Advanced govts are acting like emerging states
Yields on German government bonds on Tuesday ventured deeper into the uncharted territory of negative nominal levels, triggering various direct and indirect market reactions. More subtly, this reinforces a trend of the past decade: Advanced countries are behaving more like emerging economies in certain ways.
This does not mean that these countries are converging down toward their less prosperous and more institutionally unstable counterparts. But it does mean that adding an emerging-market perspective can help in analysing the prospects of advanced economies.
Reacting to concerns of sluggish economic growth and inflationary expectations that could dip lower, European Central Bank President Mario Draghi announced in Portugal that “further cuts in policy interest rates and mitigating measures to contain any side effects remain part of our tools”. With some commentators likening his remarks to the famous July 2012 “whatever it takes” speech in London, the reaction in markets has included a sharp upswing in the prices of German government bonds. With that, the yield on the euro zone’s benchmark 10-year German Bund traded down 8 points to end the day at -0.32%.
The prospect of additional ECB stimulus has also boosted stocks, with the German DAX gaining 2% on Tuesday, and weakened the euro. It also added to the upward push experienced by US stocks on the back of news that Presidents Donald Trump and Xi Jinping will be having an extended meeting at the G-20 this weekend in Japan to discuss trade.
Not all the news is good for markets, however. The weaker euro set off a Twitter reaction from Mr Trump that has some wondering whether and how the focus of US trade policy will shift to Europe, with its protractedly large trade surpluses. There is also more concern about what persistent and more negative interest rates will do to the integrity of the European financial system, including its ability to deliver long-term financial protection services to households — the sort of thing people in the most developed nations have taken for granted in planning for their future.
This illustrates why the ECB announcement is yet another example of advanced countries behaving more like emerging economies. Erupting in the core of the global economy in 2008, the financial crisis involved “sudden stop” dynamics that tipped the advanced world into a “great recession” and threatened a multi-year depression. This so unsettled the advanced world that rather than returning to a status quo ante, faced “multiple equilibrium” — in which the prospect of one outcome increased the likelihood of a similar more pronounced outcome.
Policymakers in advanced economies failed to react quickly to structural impediments using structural tools. Instead, the mindset remained cyclical for far too long, deepening the structural challenges. With that, what was an economic problem quickly gained political, social and institutional dimensions — again similar to what repeatedly happens in the emerging world.
When it comes to the relationship between the economy and political conditions, the similarities between advanced and emerging countries have not stopped at bad economics fuelling messy politics. More recently, we have also seen a reverse causation, in which the messy politics contaminates economics and institutions. Examples include the rise of populist policies and political attacks on the independence and effectiveness of central banks.
Viewed in this context, the latest ECB announcement looks like yet another step in this broader process.
While ECB President Draghi has not tired from stressing on multiple occasions the importance of a more comprehensive policy response, including structural measures to promote higher productivity and lift other impediments to growth and financial stability, the central bank is again reverting to shortterm stimulus measures whose effectiveness is increasingly in doubt.
Advanced economies are not actually becoming developing economies. But analysts and policymakers alike can benefit from looking more at the experience of emerging economies in assessing some of what lies ahead for the advanced world. The most important lesson to grasp now is that cyclical liquidity measures are no answer to structural impediments to growth and financial stability.
Such measures may buy the economy some time and give a short-term boost to asset prices. But this comes at mounting costs and risks, and these are not just economic and financial. With time, they are also developing deeper sociopolitical roots that render incremental reforms harder to enact, taking economies ever closer to cliff-like conditions involving the threat of accelerating economic and financial weakness in the absence of “big bang” reforms.