Originally from our sister publication, Advisor.ca.

The developed world’s current woes—anaemic economic recovery, deleveraging of private sectors and shrinking balance sheets of the financial sector—will likely continue for another decade. At the same time, the dynamic emerging world will create a desirable background story.

Martin Wolf, associate editor and chief economics commentator for the Financial Times, is not known to mince words when it comes to his vision of the world economy. He was true to form Thursday during a lunch-hour speech made to what he facetiously referred to as “a bunch of serious masochists,” at the Economic Club of Canada, in Toronto.

The world, he said, is in the middle of two gigantic economic processes.

“First, the shift: the rise of the emerging world, above all, of east and south Asia,” he said. “The second: the unwinding of a generation-long leverage process [in the developed world].”

The processes playing out in the world economy and the difficulties witnessed by the Western nations are not transitory, he said. “We are being driven by [what is happening in the world economy], rather than making our own choices, [and that is] one of the big points of fixing global finance.”

The shift
Wolf reminded the audience that in the last 10 years the growth rate of the emerging world has been 6% a year while that of the developed world, has been, in aggregate, 1.5% a year.

“We’ve moved into a completely different dynamic, in terms of the relative growth of the components of the world economy and their relative size,” he said. “This has continued during the Great Recession to a quite extraordinary degree.”

Quoting an IMF report, he said the Chinese economy will expand by 60% between 2007 and 2012. Asian, emerging and developing economies together, which make up half of humanity, will expand by slightly over 50%, while the developed economies, in aggregate, will not grow at all. This is a numerical way of saying that the global recovery will continue to remain polarized.

“The speed of change that is now occurring [in the emerging world], and the relative size of economies, has no historical precedent,” said Wolf. “This, [by comparison], makes the rise of the U.S. in the late 19th and early 20th centuries a really slow motion event.”

The biggest effect, however, was created by what Wolf calls the savings shock; namely, the emergence of a rapidly growing set of economies that emerged as savings-surplus economies.

“This is quite an extraordinary development and people still don’t understand fully how significant and surprising it is,” he said.

In the late 19th and early 20th centuries, the world saw a vast outpouring of capital from the developed world to the emerging world of better opportunities. This time, however, the reverse happened.

“Throughout the last 10 years, and it’s still true today, the emerging world became a net capital exporter; on a very large scale,” said Wolf. “The principal reason for this was [certain] policy choices designed to protect these economies, particularly China, from what they saw as the incredible dangers of allowing the free flow of capital into them.”

A lesson emerging economies have learnt from waves of massive financial crises, particularly the one in 1997, which Wolf says was the turning point in world financial history.

In the late ‘90s, the world entered a phase of very fast growth and very low interest rates. In Wolf’s view, it was “a very strange world” of “extraordinary excesses in the asset market,” of which housing is the most important example. A phenomenon to which Wolf imputed the rise of housing prices in many countries, particularly in those countries with elastic credit systems.

“This is directly related to the emergence of the emerging world, the global imbalances that followed the failure of finance in the ‘90s, the extraordinary low interest rates that we had,” he said. “That is the line between the great shift and the extraordinary shock we have subsequently been experiencing.”

The shocks
The Western financial and economic systems that were put on government life support in October 2008 are still on that support. There are clear indicators of this, said Wolf.

“First, nobody really believes that a major bank will be allowed to fold. Secondly, monetary policy is being run in the way we’ve simply never seen before in world history,” he said. “We are living in the world in which the highest rate of interest offered by the most prudent and cautions Western central bank is 1%; all the rest are between 0% and 1%.”

This is a gigantic fiscal event and despite the massive unprecedented interventions by Western policymakers, the recovery remains laboured and limp.

This, of course, excludes Canada which Wolf calls “a happy country.”

Aside from Canada there are only two other G-7 countries—the U.S. and Germany—whose GDP in the last quarter of 2011 was marginally above the starting point before the crisis. All the others are well below it and three of them—the U.K., Italy and Japan—are 4% to 6% below and show no signs of convergence to the starting point.

“This remains a very weird world, but the good thing about it that the governments have been able to get away with these fiscal policies,” said Wolf, who expects them to continue to do so, “for there is no way these fiscal deficits will be eliminated quickly,” unless their economies recover.

The prospect
A nation’s economy, said Wolf, can only recover if one, or all of, three things occur: a surge in net exports, a surge in consumption or a surge in private investment.

“None of these things are in the least likely [for the industrialized world],” said Wolf. “The net exports are blocked by continued lack of competitiveness and the constructional surpluses in much of the rest of the world. Consumption is blocked by the continued overhang of debt and the fact that the savings interest rates are very low.

“Investment is blocked by the fact that companies that are sitting on lots of cash see no reason why they should build huge factories in the Western world, where there is no demand and, anyway, they are not competitive.”

The financial world, he concluded, is in a big mess and the challenge of getting out is proving to be long and painfully slow.

However, the good news is that all this led emerging market governments to adopt policies that would ensure they’d never again be made vulnerable by the reckless ways of the West.

“The emerging countries truly are not in the same way at the mercy of the irresponsibilities of Western-style finance,” said Wolf. “They got through the [Gallery not found] crisis astonishingly easily; the reserves they’d accumulated proved valuable insurance and it gave them room for manoeuvre to pursue expansionary policies, dramatically so in China.”

The dynamic of the emerging world remains powerful and deeply rooted in structural transformation of these economies.

“There’s a very good chance they will continue to grow pretty quickly over the next ten years, generating significant growth in the world and [ensuring] further transformation of the relative weight of economies.”

Copyright © 2020 Transcontinental Media G.P. Originally published on benefitscanada.com

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