What can bankers learn from Nikolai Gogol?
The long sweep of history doesn’t often seem to be of much use in helping a credit committee reach decisions! While this is true in steady-state conditions, i.e. at times when things are economically and politically “normal”, it doesn’t hold true when the weather turns rough. On the contrary, when the forecasting universe becomes volatile or anxiety-inducing, history can help us identify some points of stability. This is particularly true in the world of geopolitics. Furthermore, when trying to work out where these foundational points are, it’s worth using the investigative method recommended by Max Weber to measure the true scope of a historical factor: what would have happened if it hadn’t existed? Or, to put it more succinctly, “What if?” Well, if the COVID crisis hadn’t happened, the rivalry between the United States and China would still be just as potent and formative for politics and the global economy.
From this flow three ideas that are now more or less consensual, and which thus deserve to be looked at more closely. Shifts in the consensus are always important for business and economics alike: they influence decision-makers, and therefore scenarios themselves. They’re also important because a consensus proceeds as much from a clearer view of reality as it does from a less clear desire to write about that reality. And here it’s worth considering a methodological precaution from the world of economic investigation: János Kornai has recommended that one should go back over one’s forecasting errors every ten years to identify one’s own judgement biases.
Beware the American “chinovniks”
The first idea is that the United States and China will continue to clash once the US elections are over, even if the faces and forms have changed and even if there seems to be a break in hostilities – which the market will quickly latch onto as a signal of peace. Such a state of permanent conflict, whether it is an underlying state of affairs or not, is likely for three reasons.
First, this tension arises from the inevitability of the “big story” – the story of US domination in the face of a resurgent China. When challenged, a hegemonic nation-state never relinquishes its position without a fight.
Second, populations have become even more hostile thanks to COVID-19, and the issue has thus moved into the realm of domestic politics, where it will remain for a long time to come: generational effects are a powerful force in politics. For some authors, such as George Modelski, such effects are the source of long cycles of political opinion – the geopolitical equivalent of Kondratieff cycles in economics.
Third, and this is the most objective argument, the clash is no longer driven solely by governments’ political leadership: it is baked into laws, regulations and administrative structures. Sociologists have long demonstrated that this creates both inertia that restricts forward movement and a ripple effect. Incidentally, Russian writer Nikolai Gogol was a specialist in this subject, having long ago identified “chinovniks” (officials) and their ability to influence a society… The US administration has bought into both the legitimacy (questionable as it is) of the extraterritoriality of US law and the logic of political rivalry.
Lessons from history about globalisation
The second idea shaping the consensus is that this rivalry can play out in every sector, from economics to the military, not forgetting culture, education and diplomacy; that it will be more intense in so-called strategic areas like technology, control over commodities, healthcare and so on; and that it will involve a kind of decoupling of value chains. Well, okay, but when? And how far will this go? That’s where the consensus breaks down. The most widespread view among economists is that there will be a slow process of partial deglobalisation out of which the two powers’ respective areas of influence will gradually become clearer. This projected future effectively maps out a polarised world in which the new normal could be anything from another Cold War to cooperation in some areas. And, as it happens, such a world does not appear to be incompatible with current financial structures.
However, some political analysts are more cautious – and are all too quickly labelled pessimists as soon as they step outside the consensus. Indeed, the history of declining hegemonic nation-states tends to teach us that such nation-states seek to destroy their rival powers at any cost, including by military force. Taking all this into consideration, it’s hard to say which will prevail, historical experience or the particularities of today – namely, the far-reaching economic interdependence that has arisen from globalisation. Or, indeed, the nuclearisation of the world, which is giving rise to new military rules of engagement.
Might the power of the dollar indicate a phase of geopolitical decline?
The third idea is the most important of all. COVID-19 and the social crisis currently rocking the United States have intensified a paradoxical situation: on the one hand, there is growing certainty that US hegemonic power is declining and the economic and political balance is shifting ever more starkly towards Asia; on the other, the undeniable hegemony of the dollar – even though many countries are gradually holding less and less of it as a reserve currency – serves to lock in the existing balance of power. What does history teach us? What role has money played at previous times of hegemonic tension?
