of the major economies to 2016-20 forecasts

Contribution 2016 2017 2018 2019 2020

United States 0.66% 0.65% 0.61% 0.56% 0.53%

Europe 0.41% 0.39% 0.35% 0.32% 0.31%

Japan 0.04% 0.13% 0.11% 0.09% 0.07%

South Korea 0.04% 0.04% 0.05% 0.04% 0.03%

Canada 0.04% 0.05% 0.05% 0.05% 0.05%

Australia 0.05% 0.05% 0.05% 0.05% 0.05%

China 0.57% 0.56% 0.57% 0.58% 0.58%

Hong Kong, China 0.01% 0.01% 0.01% 0.01% 0.01%

Indonesia 0.06% 0.07% 0.08% 0.08% 0.08%

Taiwan 0.01% 0.02% 0.02% 0.02% 0.02%

Latin America -0.09% 0.06% 0.14% 0.16% 0.18%

Mexico 0.06% 0.06% 0.06% 0.06% 0.06%

Turkey 0.06% 0.06% 0.05% 0.06% 0.06%

Total: World 2.50% 2.87% 2.88% 2.85% 2.78%

Note: Forecasts and calculations by Oxford Economics. Constant prices and exchange rate


-1.0

0.0

1.0

2.0

3.0

4.0

5.0(%) Private Consumption, real US$

The key to global

growth forecasts


14 April 2016 4

Seeking a high frequency indicator, Fig 4 presents the OECD US and eurozone consumer

confidence monthly series along with the Oxford Economics global real private consumption

series (quarterly data, 4Q ma). Consumption growth has softened over the last six months.

Nonetheless, consumer confidence in both the US and the eurozone remains at high levels.

The benefit to household real incomes from plunging oil prices is still positive, though at a

diminishing rate.

Fig 4 Global real private consumption growth and the consumer confidence indices for the US and the eurozone, 2006-2015

Source: OECD, Oxford Economics, Macquarie Research, April 2016

The eurozone is of a similar size to China on market exchange rates. With a higher

consumption to GDP ratio, the eurozone is about 50% more important than China from a

current consumption perspective. There have been fears that the eurozone would follow

Japan into a lost decade. We do believe this, as explained in the 12 January 2016 Macq-ro

insights: Diminishing “Japanization” fears. Fig 5 shows how weak Japanese consumption was

over 1991-2004.

Fig 5 Retail sales volumes (3m % YoY)

Source: Datastream, Macquarie Research, April 2016

Recent eurozone experience is also shown in Fig 5, whilst Fig 6 makes it easier to see the

current trend. Eurozone consumption growth is currently growing by around 1.5% YoY.

Retail sales volume data is a proxy for consumption expenditures, but has two well-known

downward biases. Firstly, household expenditures are becoming more services orientated.

Secondly, the rapid evolution of retail distribution, from general to speciality stores to e-

commerce increases the risk that official statistics take time to catch-up.

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

94

95

96

97

98

99

100

101

102

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

(%) US - Consumer Confindence [LHS] Eurozone - Consumer Confidence [LHS]

World - Consumption [RHS]

(%)

-15

-10

-5

0

5

10

15 (%) UK US Japan Eurozone

Consumption

growth has softened

over the last six

months

The eurozone is of a

similar size to China

on market exchange

rates

With a higher

consumption to

GDP ratio, the

eurozone is about

50% more important

than China from a

current

consumption

perspective


14 April 2016 5

Fig 6 Retail sales volumes (3m % YoY)

Source: Datastream, Macquarie Research, April 2016

Whilst global consumption growth has been firm since 2012, the global CPI has been on a

persistent down-trend, Fig 7.

Fig 7 Global consumer price index, YoY

Note: forecasts Oxford Economics, index: 2000=100


The G7 meets 26-27 May 2016 at Ise-Shima, Japan

As reported in the 6 April 2016 Financial Times, the IMF chief, Christine Lagarde “called on

the US to raise the federal minimum wage, expand earned income tax and strengthen family-

friendly benefits. The eurozone needed to unveil better training and employment-matching

policies to tackle the unemployment rate that remains in double figures. Commodity exporters

and low-income countries should diversify.”

In the context of a developing global push to support consumption, it appears difficult for PM

Abe and Japan, as hosts, to proceed with the consumption tax rate increase (from 8% to

10%) legislated for April 2017. A postponement is now in our best case, 6 April 2016 PEC’s

Japan strategy; Grinding out minimal growth.

The revival of the private sector

Ideally, rather than additional policy stimulation, the world will experience a new private

sector-driven global growth engine.

The most likely candidate, in our opinion, is innovation clusters, or “brainbelts” as described in

the book by Antoine van Agtmael and Fred Bakker: The Smartest Places on Earth (2016).

Please see the next page. These are an advanced economy phenomenon.

-10

-8

-6

-4

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0

2

4

6

8 (%) UK US Japan Eurozone

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0 (%) Consumer price index

A new global growth

engine


14 April 2016 6

Innovation clusters, “Brainbelts” After a week visiting the Southern California brain belt bringing to life the book by Antoine van

Agtmael and Fred Bakker: The Smartest Places on Earth (2016), we are optimistic about a

new global growth engine.

The catalyst for the above book was the insight that “Making things cheap to gain an edge

over high-cost Western companies just wasn’t cutting it anymore. The days of the low-cost

advantage were essentially over”. This led to an understanding that cheap is giving way to

smart, where high value-added products are being created in collaborative environments, in

“brainbelts”. The latter, to quote Antoine van Agtmael and Fred Bakker are:

Research facilities with deep, specialist knowledge; educational institutions; government

support for basic research; appealing work and living environments; capital; and, most

important, the atmosphere of trust and the freedom of thinking that stimulates unorthodox

ideas and accepts failure as a necessary part of innovation – different from the hierarchical,

regimented thinking so prevalent in many Asian and MIST economies.

MIST stands for Mexico, Indonesia, Korea and Turkey.

In addition to the brainbelts listed in Fig 8, Antoine van Agtmael and Fred Bakker identified

many others in their book, but virtually all were in North America and Europe.

Fig 8 “Brainbelts”: The Smartest Places on Earth

Country Region Name/place Focus Universities, research institutes, hospitals

United States: Well-known

California West Silicon Valley IT, bioscience, electric car, next gen bendable and wearable electronic devices

Stanford, University of California, Caltech

Massachusetts East Cambridge (and Route 128) Bioscience, robotics MIT, Harvard

Texas South Austin (Silicon Hills) Computers, new materials, bioscience University of Texas

Focus of the book

North Carolina South-East Durham-Raleigh-Chapel Hill (Research Triangle Park)

Bioscience, new materials, energy (LED) Duke, UNC, NC State

New York East Albany (Hudson Tech Valley) Semiconductors SUNY, RPI

Ohio Midwest Akron New materials, polymers University of Akron, Kent State

Minnesota Midwest Minneapolis-St.Paul Medical devices/bioscience University of Minnesota

Oregon West Portland (Silicon Forest) Bioscience OHSU

Northern Europe: in book

Netherlands Eindhoven (High Tech Campus)

Semiconductors. New materials Technical University

Sweden Lund-Malmo (Ideon) Life science, new materials Lund University

Finland Oulu (Technopolis) Medical instruments, wireless Oulu University

Germany Dresden (Silicon Saxony) Semiconductors Max Planck

Switzerland Zurich Life science Technical University

Note: from the book by Antoine van Agtmael and Fred Bakker: The Smartest Places on Earth (2016)

Source: Antoine van Agtmael and Fred Bakker above, Macquarie Research, April 2016

Beyond expensive, multidisciplinary, complex new product development, these innovation

clusters are also undertaking manufacturing, highly automated, custom runs, using 3-D

printers, produced in close proximity to the customer.

