February 24, 2010

Economic update

Deficit, debt pinch a global concern

ALEX CARRICK

Chief Economist, CanaData

Several national governments around the world are in a severe financial bind, with actual and projected budgetary deficits in double digits as percentages of gross domestic product.

Included are the U.S., Britain, Spain and Greece. If not fiscal deficits that are the problem, then it’s incipient inflation. How this will play out in interest and exchange rates is anybody’s guess.

The inflation rate of the United Kingdom in January 2010 jumped to 3.5% from 2.9% the month before. Two of the chief explanations were rising oil prices and an increase in the value-added tax. In any event, the U.K. has ongoing economic problems that equal or exceed the Eurozone.

The debt-repayment problems of Greece are having repercussions throughout the Euro-currency area. As a result, the Euro has been coming under selling pressure, which is not all bad news since one side effect has been to help the export sales of Germany and some other nations.

Accusations are now flying that New York-based banking firm Goldman Sachs helped Greece hide the extent of its budgetary woes through some fancy footwork. Strict austerity measures will be required for Greece to get back on a sound financial footing. One suggestion has been for the nation to mandate a 10% cut in wages and prices. This would have the same effect as a devaluation, which is not otherwise possible with Greece under the Euro’s umbrella.

Norway is the only country in Europe with a large budgetary surplus in relation to GDP, thanks to its offshore oil revenue.

Japan’s central bank ponders foreign investor confidence due to its Greece-style debt-bloated economy. Two decades of stimulatory spending to fight deflation have met with little progress. The national debt to GDP ratio is approaching 200%, the highest among all developed nations.

China is worried about inflation. The reserve ratio held by banks has been increased for the second time in a month. That’s because one-fifth of the annual lending target for the whole year was achieved in January alone. Property prices in January climbed the fastest in two years.

China will address its overheating economy through restraining money supply growth and reining in fiscal stimulus. Interest rate increases will come eventually, but a likely first step is an appreciation in the value of the yuan. Most betting is on about a 5% gain versus the greenback.

China has been a net seller of U.S. government bonds lately. It has now dropped back to second place behind Japan as the largest creditor to the American government.

The Chinese government has expressed concern over the nearly US$3 trillion shortfall that Washington is budgeting for this year and next year combined. Moreover, the 2010 mid-term elections will make any form of austerity, such as in the form of higher taxes or entitlement spending cutbacks, a tough sell.

It seems that the U.S. dollar does best when growth is either really weak (in which case, foreign lenders are looking for a safe haven) or really strong (a jump-on-the-bandwagon effect). At other times, the prevailing sentiment is to disengage gradually and cautiously from the greenback.

In the midst of all this ongoing global financial upset, and not to understate the budgetary problems of our own various levels of government, Canada is still sitting relatively pretty.

For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog. His lifestyle blog is at www.alexcarrick.com

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