Many authors – for example Giovanni Arrighi, Immanuel Wallerstein, Samir Amin and, of course, Fernand Braudel – have attempted to compare capitalism’s successive phases of expansion in trade, production and finance with geopolitical phases of world history. From their studies emerges a striking observation: “those periods when finance takes on particular importance tend to point to a new weakness in the former hegemonic power and herald its impending replacement […]. They tend to herald a relatively imminent shift in the global system of accumulation.”
This fact appears to be related to a very simple mechanism whereby economics and geopolitics each act on the other. In its initial dominant phase, the hegemonic power generates current account surpluses; however, as it finds it is unable to keep producing the most attractive goods, these surpluses turn into deficits (production being one of the prerequisites for hegemony). From there, the hegemonic power, which still holds onto its financial power, attracts the most mobile capital flows and recycles them into income-generating activities – often in the form of direct investments in its rival power! And so we come full circle: “financial expansions that reflated the power of the declining hegemonic state would have come to an end anyway under the weight of their own contradictions.” No comment. This happened to the Dutch from 1750 onwards and to the British starting in 1919… and it looks very much like the situation in America since 1977.
Many observers today have noted the geopolitical importance of the financial sphere and are calling for alternative monetary systems. These observers are found, unsurprisingly, in Russia and China, where systems are being developed to escape the clutches of SWIFT (SPFS for Russia, which already handles 18% of Russian international transfers; CIPS for China). They are also to be found in emerging countries, notably Turkey and India, where efforts are being made to develop bilateral payments in other currencies – just as Shanghai Cooperation Organisation finance ministers recommended last March. But they can also be found right at the heart of the western financial system. For example, at the famous Jackson Hole conference last August, former Bank of England Governor Mark Carney called for the creation of a digital currency based on a basket of currencies. His choice of name for this currency was most interesting: he called it a “synthetic hegemonic currency” (SHC). The United States had better be wary of its allies as well as its rivals…
Tania Sollogoub - email@example.com
 A Hungarian economist who came up with the theory of soft budget constraints.
 “Never had anyone given such a comprehensive lesson in pathological anatomy on the Russian official.” – Aleksandr Herzen (1851), Du développement des idées révolutionnaires en Russie
 Hegemonic powers since the 15th century: Portugal, the Netherlands, Great Britain and the United States.
 Philippe Norel (2009), L’histoire économique globale, Seuil.
 Giovanni Arrighi and Beverly J. Silver (2001), “Capitalism and world (dis)order”, Review of international studies, Volume 27.
World – 2020-2021 Macroeconomic Scenario: an unprecedented shock, massive responses and unanswered questions
The Covid-19 pandemic has been unprecedented in both nature and scope. Uncertainties and grim diagnoses abound, while hopes of a robust recovery presuming a rapid return to the "pre-crisis normal" – boosted by bold, generous policies – may be thwarted. However, beyond the V-shaped – largely automatic – recovery, we can attempt to plot out some trends, and raise some questions at the same time.
Emerging countries: budget discussions in the time of COVID-19
The IMF has downgraded its global growth forecasts for 2020, casting a very painful light on the severity of the crisis: the institution expects Mexico’s economy to shrink by 10.5%, South Africa’s by 8% and Saudi Arabia’s by 6.8%. In truth, we find it hard to wrap our heads around these figures, and even harder to predict their economic and social consequences for countries not equally equipped to absorb the shock.
These downgraded forecasts also underscore the speed of the deterioration: for example, the Saudi economy had been forecast to contract by only 2% when the last report was issued in May. Lastly, the IMF has highlighted the risks for 2021, including the fact that the upturn will not be evenly distributed, raising questions over (among other things) how much scope there will be for economic policy stimulus – especially with many governments still urgently focused, for the time being, on supporting their economies in the very short term. How are you supposed to think about 2021 when you’re still battling to get through 2020?
On the monetary policy front, each week brings another raft of interest rate cuts, as we have recently seen in Russia, Turkey and Mexico. As we all know, central banks are on the front line in managing the crisis, dressed up as firefighters of last resort. The aim is not only to save the most vulnerable sections of their economies but also to manage expectations – i.e. confidence. If ever there was a key factor for the coming months, this is surely it.