From an employment perspective, Antoine van Agtmael and Fred Bakker are optimistic citing

Enrico Moretti’s book The New Geography of Jobs (2013).

For each new urban high-tech job there are five additional jobs created, three for

professionals and two for lower-wage non-professionals.

For each new urban

high-tech job there

are five additional

jobs created

Cheap is giving way

to smart, where high

value-added

products are being

created in

collaborative

environments, in

“brainbelts”


14 April 2016 7

Sub-optimal global policy-making Most commentators agree that within the eurozone, greater fiscal spending by Germany

would lead to faster overall eurozone growth. That current policies are sub-optimal reflects a

political constraint: the legislated balanced budget requirement in Germany.

Globalisation of trade and capital flows has led to all national policies being inter-dependent.

Sub-optimal policy-making at the global level is impacting global growth.

A framework for thinking about all the Interactions follows; first we provide a simple indicator

of sub-optimal policy-making, and a measure of lost global growth as a consequence (from

UNCTAD). UNCTAD estimates potential gains to global real GDP growth of 1.1% pa

2015-2019 and 1.7% pa 2020-2024, (Fig 11, next page).

A simple indicator of sub-optimal global policy-making

Under fixed exchange rates, money creation/credit cycles are dictated by the external

surplus, movements in foreign exchange reserves. Since this applies to most emerging

economies, a simple aggregate of current balances is a proxy of stable growth or global credit

boom/busts.

Fig 9 Global current account imbalances, IMF data and forecasts

Notes: CHN+EMA = China and emerging Asia (Hong Kong SAR, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan Province of China, Thailand); DEU+EURSUR = Germany and other European advanced surplus economies (Austria, Denmark, Luxembourg, Netherlands, Sweden, Switzerland); OCADC = other European pre-crisis current account deficit countries (Greece, Ireland, Italy, Portugal, Spain, United Kingdom, WEO group of emerging and developing Europe); OIL = Norway and WEO group of emerging and developing economy fuel exporters; ROW = rest of world.

Source: IMF, Macquarie Research, April 2016

The World Bank provides a longer historical perspective, Fig 10. Imbalances are still

narrowing from the 2007 highs.

Fig 10 Global current account imbalances*

* Defined as the sum of absolute current account positions for 120 countries as a percent of global GDP

Source: World Bank, Macquarie Research, April 2016

Globalisation of

trade and capital

flows has led to all

national policies

being inter-

dependent


14 April 2016 8

A measure of lost global growth

UNCTAD simulates scenarios with:

1) Consumption-enhancing policies (rebalancing in China, median household real

income growth in advanced economies);

2) Greater government spending by fiscal surplus nations.

The potential gains to global real GDP growth are 1.1% pa 2015-2019 and 1.7% pa 2020-

2024 (grey shaded cells in Fig 11). This is an indication of potential benefits, an upper limit to

global policy coordination. These numbers are very material.

The benefits are also widely spread, with developed economies, the US, etc, all seeing at

least 1.0% uplift to growth forecasts relative to the baseline forecast.

Fig 11 GDP growth in selected regions and countries, 1990–2024

Average annual growth of GDP (%)

Scenario 1990-2014 2015-2019 2020-2024

World Baseline 3.3 3.4 3.6

Balanced growth 4.7 5.5

Developed economies Baseline 1.9 1.8 2.0


Of which: US Baseline 2.5 2.3 2.6


CIS Baseline 2.7 2.0 2.1


Developing Asia Baseline 6.3 5.5 5.4


Of which: China Baseline 9.8 7.1 6.7


Of which: India Baseline 6.3 5.8 6.0


Africa Baseline 3.8 3.9 3.9


LA & Caribbean Baseline 3.1 2.9 3.0


Memo item

World, based on market exchange rates

Baseline 2.7 2.8 3.0


Note: average annual growth of GDP uses PPP weights in constant 2005 international dollars unless otherwise stated. Please note that global real GDP growth weighted by market exchange rates is around 0.6% less than the estimate based on PPP weights. This reflects the much larger weight given to China in the latter methodology. CIS includes Georgia. UNCTAD secretariat calculations, based on the GPM—a fully endogenous framework based on water-tight accounting without “black-holes” and without unexplained residuals. Please see the UNCTAD Trade and Development report, 2014 page 38, and point 21 for more.

Source: UNCTAD, Macquarie Research, April 2016

The superior growth scenario is called “balanced growth” because in addition to

utilising “fiscal space” the forecast global current account imbalances are

substantially reduced, Fig 12, light blue shading, by approximately 1.5% of world GDP. In

the context of Fig 10, this would be a little beneath the lowest reading of the 20 years.

In addition, the faster growth enables an improved public debt to GDP ratio versus the

baseline forecast, pale red highlights in Fig 12. This is around 10% better over 2020-2024 for

developed countries and the US, and 3-5% better for developing countries and China. The

improvement for India is estimated to be much greater, at around 18%.

Note: the US and ‘exorbitant privilege’

Since the US dollar is the de facto global reserve currency, the US needs to run a current

account deficit to satisfy the need from other countries for reserve assets. However, this is

probably only of the order of 0.5% to 1% of US GDP per annum.

The potential gains

to global real GDP

growth are 1.1% pa

2015-2019 and 1.7%

pa 2020-2024

...and the benefits

are widely spread

Forecast global

current account

imbalances are

substantially

reduced...

...and public debt to

GDP ratios

improved


14 April 2016 9

Fig 12 Financial variables for selected regions and countries, 1990–2024 (average in % of GDP)

Public sector balance

Public debt

Private sector balance

Current account balance

1990-2014

2015-2019

2020-2024

1990-2014

2015-2019

2020-2024

1990-2014

2015-2019

2020-2024

1990-2014

2015-2019

2020-2024 Scenarios

Developed economies Baseline -4.0 -4.0 -2.7 79.2 96.2 89.8 3.2 2.5 0.2 -0.5 -1.2 -2.1

Balanced growth -3.3 -2.8 91.2 79.7 2.3 1.7 -0.7 -0.8

Of which: US Baseline -4.3 -4.5 -3.1 71.1 87.1 78.7 1.4 0.3 -3.1 -2.9 -4.2 -6.2

Balanced growth -3.6 -3.0 83.1 72.5 0.8 0.7 -2.8 -2.3

CIS Baseline -0.6 1.9 3.0 57.7 22.7 22.2 4.3 2.5 4.3 3.8 4.4 7.3

Balanced growth -1.2 -1.2 26.6 27.2 1.5 0.9 2.7 2.9

Developing Asia Baseline -2.2 -1.3 -1.2 40.1 44.5 48.7 4.2 3.6 4.3 2.0 2.8 3.5

Balanced growth -1.2 -1.2 43.6 43.9 2.5 2.3 1.7 1.3

Of which: China Baseline -1.8 0.7 1.9 16.3 29.0 32.4 5.1 2.7 3.8 3.3 3.4 5.8

Balanced growth -0.2 -0.0 28.8 29.3 1.7 1.5 1.5 1.5

Of which: India Baseline -7.7 -7.0 -6.5 76.0 77.6 80.3 7.2 5.1 5.4 -0.5 -2.0 -1.1

Balanced growth -3.9 -3.0 69.4 62.2 2.4 2.9 -1.4 -0.1

Africa Baseline -2.1 -3.8 -4.0 59.1 59.6 64.3 2.6 0.3 0.4 0.3 -3.6 -3.6

Balanced growth -2.8 -1.9 57.8 55.9 -0.0 0.4 -2.8 -1.5

LA & Caribbean Baseline -3.0 -4.3 -3.5 51.4 54.5 53.5 1.1 1.7 1.9 -1.9 -2.6 -1.6

Balanced growth -3.0 -2.4 51.0 48.2 0.7 1.5 -2.4 -0.9

Notes: CIS includes Georgia, UNCTAD secretariat calculations based on the GPM (please see the Fig 10 footnote)

Source: UNCTAD, Macquarie Research, April 2016

Ideal globally coordinated policy-making

To summarize the foregoing, and to show how difficult it is to expect improved global policy

coordination, the following table outlines desired national policies for the three major

economies/regions of the world.

