World economy needs a stronger Chinese currency, says AXA
by Pattrick Smellie
Dec. 18 (BusinessWire) - China's practice of pegging its currency, the yuan, to the US dollar is hampering global
economic recovery and is likely to become unsustainable in the year ahead, says the chief economist for AXA Global
Investors in New Zealand, Bevan Graham.
In a report on the outlook for 2010, Graham identifies emerging markets as the most potent source of sustainable
recovery, but says deep structural changes that are required in the world economy will only occur if indebted countries
have weaker currencies, while savers allow theirs to appreciate.
"China is an interesting case in point. When a country has its exchange rate pegged to another, it effectively pegs
interest rates as well," says Graham. "If China continues to grow at a strong clip, which we expect it will, and if
inflationary pressures remain benign in the United States, which we expect they will, China will need higher interest
rates well before the US. All else being equal, the Chinese yuan peg to the US dollar will become increasingly
unsustainable in 2010."
Turning to the New Zealand dollar, Graham says the end of expansionary fiscal and monetary policies in the major
developed countries may prove the trigger for an over-valued Kiwi dollar to start falling.
Picking that 2010 would be the year of the "great unwinding", following the "great recession" of 2008-09, AXA GI
suggests it will be late 2010 before the US Federal Reserve starts to tighten monetary policy, and warns that while
slack industrial capacity may help fuel a growth rebound, there is equally a risk that much spare capacity will turn out
to be redundant.
Most important will be developed economies' willingness to get fiscal policy back on track, after a frenzy of borrowing
and money-printing over the last 18 months.
"For developed economies, on average, to get the debt to GDP ratio down to 60% within the next two decades requires
steadily improving the cyclically adjusted primary fiscal balance from a deficit of 3.5% of GDP in 2010 to a surplus of
4.5% in 2020 - an 8% adjustment!" says Graham, citing recent International Monetary Fund analysis.
"Not renewing the fiscal stimulus gets us part way there, but only by about 1.5% or less than a quarter of the 8% shift
required. The job ahead is still immense. It is unlikely that economic growth will do the job by itself. That means
serious fiscal reform is ahead, and the earlier we start, the less dramatic that reform will be."
Meanwhile, the global financial crisis had created one of the most significant shifts in geo-political power in recent
times, with the previously dominant G-7 group of developed nations ceding influence to the G-20, which includes the
emerging super-economies of China, India, and Brazil.
With AXA GI judging emerging markets the most attractive venue for equity investment in the year ahead, and emerging
economies forecast to account for more than half of the world economy for the first time, in 2014, "emerging markets
will be a big part of the solution".
However, their impact on recent orthodoxies regarding monetary policy could be unpredictable when it tests the G-7's
influence on the global financial system.
"Belief in the free flow of capital and a belief in floating exchange rates, for example, both of which have been a core
premise underpinning the economic development of the developed world, are not shared as widely amongst emerging
countries such as China and India," Graham says.