However, some countries will soon run out of monetary ammo, especially given that emerging countries have less monetary room for manoeuvre than their more “developed” peers to live with negative interest rates. All of which raises big questions over fiscal policy, which is caught between competing demands.
A fiscal shock generating budget discussions
Almost everywhere you look, deficits are ballooning: to take just a handful of examples for 2020, South Africa’s forecast deficit is 14.6%, Saudi Arabia’s is 11.2% and Brazil’s is 9.3%. In the short term, the first question is obviously how these deficits should be financed; depending on what solutions are chosen, some countries will be more vulnerable than others a year or two from now. Countries like Brazil, which makes little use of external funding, will see outflows of domestic liquidity. This means bank financing will, in the medium term, be diverted away from the real economy, and this is bound to have an effect on already insufficient potential growth. Meanwhile, those countries that do turn to the markets for funding will face higher borrowing costs, making them externally more vulnerable if their currencies depreciate.
Oil-producing countries will obviously tap into their sovereign wealth funds, as is already happening, for example, in Azerbaijan and Kazakhstan – and, in fact, pretty much every other oil-producing country. It will thus be important to keep an eye on these countries, though in practice that is very difficult: with very few exceptions, these sovereign wealth funds are less transparent than they might be…
The other two questions that are coming up in the budget discussions underway in many emerging countries have to do with funding allocation and tax reform. Indeed, it’s vital not only to make the right expenditure choices but also to go where the money is: the wealthiest individuals. On the expenditure front, many draft budgets propose allocating more funding to strategic sectors, notably healthcare, as is the case, for example, in Egypt. Unfortunately, this will impact sectors not considered a priority, such as the monitoring of Indonesia’s many forest fires, and we can well imagine what might happen in the culture sector around the world…
Inequality debate set to heat up
The picture is perhaps a bit more encouraging as regards tax receipts. The fiscal shock triggered by the COVID-19 pandemic has forced out into the open longstanding debates that have often not been settled for political reasons: wealth taxes in various Latin American countries and Russia, taxes on bank deposits, etc.
At a deeper level, the disease and the resulting fiscal emergencies could succeed in forcing change on issues already highlighted by major events over the past few years and by the work of Thomas Piketty, whose global success speaks volumes: a degree of inequality that breaks down social and political cohesion as well as limiting growth potential.
And so, reading South African President Cyril Ramaphosa’s words about the country’s draft budget – “We must transform […] We can’t countenance ten million people out of work” – we find ourselves hoping that the emergency will change the rules of the game, as it seems to be doing in Europe. And this hope need not be a pipe dream. In fact, all of this is quite rational: for many governments, in a fiscal environment where the money needs to be found in any event, the door is wide open to address inequalities. Beware tax havens…
How can investment be maintained?
Finally, behind each of these debates, another debate is looming: how to attract private capital and stimulate investment in the face of what are likely to be severe constraints next year (notably higher taxes!). In this area, many governments – like Tunisia, for example – are saying they want to favour public-private partnerships. Or there is the example of Brazil, whose far-reaching new sanitation framework is reportedly smashing public corporations’ near-monopoly in the sector. However, the financial position of local authorities coming out of the crisis will not be conducive to these kinds of deals – especially in Russia, where regional deficits and debt are growing fast.
Here again, sovereign wealth funds will be called upon, with a growing proportion of their investment channelled into local projects. In fact, this was already a trend before the crisis: this proportion had already doubled since 2015, with the International Forum of Sovereign Wealth Funds estimating it at 21% of the total. So, even if sovereign wealth funds take advantage of the crisis to go on a shopping spree – as Qatar did after 2009 and as Saudi Arabia’s Public Investment Fund is doing now – they have and will continue to have an increasingly important role to play in supporting their domestic economies.
Tania SOLLOGOUB - Tania.SOLLOGOUB@credit-agricole-sa.fr
World – 2020-2021 Macroeconomic Scenario: economic and financial forecasts
Aperiodic - Tabular data for Crédit Agricole economic and financial forecasts
Italy – Covid-19 special: the first to face the worst
The Covid epidemic is a major shock to the Italian economy. Italy, the first country affected among Europeans, was the precursor in the implementation of containment and production shutdown measures. The response to the crisis has been prompt, rigorous and consistent. It has drawn the consequences of the 2008 and 2012 crises, focusing measures on preserving employment and income and providing liquidity to companies, especially SMEs.