Fig 13 Desired national policies and reality

Ideal policies for global growth Probability

Eurozone Current account surplus countries introduce pro-consumption (*) and fiscal expansion policies

Unlikely

China Pro-consumption (*) and fiscal expansion policies. Targeting a lower current account surplus through a persistently high REER

Possible

US Pro-consumption policies (*), tighter fiscal policy, a depreciation in the REER leading to a shrinkage of the current account deficit

Unlikely

Note: (*) this could include higher real returns to savers/households (less expansionary monetary policy, a reduction in financial repression), tax policies that bolster median household incomes


If most countries try to grow through exports by tapping into other countries’ domestic

demand, rather than introducing policies to stimulate demand at home, then the world will

continue to underperform its potential.

If most countries try

to grow through

exports, by tapping

into other countries’

domestic demand,

rather than

introducing policies

to stimulate demand

at home, then the

world will continue

to underperform its

potential


14 April 2016 10

The global policy-making framework Understanding how economists conceptualise global policy coordination illustrates the many

impediments to currently achieving it. The diagrams below are Swan diagrams. Please see

the book The Leaderless Economy (2013) by Peter Temin & David Vines pages 257 to 273

for a more detailed explanation.

Executive summary

National priorities and the loss of efficiency of traditional policy instruments have resulted in

the following impediments. China’s external policy goal is probably still a substantial current

account surplus, achieved through a variety of pro-production, anti-consumption policies. The

eurozone has constrained the use of fiscal policy. Balance sheet recessions following on from

credit/financial booms undermine the potency of monetary policy, considerably diminishing its

effect on real domestic demand. Private sector debt-deleveraging is further advanced in the

US than in the eurozone.

The global policy-making framework

We begin with the “External balance”, which for now is defined as a current account balance

of around zero, i.e. exports and imports in balance.

Fig 14 External balance

Fig 15 Internal balance

Note: REER is the real effective exchange rate. Real domestic demand = C+I+(G-T)+(X-M) where C=Consumption, I=Investment, G=Government expenditure, T=Taxes, X=Exports, M=Imports




Please look at Fig 14. The stronger real domestic demand becomes, the bigger imports

become. The more competitive the exchange rate, the bigger exports become. To maintain

external balance (X-M) as imports become bigger, exports need to become bigger, the

external balance line is downward-sloping.

To the left of the line there is a current account surplus, the exchange rate is too low,

producing exports in excess of implied imports. To the right of the line there is a current

account deficit, the exchange rate is too high, producing insufficient exports relative to implied

imports.

There is an increased awareness of external balances after the ‘global imbalances’ that led

through the global credit boom of 2004-07 to the Global Financial Crisis of 2008-09.

Nonetheless, policymakers’ primary focus is domestic balance: full employment, broad price

stability.

Please look at Fig 15. An economy has limited resources. If real domestic demand is too low

there is unemployment, if too high, inflation. Boosting real domestic demand from internal

balance, by say cutting taxes, will lead to inflation and the REER becoming less competitive

such that (X-M) deteriorates to offset the higher (G-T). The internal balance line slopes

upwards.

C/A surplus

External balance

More competitive

C/A deficit

REER

Less competitive

Real domstic demand

External balance

More competitive

REER

Unemployment

Internal balance

Inflation

Less competitive

Real domstic demand

Domestic balance:

full employment,

broad price stability

External balance


14 April 2016 11

Fig 16 The global policy-making framework Fig 17 Global positioning at the start of 2016





There is a need to make explicit the global inter-dependence of policy-making.

Inter-dependence: the US and the eurozone, a floating exchange rate regime

The US and the eurozone are linked through a floating exchange rate. Deep, open capital

accounts mean that the external balance (in theory) can be left to the market, and the market

determined nominal exchange rate (Euro/US$). This means that to avoid massive capital

flows, interest rates have to be broadly similar.

To reiterate, monetary policy in the US and the eurozone, and the Euro/US$ exchange rate

are jointly determined. The exchange rate is part of the interest rate transmission process.

Attempts by the ECB to suppress eurozone interest rates (and future market expectations

thereof) beneath US interest rates should result in a marked fall in the Euro, and have.

The policy is full of tensions. The constraining of fiscal policy in the eurozone has led to the

ECB being co-opted as the principal policy manager of domestic balance.

Interdependence: a China policy-determined RMB/US$

The RMB/US$ exchange rate influences output/the domestic balance in all three regions (as

does the Euro/US$).

A fixed RMB/US$ absent capital controls would result in Chinese interest rates similar to the

US. China still maintains partial capital controls, allowing some divergence.

An undervalued RMB versus the US$ takes demand away from both the US and the

eurozone, leading to the US Fed and the ECB easing monetary policy.

The distribution of the deterioration of the US and eurozone current account positions

depends on the relative monetary policy easing and its impact on the Euro/US$ exchange

rate, and the US and eurozone’s export industries’ sensitivity to the increased Chinese

demand growth, and the increased demand generated by a lower global interest rate. In other

words, it is mutually interdependent and complex.

The wisdom of austerity depends on the starting point

Please look back to Fig 16.

Moving horizontally from right to left in Zone 1: ‘Inflation, current account deficit’ will help to

reduce both inflation and the current account deficit. The UK has been an example of this.

The ‘PIIGS’ countries began in Zone 4: ‘Unemployment, current account deficit’ such that

austerity has improved the external balance (reducing the current account deficit), but has

worsened the domestic balance (increasing unemployment).

3) UnemploymentC/A surplus

External balance

More competitive

1) InflationC/A deficit

REER

4) UnemploymentC/A deficit

Internal balance

2) InflationC/A surplus

Less competitive

Real domstic demand

X

Euro Zone

External balance

More

competitive

X

REER

USA

Internal balance

China

Less

competitive

Real domstic demand

X

It is mutually

interdependent and

complex

There is a need to

make explicit the

global inter-

dependence of

policy-making


14 April 2016 12

The example of fiscal austerity in the eurozone

As eurozone private savings increase, the market real interest rate is depressed, leading to

the Euro depreciating versus the US$ and the RMB. The eurozone runs a current account

surplus; the US runs a current account deficit. China’s current surplus declines.

Fig 18 The fiscal impulse: the eurozone’s 2011-13 fiscal squeeze

Fig 19 Eurozone: Tight lending conditions 2007-09 and 2011-13

Note: Year over year change in the cyclically adjusted net lending (+) or net borrowing (-) of general government, adjusted based on potential GDP, excessive deficit procedure. Forecasts for 2015-17 from the European Commission

Source: EC Annual Macroeconomic Database, Macquarie Research, April 2016

Note: Net percentage is used. The net percentage is defined as the difference between the sum of the percentages for “tightened considerably” and “tightened somewhat”, and the sum of the percentages for “eased somewhat” and “eased considerably”. Positive numbers imply tight lending conditions.

