The great global rebalancing act

The US’s economic prospects look strong – strong enough even to reduce China’s competitive advantage. Europe’s future looks far less rosy

At the turn of the century, economists in Europe feared that the European Union was falling increasingly behind the United States. The Lisbon Agenda agreed in March 2000, rich in rhetoric but light on substance, was some kind of response. Today, those fears of being left behind are resurfacing. Is the US about to leave Europe floundering in its wake again and, if so, why?

During a speech in New York earlier this month (14 November), Ben Bernanke, the chairman of the Federal Reserve Board, the central bank of the US, listed the many “headwinds” that the American economy faces. But he then struck an optimistic note. Urging the US Congress to sidestep the potentially disastrous deadlock on budget policy, thereby avoiding the looming ‘fiscal cliff’ that threatens to push the US back into recession, he said such action “could help make the new year a very good one for the American economy”.

The latest economic forecasts from the European Commission see economic recovery in the US gathering pace over the next two years (see table). Even if things go well, however, it will not be until 2014 that the rate of expansion of the EU’s economy, now back in recession, will approach the 1.8% rate of growth that the US recorded last year.

It is a mistake to give too much weight to such forecasts. Over short periods, growth can be delivered by dangerous economic policies, as in 2002-07. Moreover, as a recent Bank of England study concluded, the economic models from which the forecasts are derived are unreliable. More than that, they have been dangerous, consistently over-optimistic, leading governments from 2002 until today to make the wrong choices.

It is, nevertheless, worth looking at what accounts for Bernanke’s upbeat mood. One reason is changes in energy production. The International Energy Agency, the official energy sector watchdog, issued its own, astonishing, forecast this month. It said that the US could overtake Saudi Arabia as the world’s biggest oil producer by 2020.

“Whether that happens or not, what is unfolding in the US will continue to change its economy and affect both international relations and the global economic outlook,” says Daniel Yergin, an eminent energy-market consultant.

“The rebalancing of world oil production has already begun,” Yergin says. “The US will soon join the ranks of exporters of liquefied natural gas.” The exploitation of shale oil and gas is worrying environmentalists, but ample energy supplies, including cheap natural gas, are once again underpinning the economic might of the US.

Other reasons for being optimistic about a more vigorous US economic future are familiar. The list includes positive demographics, enviable innovative capacities and ruthlessly flexible labour markets. Yes, inequality is increasing, as in Europe, and both social-welfare provision and educational performance are inadequate. But US capitalists enjoy a vital growth elixir: they have in abundance what economist John Maynard Keynes termed as “animal spirits”.

There are signs of increasing international price competitiveness too. Over the past three years, according to George Magnus, senior economic adviser at Swiss bank UBS, the nominal exchange rate of the Chinese renminbi against the dollar has risen by about a third.

China’s narrowing advantage

Rapidly rising Chinese wages, particularly in export sectors, mean the real exchange rate against the dollar has moved even further to the advantage of the US. “China’s competitive advantage in the global economy is steadily being chipped away,” Magnus says.

He is not alone in expressing doubts about how successful China will be in the longer term with the politically and socially onerous task of rebalancing its growth model of the past 20 years, which was built on investment and exports, and shifting towards domestically generated, consumption-led growth. He warns that China faces a “disruptive bust” in investment in the next 12-24 months, and longer-term growth trends could slip down from the past decade’s 10% to 5% a year, rather than the widely assumed 7%.

With the US economy rebalancing, and China’s political system threatened by a potentially existential rebalancing challenge, what about the European Union?

More than three years ago (June 2009), Nicolas Veron of Bruegel, a Brussels-based think-tank, called for an urgent clean-up of the bad assets clogging the European banking system. Failure to restore banks to health would continue “to be a drag on growth”, he said. He was right. In fact, with the EU then still blissfully unaware of the sovereign-debt crisis about to crash down on it, he underestimated the danger.

Last month (23 October), Mervyn King, governor of the Bank of England, warned that there would be no economic recovery in several advanced economies until weak banks were cleaned up. Last week, Stefan Ingves, governor of the Riksbank, Sweden’s central bank, delivered the same message in London, based on the evidence from Sweden’s banking crisis in the early 1990s.

Cleaning up banks

In the US, banks are less central to the economy. They deliver only about 25% of the private-sector credit that the US economy needs, and almost none to the public sector. Separate securities markets deliver the lion’s share. The US has had a much easier task, but it has done a much better job of cleaning up its banking sector than the EU. There is more to be done, but the US is reaping the rewards.

The EU, by contrast, is hamstrung by a crippled banking sector, with the private sector depending on bank finance for more than 70% of its credit. It is, economists estimate, still no more than halfway through the clean-up and recapitalisation process (‘deleveraging’) necessary for economic revival.

In two weeks’ time (13-14 December), banking reform will be high on the agenda of the European Council. But that does not yet mean cleaning up the bad banks. As Jens Weidmann, president of the Bundesbank, Germany’s central bank, noted in a speech this month (19 November), the banking union is and should be “a future-orientated concept”. It is not the key to finding a solution to the current crisis.

Weak banks are a clear and present threat to Europe’s long-term economic prospects. The EU’s growth model, dependent on banking finance, is broken, with too many ‘zombie’ banks hanging on to bad loans in ‘zombie’ companies. Europe’s financial system needs cleaning up and rebalancing just as much as China’s export and investment-led growth model.

Stewart Fleming is a freelance journalist basedin London.

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