Source: ECB, Macquarie Research, April 2016

The US Fed responds by lowering US interest rates, the Chinese resist the downward pressure

on their interest rates. US domestic demand recovers to the benefit of both the eurozone and

Chinese current accounts. The US current account deficit becomes bigger still.

There might be approximate domestic balance in all three regions, but there is a major

external imbalance in the US current account deficit.

This is not the end of the story, as the US current account imbalance has spill-over effects

into fixed exchange rate currency regimes, triggering credit boom/bust cycles.

Beyond the US, the eurozone and China

1) Japan and the UK should be treated as floating exchange rate economies, in the

same group as the US and the eurozone.

2) Small commodity exporters/emerging market economies often operate on fixed or

semi-fixed exchange rates.

Fixed exchange rates and capital mobility

Whilst capital mobility and floating exchange rates mean that the US and the eurozone can

ignore balance of payments issues, this does not apply to nations on fixed or semi-fixed

exchange rate regimes. Given the interconnectedness of all policy outcomes, the US and the

eurozone cannot ignore the spill-over consequences of the tendency for capital mobility and

fixed exchange rate regimes to generate boom/bust credit cycles.

Under fixed exchange rates, monetary base creation is dictated by the external surplus

(current account and private sector capital flows), the movement in foreign exchange

reserves. This fuels the domestic credit cycle.

The consequence of falling foreign exchange reserves, currently the case in emerging

markets/commodity exporters, is either or both of: a) deflation, b) devaluation.

It appears that policymakers in emerging market economies are currently choosing

devaluations, Fig 20.

-2

-1

0

1

2

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

(% of potential GDP)

YoY change in cyclically adjusted budget balance

-40

-20

0

20

40

60

80

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

(%)Changes in credit standards applied to enterprises over the past three months

Under fixed exchange

rates, monetary base

creation is dictated by

the movement in

foreign exchange

reserves

This fuels the

domestic credit cycle


14 April 2016 13

Fig 20 Emerging Market currencies (nominal)

Source: Bloomberg, Macquarie Research, April 2016

Improving the probability of success

Economic historian and academic Barry Eichengreen has listed four conditions that make

international cooperation more likely: please see the chapter “International Policy Coordination:

The Long View” in Globalization in an Age of Crisis: Multilateral Economic Cooperation in the

Twenty-First Century, Feenstra and Taylor, 2014.

1) Technical issues: It is easier to get agreement on technical issues, delegated to

experts who share a common understanding, rather than grander and more political

monetary and (especially) fiscal policies. So central bank FX swap lines are easier to

agree on than co-ordinated fiscal easing.

2) Institutionalisation: The use of well-understood forums or mechanisms such as the

G20 and to set agendas and enforce compliance make co-operation more likely than

ad hoc arrangements.

3) Status quo: Co-operation aimed at preserving an existing order is more likely than

that which creates a new order given that politicians and other officials have a vested

interest in maintaining the status quo.

4) Friendship: When nations are on good terms they are more likely to co-operate.

Another background paper is the December 2013 IMF staff discussion paper by Jonathan D.

Ostry & Atish R. Ghosh, Obstacles to International Policy Coordination and How to Overcome

Them. To quote the paper:

Notwithstanding a handful of exceptions, examples of international macro policy coordination

have been few. The most successful cases have been when the world economy seemed on

the brink of collapse. In more normal times, despite strong theoretical arguments and evident

systemic stresses, policymaking takes a national rather than multilateral perspective.

Why do we not see more policy coordination in practice?

This paper argues that the most compelling reasons are asymmetries in country size;

disagreement about the economic situation and cross-border transmission effects of policies;

and often policymakers’ failure to recognize that they face important tradeoffs across various

objectives.

Coordination works by allowing countries to improve the policy tradeoffs they face under

autarky. Like most efficiency arguments, welfare gains will not be huge (they are, in fact, very

similar to estimated gains from global trade liberalization) but certainly measurable and worth

pursuing.

60

80

100

120

1999 2001 2003 2005 2007 2009 2011 2013 2015

Emerging Market Currencies (nominal)

Why do we not see

more policy

coordination in

practice?

Asymmetries in

country size;

disagreement about

the economic

situation and cross-

border transmission

effects of policies;

and often

policymakers’

failure to recognize

that they face

important tradeoffs

across various

objectives


14 April 2016 14

A check-list of policy coordination policies

There are a number of ways in which the G20 could help, in rough order of likelihood.

1) Proposals to reform economies to deliver growth

The easiest to agree on, and undoubtedly important over the long term, this is the least useful

from the perspective of the short-term impact on economic growth. It is also the hardest to

credibly commit to given its open-ended nature.

2) Increased monetary co-operation

This would take the form of technical improvements such as more FX swap lines (to improve

liquidity) between central banks.

3) Co-ordinated monetary easing

Perhaps once seen as more technical in nature, but increasingly politicised given concerns

about negative rates. In any case most central banks are already easing and it is complicated

by the fact that the Fed wants to tighten.

4) Pro-consumption policies

Upping the minimum wage rate, reducing the tax burden on households, introducing income

redistributive policies and increasing the returns on savings (a reduction in financial

repression) – in combination an almost revolutionary shift in political priorities.

These are all redistribution policies: Either from high income, high saving ratio households to

lower income, higher consumption ratio households, or from net debtors (the government and

corporate sectors) to net savers (the household sector).

5) FX intervention

Policies to stabilise emerging market currencies, including the Chinese Renminbi. This would

be the most fitting of being termed a ‘new Plaza’ agreement, would (sort of) maintain the

‘status quo’ in Eichengreen’s formulation, and could be affected by a policy of developed

economies adding Renminbi reserves post its inclusion into the SDR. But working against

such an agreement is a still prevailing belief among many countries that exchange rates

should be allowed to find their own level, a lack of clarity over what the appropriate USDCNY

level is, and a general desire globally for weak exchange rates.

6) Co-ordinated fiscal easing

Probably the most effective, given the limits to monetary policy, and with strong advocates

(even the IMF called for it in their pre-Shanghai G-20 meeting briefings). This is the hardest to

achieve given its highly politicised nature, especially in a US election year, practicality given

already strained budgets in many European countries and Japan, and some remaining key

disagreements intellectually over its efficacy.

German resistance to fiscal easing

To quote the 27 February 2016 Financial Times:

“The debt-financed growth model has reached its limits,” Wolfgang Schauble, the German

Finance Minister, said on the sidelines of a two-day G-20 meeting in Shanghai. “We therefore

do not agree with a G-20 fiscal package as some argue... There are no short-cuts that aren’t

reforms.”

In rough order of

likelihood


14 April 2016 15

Global policy coordination prospects: low 2015 in retrospect, 2016-18 in prospect

The 2015 collapse in oil prices benefitted consumers at the expense of commodity

exporters/emerging market economies, a case of dispersed winners and concentrated losers.

Please see the 11 February 2016 Macq-ro insights: Oil and sovereign defaults for more.

At the country level, unfortunately, it has led to increased current surpluses in countries such

as Japan and Germany, which have been historically slow to address the opportunities and

responsibilities in having sizable current account surpluses.

Over 2016-18, national perspectives are expected to dominate: the US having achieved

domestic balance will slowly raise policy interest rates; the eurozone will nurture the revival of

its private sector; China will focus on the quality of its growth. For more on the latter, please

see the 8 April 2016 Macq-ro insights: What’s next for EM economies?

Global positioning at the start of 2016, please look at back Fig 17

The eurozone had a current account surplus and material unemployment. The eurozone has

ruled out fiscal stimulus (G-T) and in aggregate there is still a tendency to go ‘the wrong way’

with austerity pushing from right to left.

China’s external balance goal is probably still a current account surplus of some 2% of GDP.

Whilst internal balance is broadly achieved, there is no urgency to change. Rebalancing away

from its investment and credit-driven growth model could take 5-10 years.

Debt restructuring issues are discussed in Larry Hu’s 8 April 2016 Debt/equity swap: What

can we learn from the past?

The US has been relying heavily on monetary policy to accomplish domestic balance, whilst

the external balance is left to the markets. The potency of monetary policy was greatly

diminished in the US and the eurozone when interest rates reached the nominal zero interest

rate bound. The transmission mechanism into C+I became much muted. Unconventional

monetary policies have had impacts on asset inflation and on the REER.

Fortunately, the private sector in the US has healed, as evidenced by the revival in private

sector non-financial credit growth, Fig 21, and persistent monthly employment growth (around

200,000) above the labour force growth rate (estimated between 55,000 and 110,000), Fig

22. With domestic balance approaching, monetary largesse is being cautiously withdrawn.

The private sector is less robust beyond the US, suggesting the ongoing need for cyclical

policy support.

Fig 21 US private sector nonfinancial credit is growing faster than GDP for the first time since 2008

Fig 22 US non-farm payrolls, monthly data since the beginning of 2011

Source: FRB of St. Louis, Macquarie Securities, April 2016 Source: Datastream, Macquarie Research, April 2016

In the eurozone, Fig 23, credit growth turned positive YoY in 2015, four years behind the US

which saw positive growth in 2011, Fig 21.

-4

-2

0

2

4

6

8

10

12 (YoY% change) Private nonfinancial credit

Nominal GDP

late0

50

100

150

200

250

300

350

400

0

50

100

150

200

250

300

350

400

2011 2011 2012 2012 2013 2013 2014 2014 2015 2015 2016

Thousands

Monthly average 12-months average 3-months average

The eurozone

China

The US

The private sector

2015

2016-18


14 April 2016 16

As Fig 23 also shows, private non-financial credit growth in the eurozone double-dipped over

2011-14 reflecting the fiscal tightening (Fig 18), the second credit crunch (Fig 23) and the

associated economic recession.

Fig 24 shows that Japan is now normal, with private sector non-financial credit growth

growing in line with nominal GDP growth. Both, however, are a subdued 2% pa. From a

global perspective Japan is not very important, but it is reassuring that Japan has completed

its private sector debt deleveraging, even in the face of a decade-plus of policy mistakes, as

detailed in the 12 January 2016 Macq-ro insights: Diminishing “Japanization” risks.

Fig 23 Euro Area: private nonfinancial credit growth vs. Nominal GDP growth

Fig 24 Japan: private non-financial credit growth vs. Nominal GDP growth

Source: FRB of St Louis, Datastream, Macquarie Research, April 2016 Source: FRB of St Louis, Datastream, Macquarie Research, April 2016

Policy spill-over headwinds to global growth are forecast to persist 2016-18

1) The eurozone:

The constitutional requirements and budget laws across the eurozone mandating near zero

fiscal deficits are causing the eurozone’s structural adjustments to spill over onto the rest of

the world through a mounting current account surplus. The latter is now over 3% of eurozone

GDP, whilst it averaged around zero prior to the Global Financial Crisis, Fig 25.

The eurozone current account surplus was 3.0% of GDP in 2015, up from 2.4% in 2014.

Germany’s current account surplus was 7.4% of its GDP in 2014 and an estimated 8.8% of

GDP in 2015. Unless the private sector becomes more risk tolerant and starts to narrow their

savings-investment balances, these current account surpluses could expand further.

Fig 25 An expanding eurozone current account surplus, below, requires matching capital outflows

Fig 26 Fiscal deficit forecasts, 2016, % of GDP

Source: Oxford Economics/Haver Analytics, Macquarie Research, April 2016


The eurozone fiscal deficit is still over 2% of GDP, though the fiscal impulse is slowly

becoming marginally positive, Fig 18, page 12. Much more than this remains unlikely.

-6

-4

-2

0

2

4

6

8

10

12

14(YoY % change) Private nonfinancial credit

Nominal GDP

latest

-12

-9

-6

-3

0

3

6

1992 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

(YoY % change) Private nonfinancial credit

Nominal GDP

latest

The eurozone is four

years behind the

USA

The eurozone

current account

surplus was 3.0% of

GDP in 2015, up

from 2.4% in 2014


14 April 2016 17

2) China:

The ongoing deceleration in investment growth, the 2015 industrial sector destocking and

intensifying import substitution, and the consequent step-down in imports has resulted in a

record China trade surplus, and is keeping China’s overall current account surplus high at 2-

3% of GDP. The rebalancing of the China economy to consumption-led growth is expected to

be a slow five-to-ten-year process. A stepped up fiscal expansion program would be

welcomed. A real effective exchange rate depreciation in an economy with a large current

account surplus would not be helpful.

Fig 27 BIS Real Effective Exchange Rate

Source: BIS, Macquarie Research, April 2016

A high real effective exchange rate is part of the mechanism that induces a rebalancing from

an investment-led growth model to a consumption-led growth model.

The average step-down in gross capital formation to GDP over 1996-98 for Malaysia,

Thailand, Indonesia and Korea was approximately 14%, Fig 28. The 5 February 2016 Macq-

ro insights: Global liquidity – ASEAN has more on the Asian Financial Crisis. As Fig 29

shows, China’s ratio of investment to GDP has so far come down around 3%. Unlike the hard

stop caused by the withdrawal of private credit by international banks during the Asian crisis,

the equivalent today in China is household deposits in the banking system. There is no

indication of these becoming destabilised. A radical change in the Chinese investment and

credit-led growth model is not underway.

Fig 28 Gross fixed capital formation, % of GDP Fig 29 China’s investment, % of GDP

Source: BIS, Macquarie Securities, April 2016

Note: Investment is private investment and includes residential investment. The last two data points are IMF forecasts.

Source: IMF WEO database, Macquarie Research, April 2016

60

70

80

90

100

110

120

130

140 China Japan US EU

(2010=100)

10

20

30

40

50 (% of GDP)Malaysia Thailand Indonesia Korea

25

30

35

40

45

50

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

(%GDP) China's investment, % of GDP

A radical change in

the Chinese

investment and

credit-led growth

model is not

underway


14 April 2016 18

An additional uncertainty relates to the slackness in the Chinese labour market, since there

are no regular, reliable statistics available.

One explanation for the new RMB policy of 11 August 2015 was that was intended to slow the

relocation of manufacturing assembly operations out of China.

Manufacturing assembly operations are highly absorptive of low-skilled labour.

3) Oil/energy/commodity prices:

The large declines in oil/energy/commodity prices since late 2014 have resulted in a very

significant terms of trade effect to the benefit of oil/energy/commodity importing nations and

regions, e.g. Japan, Europe, the US.

The combined current account of the OPEC countries in 2015 fell by approximately

US$320bn. This is equivalent to 0.4% of global GDP (approximately US$78tr).

Unfortunately, the result is increased current surpluses in countries such as Japan and

Germany, which have been historically slow to address the opportunities and responsibilities

in having sizeable current account surpluses.

Please see the 11 February 2016 Macq-ro insights: Oil & sovereign defaults for more.

Fig 30 Commodity exporter current account Fig 31 Major current account improvements, 2015

Source: Oxford Economics/Haver Analytics, Macquarie Research, April 2016


4) US monetary tightening:

Exiting from a liquidity trap (near zero interest rates, excess reserves) has proved particularly

difficult historically. Nonetheless, the US Fed is attempting it. There is a supplementary

section on this from page 20.

Fig 32 Books used in the preparation of this report

Peter Temin & David Vines The Leaderless Economy Michael Pettis The Great Rebalancing James K. Galbraith The End of Normal Martin Sandbu Europe’s orphan: The future of the Euro and the politics of debt


Manufacturing

assembly

operations are

highly absorptive of

low skilled labour

The combined

current account of

the OPEC countries

in 2015 fell by 0.4%

of global GDP


14 April 2016 19

Afterword The following quote from Oxford Economics sums it up succinctly:

If everyone wants to save and no one wants to invest, activity will slump; if everyone wants to

invest and nobody wants to save, the result is overheating.

Currently, the world’s problem is more the former, than the latter. Overall, global imbalances

remain large.

It is not all conflict and missed opportunities

International economic co-ordination has a long history, starting with the 1867 monetary

summit in Paris to discuss the adoption of a single gold standard. The most famous in recent

history was the September 1985 Plaza Accord, where the G5 (US, Japan, German, France

and the UK) finance ministers agreed to weaken a very strong dollar by FX intervention. This

was so effective (though debate rages on whether it would have happened anyway), with the

dollar falling so much that policymakers had to have another agreement 18 months later to

support the US dollar, this time involving increases in fiscal spending. This was less effective.

G-20 global policy coordination during the 2008-09 Global Financial Crisis

The April 2009 G-20 agreement was the first successful global policy coordination since the

1978-87 period (the G7 Bonn summit in 1978 had introduced coordinated reflationary

policies; the 1985 Plaza Accord realigned the US dollar).

As well as bilateral swap agreements between central banks, there were various helpful G20

statements, including crucially an agreement at the London April 2009 G-20 summit for the

largest and most coordinated fiscal and monetary stimulus ever undertaken. However, by the

Toronto summit a year later there were already disputes over further fiscal stimulus and Seoul

later that year is now seen as a missed opportunity.

As an example of the unravelling consensus, the G-20 Mutual Assessment process –

Alternative Policy Scenarios, prepared for the G-20 Toronto Summit of June 2010 by the IMF

prescribed fiscal reconstruction for advanced economies with fiscal deficits (represented by

the US in their model): as credibility of fiscal policy increases over time, private spending is

increasingly “crowded in”. It was not agreed. The reasons why we believe that this was a bad

policy recommendation are outlined in our 12 January 2016 Macq-ro insights: Diminishing

“Japanization” risks.

Fig 33 Recent Macquarie Global Macro reports

Macq-ro insights 2016 publications

12 Jan. 2016 Diminishing “Japanization” fears The revival of private sector credit demand in advanced economies

21 Jan. 2016 The corporate savings ”glut” & cross-border M&A Company cash-flow choices

25 Jan. 2016 Global liquidity The credit down-cycle in emerging market economies

05 Feb. 2016 Global liquidity #2, ASEAN Contrasting today with the Asian Financial Crisis

11 Feb. 2016 Oil & sovereign defaults A decade-long wave of defaults in the 1980s, then and now

26 Feb. 2016 The G-20 in Shanghai Policy coordination challenges

08 Apr 2016 What’s next for EM economies? An extended period of subdued growth

The latest Global Macro Outlook

14 Mar 2016 The Global Macro Outlook: Post the deleveraging twister



14 April 2016 20

Exiting liquidity traps We are living in interesting times. Interest rates today appear to be the lowest in 5,000 years:

Fig 34 Short- and long-term interest rates back to Babylonian times: today appears to be the lowest ever

Note: from the speech “Stuck” by Andrew G Haldane, Chief Economist Bank of England, 30 June 2015

Source: above, Macquarie Research, April 2016

This is despite the US having learnt from Japan’s monetary policy mistakes of the 1990s,

leading to policy responses to the Global Financial Crisis being markedly different. Please

see the 12 January 2016 Macq-ro insights: Diminishing “Japanization” risks. It is also highly

likely that the US Fed is well aware of the two BOJ premature tightening periods of August

2000 and July 2006 to February 2007, Fig 35.

Fig 35 Examples of policy reversals by central banks

Country Period of tightening Period of loosening

Size of tightening

(bps)

Size of loosening

(bps)

May 1989 to Aug 1990 Jul 1991 to Oct 1999 350 -600

Japan Aug 2000 Mar 2001 25 -25

Jul 2006 to Feb 2007 Oct to Dec 2008 50 -40

Sweden Jul 2010 to Jul 2011 Dec 2011 to Mar 2015 175 -225

Euro area Apr to Jul 2011 Nov 2011 to Sept 2014 50 -95

N. Z. Mar to Jul 2014 Jun 2015 100 -25

Australia Oct 2009 to Nov 2010 Nov 2011 to May 2015 175 -275

Norway Oct 2009 to May 2011 Dec 2011 to Jun 2015 100 -125

Iceland Aug 2011 to Nov 2012 Nov to Dec 2014 175 -75

US Jul 1936 to May 1937 Sep 1937 to Apr 1938 Reserve

requirements were

increased. US

Treasury also

began Gold

sterilization

programme

Reserve

requirements were

decreased. Gold

sterilization

programme ended

Note: “Stuck”, a speech by Andrew Haldane, the Chief economist of the Bank of England, 30 June 2015. Information for the US based on Velde (2009)

Source: Note above, Bank of England calculations, Datastream, Macquarie Research, April 2016

Exiting from a

liquidity trap (near

zero interest rates,

excess reserves)

has proved

particularly difficult.

Nonetheless, the US

Fed is attempting it


14 April 2016 21

In Japan’s experience, exiting from a liquidity trap (near zero interest rates, excess reserves)

has proved particularly difficult. Nonetheless, the US Fed is attempting it.

Since 1999, Japan has had extended periods of excess reserves and near zero interest rates,

Fig 36 and Fig 37. The BOJ has paid 10bp on excess reserves (IOER) up until its 29 January

policy announcement, moving to negative interest rates on a slither of excess reserves.

Fig 36 3-Month JGB Yield and Excess Reserves:1986 to end 2011

Fig 37 3-Month JGB Yield and Excess Reserves, start 2012 to latest

Source: Datastream, Macquarie Research, April 2016 Source: Datastream, Macquarie Research, April 2016

Please note the declines in excess reserves in 2000 and 2006 and the increases in interest

rates at those times (above and below). It is interesting how small the build and decline in

excess reserves in 2000 appears in retrospect.

Fig 38 Japan’s key interest rates, 1996 to latest

Source: BOJ, Bloomberg, Datastream, Macquarie Research, April 2016

The ratio of excess reserves to required reserves in Japan reached 7 times in 2003 and over

24 times recently.

This contrasts to ratios in the US of 2 times in the 1930s and 20 times more recently.

In 2015, the FRB of St Louis held a conference on monetary history. We believe the

institutional memory of the US Fed is very long.

Presented at the FRB of St Louis conference, Stephen Williamson’s “Current Federal

Reserve policy under the lens of economic history: a review essay” July 2015 includes an

important passage on the US policy reversal of 1937-38 (highlighted in grey in Fig 35).

0

1

2

3

4

5

6

7

8

9

1986 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Ratio of Reserves Held to Reserves Required

3-Month JGB Yield

0.00

0.05

0.10

0.15

0.20

0.25

0

5

10

15

20

25

30 Ratio of Reserves Held to Reserves Required

3-Month JGB Yield

-0.5

0.5

1.5

2.5

3.5(%)

target rate 2yr bond rate 10yr bond rate

The US policy

reversal of 1937-38


14 April 2016 22

Fig 39 Three-Month TB yield and Excess Reserves during the Great Depression

Note: The ratio of reserves held/required reserves (LHS) should never fall below 1.0x (an individual bank in severe financial distress might). The scale above goes down to 0.5 only to make the chart easier to read

Source: FRB of St. Louis, Macquarie Research, April 2016

That paper points out that when there is a significant amount of excess reserves in the

system; interest rates are determined by the interest rate on excess reserves (IOER).

Please note that interest rates were near zero (RHS) before and after the tightening of 1936-

37.

To quote Williamson: During the Great Depression, the interest rate on reserves was zero, so

we would expect that a period when there were significant excess reserves in the system

would also be a ZIRP period during the great depression. These ZIRP periods were liquidity

trap periods.

The July 1936 to May 1937 tightening of monetary policy was quickly followed by the US

economy falling into a recession, and the monetary policy actions were reversed over

September 1937 to April 1938.

In the US, in the post war period, the ratio of reserves held to required reserves remained

around 1.0 until 2009, RHS, Fig 40.

The arrival of excess reserves coincided with the arrival of near zero interest rates.

The US Fed paid 25bp on excess reserves (IOER) until the December 2015 “lift-off”. The US

has been in a liquidity trap.

Fig 40 Three-Month Treasury Bill Yield and Excess Reserves

Source: FRB of St. Louis, Macquarie Research, April 2016

0

1

2

3

4

0.5

1.0

1.5

2.0

2.5

1931 1933 1935 1937 1939 1941 1943

Ratio of Reserves Held to Reserves Required [Left]3-Month Treasury Bill Yield (% per Annum) [Right]

0

5

10

15

20

25

0

2

4

6

8

10

12

14

16

183-Month Treasury Bill Yield (% per Annum) [Left]

Ratio of Reserves Held to Reserves Required [Right]

The arrival of excess

reserves coincided

with the arrival of

near zero interest

rates


14 April 2016 23

We believe the US Fed is aware of the lessons of monetary history. Exiting a liquidity trap is

fraught with risk. As a consequence, David Doyle is expecting the tightening cycle to be

gradual, cautious, and supportive of risk-taking, reaching 2% by end 2018.

In the case of the US, as David argues in his 4 April 2016 FOMC: The hiking cycle and the

neutral rate, the “neutral real rate” looks set to remain near its current estimated level of

approximately zero. To quote from that report:

As we highlighted last year in Lower potential and Fed liftoff, low productivity growth is likely to

continue over the coming 5–10 years. Our research suggests this is driven by the US

demographic profile and elevated retirements—structural factors that are unlikely to change

over the next decade.

In coming quarters we anticipate that FOMC guidance will move towards our perspective of a

lower for longer real neutral Fed Funds rate of just 0%. Combined with a 2% inflation target,

this suggests an eventual return in the Fed Funds rate to 2% (Fig 42). Alongside this, we

anticipate members to adjust to a lower pace of rate hikes in 2017/18. This may occur even

as domestic inflation and employment data strengthen the case for two rate hikes in 2016.

Fig 41 The Laubach-Williams model suggests the real neutral rate has been in decline for 50 years…

Note: an economy’s neutral real rate is the level of real policy rates that would be neither expansionary nor contractionary when an economy is operating at its potential

Source: Federal Reserve, Macquarie Research, April 2016

Fig 42 …the FOMC has gradually moved towards accepting a lower neutral rate, but has much further to go, in our view

Source: Federal Reserve, Macquarie Research, April 2016

-1

0

1

2

3

4

5

1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013

Brief rise due to late 90s

productivity

2% = Traditional rule assumption

Estimated natural real rate of interest from the "Laubach-Williams" Model

1.25% = current FOMC median projection

4.25% 4.25% 4.25%4.13% 4.13%

4.00% 4.00% 4.00% 4.00% 4.00%

3.75% 3.75% 3.75% 3.75% 3.75%

3.50% 3.50%

3.25%

2.00%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

Jan-12 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Macq.

Fed

fun

ds rate

Timing of projection

Median FOMC member projections for longer-run nominal Fed Funds rate

Exiting a liquidity

trap is fraught with

risk

As a consequence,

David Doyle is

expecting the

tightening cycle to

be gradual,

cautious, and

supportive of risk-

taking


14 April 2016 24

The chart below shows how far away current global monetary policy settings are from

traditional benchmarks.

Fig 43 Taylor rule, global

Note: weighted averages based on 2005 PPP weights. For more details, please see the BIS 85th annual report,

graph V3

Source: BIS, Macquarie Research, April 2016


14 April 2016 25

Important disclosures:

Recommendation definitions

Macquarie - Australia/New Zealand Outperform – return >3% in excess of benchmark return Neutral – return within 3% of benchmark return Underperform – return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield

Macquarie – Asia/Europe Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie – South Africa Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie - Canada

Outperform – return >5% in excess of benchmark return Neutral – return within 5% of benchmark return Underperform – return >5% below benchmark return

Macquarie - USA Outperform (Buy) – return >5% in excess of Russell 3000 index return Neutral (Hold) – return within 5% of Russell 3000 index return Underperform (Sell)– return >5% below Russell 3000 index return

Volatility index definition*

This is calculated from the volatility of historical price movements. Very high–highest risk – Stock should be

expected to move up or down 60–100% in a year – investors should be aware this stock is highly speculative. High – stock should be expected to move up or down at least 40–60% in a year – investors should be aware this stock could be speculative. Medium – stock should be expected to move up or down at least 30–40% in a year. Low–medium – stock should be expected to move up or down at least 25–30% in a year. Low – stock should be expected to move up or down at least 15–25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only

Recommendations – 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations

Financial definitions

All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards).

Recommendation proportions – For quarter ending 31 December 2015

AU/NZ Asia RSA USA CA EUR Outperform 50.68% 61.04% 53.16% 47.90% 65.22% 43.59% (for global coverage by Macquarie, 5.33% of stocks followed are investment banking clients)

Neutral 31.51% 24.66% 34.18% 47.70% 29.71% 34.62% (for global coverage by Macquarie, 5.02% of stocks followed are investment banking clients)

Underperform 17.81% 14.30% 12.66% 4.39% 5.07% 21.79% (for global coverage by Macquarie, 3.78% of stocks followed are investment banking clients)

Company-specific disclosures: Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/research/disclosures.

Analyst certification: We hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. The Analysts responsible for preparing this report receive compensation from Macquarie that is based upon various factors including Macquarie Group Ltd total revenues, a portion of which are generated by Macquarie Group’s Investment Banking activities. 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14 April 2016 26

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Asia Research Head of Equity Research

Peter Redhead (Global – Head) (852) 3922 4836

Matt Nacard (Asia – Head) (852) 3922 1362

Automobiles/Auto Parts

Janet Lewis (China) (852) 3922 5417

Zhixuan Lin (China) (8621) 2412 9006

Amit Mishra (India) (9122) 6720 4084

Lyall Taylor (Indonesia) (6221) 2598 8489

Takuo Katayama (Japan) (813) 3512 7856

James Hong (Korea) (822) 3705 8661

Banks and Non-Bank Financials

Matthew Smith (China) (8621) 2412 9022

Suresh Ganapathy (India) (9122) 6720 4078


Keisuke Moriyama (Japan) (813) 3512 7476

Leo Nakada (Japan) (813) 3512 6050

Chan Hwang (Korea) (822) 3705 8643

Gilbert Lopez (Philippines) (632) 857 0892

Thomas Stoegner (Singapore) (65) 6601 0854

Dexter Hsu (Taiwan) (8862) 2734 7530

Passakorn Linmaneechote (Thailand) (662) 694 7728

Conglomerates


Consumer and Gaming

Linda Huang (China, Hong Kong) (852) 3922 4068

Kai Tan (China) (852) 3922 3720

Zibo Chen (Hong Kong) (852) 3922 1130

Amit Mishra (India) (9122) 6720 4084

Fransisca Widjaja (Singapore) (65) 6601 0847

Hendy Soegiarto (Indonesia) (6221) 2598 8369

Toby Williams (Japan) (813) 3512 7392

HongSuk Na (Korea) (822) 3705 8678

Karisa Magpayo (Philippines) (632) 857 0899

Emerging Leaders

Jake Lynch (China, Asia) (852) 3922 3583

Aditya Suresh (Asia) (852) 3922 1265

Neel Sinha (ASEAN) (65) 6601 0562

Timothy Lam (Hong Kong) (852) 3922 1086

Mike Allen (Japan) (813) 3512 7859

Kwang Cho (Korea) (822) 3705 4953

Industrials

Janet Lewis (Asia) (852) 3922 5417

Patrick Dai (China) (8621) 2412 9082

Inderjeetsingh Bhatia (India) (9122) 6720 4087


Kenjin Hotta (Japan) (813) 3512 7871

James Hong (Korea) (822) 3705 8661

Insurance

Scott Russell (Asia, Japan) (852) 3922 3567

Leo Nakada (Japan) (813) 3512 6050


Software and Internet

Wendy Huang (Asia) (852) 3922 3378

David Gibson (Asia) (813) 3512 7880

Hillman Chan (China, Hong Kong) (852) 3922 3716

Nitin Mohta (India) (9122) 6720 4090

Nathan Ramler (Japan) (813) 3512 7875

Prem Jearajasingam (Malaysia) (603) 2059 8989

Oil, Gas and Petrochemicals

James Hubbard (Asia) (852) 3922 1226

Aditya Suresh (Asia) (852) 3922 1265

Duke Suttikulpanich (ASEAN) (65) 6601 0148

Abhishek Agarwal (India) (9122) 6720 4079

Polina Diyachkina (Japan) (813) 3512 7886

Anna Park (Korea) (822) 3705 8669

Isaac Chow (Malaysia) (603) 2059 8982

Pharmaceuticals and Healthcare

Abhishek Singhal (India) (9122) 6720 4086

David Lee (Korea) (822) 3705 8686

Property

Tuck Yin Soong (Asia, Singapore) (65) 6601 0838

David Ng (China, Hong Kong) (852) 3922 1291

Kai Tan (China, Hong Kong) (852) 3922 3720

Raymond Liu (China, Hong Kong) (852) 3922 3629

Wilson Ho (China) (852) 3922 3248

Abhishek Bhandari (India) (9122) 6720 4088

William Montgomery (Japan) (813) 3512 7864

Aiman Mohamad (Malaysia) (603) 2059 8986

Kervin Sisayan (Philippines) (632) 857 0893

Corinne Jian (Taiwan) (8862) 2734 7522

Patti Tomaitrichitr (Thailand) (662) 694 7727

Resources / Metals and Mining

Rakesh Arora (India) (9122) 6720 4093

Stanley Liong (Indonesia) (6221) 2598 8381

Polina Diyachkina (Japan) (813) 3512 7886

Anna Park (Korea) (822) 3705 8669

Technology

Damian Thong (Asia, Japan) (813) 3512 7877

Allen Chang (852) 3922 1136 (China, Hong Kong, Taiwan)

Nitin Mohta (India) (9122) 6720 4090

David Gibson (Japan) (813) 3512 7880

George Chang (Japan) (813) 3512 7854

Daniel Kim (Korea) (822) 3705 8641

Soyun Shin (Korea) (822) 3705 8659

Patrick Liao (Taiwan) (8862) 2734 7515

Louis Cheng (Taiwan) (8862) 2734 7526

Telecoms

Nathan Ramler (Asia, Japan) (813) 3512 7875

Danny Chu (852) 3922 4762 (China, Hong Kong, Taiwan)

Abhishek Agarwal (India) (9122) 6720 4079

David Lee (Korea) (822) 3705 8686

Prem Jearajasingam (Malaysia, Singapore) (603) 2059 8989

Kervin Sisayan (Philippines) (632) 857 0893

Transport & Infrastructure

Janet Lewis (Asia) (852) 3922 5417

Azita Nazrene (ASEAN) (603) 2059 8980

Corinne Jian (Taiwan) (8862) 2734 7522

Utilities & Renewables

Alan Hon (Hong Kong) (852) 3922 3589

Inderjeetsingh Bhatia (India) (9122) 6720 4087

Prem Jearajasingam (Malaysia) (603) 2059 8989

Karisa Magpayo (Philippines) (632) 857 0899

Commodities

Colin Hamilton (Global) (4420) 3037 4061

Ian Roper (65) 6601 0698

Jim Lennon (4420) 3037 4271

Lynn Zhao (8621) 2412 9035

Matthew Turner (4420) 3037 4340

Rakesh Arora (9122) 6720 4093

Economics

Peter Eadon-Clarke (Global) (813) 3512 7850

Larry Hu (China, Hong Kong) (852) 3922 3778

Tanvee Gupta Jain (India) (9122) 6720 4355

Quantitative / CPG

Gurvinder Brar (Global) (4420) 3037 4036

Woei Chan (Asia) (852) 3922 1421

Anthony Ng (Asia) (852) 3922 1561

Danny Deng (Asia) (852) 3922 4646

Per Gullberg (Asia) (852) 3922 1478

Strategy/Country

Viktor Shvets (Asia, Global) (852) 3922 3883

Chetan Seth (Asia) (852) 3922 4769

Peter Eadon-Clarke (Japan) (813) 3512 7850

David Ng (China, Hong Kong) (852) 3922 1291

Erwin Sanft (China, Hong Kong) (852) 3922 1516

Rakesh Arora (India) (9122) 6720 4093




Conrad Werner (Singapore) (65) 6601 0182

Jeffrey Ohlweiler (Taiwan) (8862) 2734 7512

Alastair Macdonald (Thailand) (662) 694 7753

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Miki Edelman (Global) (1 212) 231 6121

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Riaz Hyder (Indonesia) (6221) 2598 8486

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John Jay Lee (Korea) (822) 3705 9988

Nik Hadi (Malaysia) (603) 2059 8888

Eric Roles (New York) (1 212) 231 2559

Gino C Rojas (Philippines) (632) 857 0861

Regional Heads of Sales cont’d

Paul Colaco (San Francisco) (1 415) 762 5003

Ruben Boopalan (Singapore) (603) 2059 8888

Erica Wang (Taiwan) (8862) 2734 7586

Angus Kent (Thailand) (662) 694 7601

Ben Musgrave (UK/Europe) (44) 20 3037 4882

Julien Roux (UK/Europe) (44) 20 3037 4867

Sales Trading

Adam Zaki (Asia) (852) 3922 2002

Stanley Dunda (Indonesia) (6221) 515 1555

Sales Trading cont’d

Suhaida Samsudin (Malaysia) (603) 2059 8888

Michael Santos (Philippines) (632) 857 0813

Chris Reale (New York) (1 212) 231 2555

Marc Rosa (New York) (1 212) 231 2555

Justin Morrison (Singapore) (65) 6601 0288

Isaac Huang (Taiwan) (8862) 2734 7582

Brendan Rake (Thailand) (662) 694 7707

Mike Keen (UK/Europe) (44) 20 3037 4905

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