Emerging countries: some things to keep an eye on
IMF staff have described the current crisis as a “perfect storm” for emerging countries, and even more so for “frontier countries”, i.e. those at the very edge of being developed countries. The crisis has indeed triggered multiple shocks. As well as the obvious internal shocks directly linked to COVID-19, there are also – as with each and every great financial crisis – external shocks. And, if the term “emerging countries” still means anything (which there is reason to doubt), it is in relation to this issue of external shocks that common ground can be found between just about all the countries hastily put into the emerging “pot”.
Different types of external shock
A brief overview of what might be in store for these countries over the coming months (and which they have already partly been experiencing over the past two months): in the short term, withdrawals of portfolio investments, difficulties refinancing external debt and currency attacks. They already experienced almost all of this in March, with sovereign spreads reaching an all-time high, central banks forced to defend their currencies, and withdrawals of portfolio investments estimated by the IMF at $100 billion, three times more than during the 2009 crisis…
Now, let us not be naive: even though sovereign spreads are coming down, some exchange rates are less under pressure and the price of oil is going back up, we must keep in mind the prudent assumption that emerging markets may be subject to further bouts of volatility this year, even if on a smaller scale and less indiscriminately. This assumption is, of course, linked to the growth shock, which will be severe for virtually every one of these countries (unlike in 2009, emerging countries will be in recession), but it is linked even more closely to their external accounts. Even in the best case scenario whereby GDP growth quickly bounces back in 2021, current account deficits will take longer to come down, subject as they are to greater inertia. Furthermore, many emerging countries’ external surpluses had already been gradually decreasing long before the advent of COVID-19. This is a longstanding trend: surpluses have never managed to return to their pre-2009 levels.
In the medium term, other structural problems could also cause external deficits to deepen. For example, revenue from direct foreign investment could be repatriated, and direct investment itself could potentially even be withdrawn (though this is quite rare due to the high cost of pulling out). There is also the slowdown in trade, the more or less lasting decline in tourist revenue, the crisis in certain sectors (automotive, air travel, shipping, etc.), the issue of commodity prices (oil first and foremost) and a shock arising from the repatriation of foreign worker’s income; the World Bank estimates that migrants have sent home some $554 billion dollars – more than the total amount of foreign direct investment received by the affected countries…
Given this avalanche of potential shocks, the question of financial risks is a major one. It revolves around exchange rates and debt, solvency and liquidity, all of which are important in identifying not only the highest-risk countries or actors (governments, households, companies and banks) but also potential systemic chain reactions. It is not our intention to answer these questions, which will keep us busy for several months (if not years), in a few short lines. Our aim is simply to highlight a few key things to keep an eye on this year.
An end to the original sin for public debt?
When it comes to public debt, the BIS and the IMF are in agreement: almost all emerging countries have got over their “original sin” , which had been leading them into crises since the 1980s. At the end of 2019, 80% of emerging countries’ public debt was financed in local currency, most of it at fixed interest rates. This limits their vulnerability to foreign exchange risk as well as limiting the risk of a systemic crisis affecting emerging public debt.
There are, however, still risks, as the BIS points out. This is partly because the average stock of emerging countries’ public debt has tended to increase (though it is lower than that of non-emerging countries). It is also because some countries have kept a portion of their public debt – between 10% and 20% of the total – in foreign currency, with the result that they continue to be exposed (setting aside those in default, countries that do this include, among others, Hungary, Turkey and Mexico). Moreover, the BIS also highlights the vulnerability of large public corporations in this area: they are much more exposed than sovereigns, especially in commodity-exporting countries. This is because corporations are “naturally hedged” against foreign exchange risk precisely because they are exporters – the very reason for which they were able to borrow in foreign currency! This situation becomes dangerous if the price of the commodities they export becomes structurally lower.
Another thing to keep an eye on: foreign investors’ participation in local sovereign debt markets, which has risen from an average of 10% in the 2000s to 25% today (obviously with very large divergences between countries). The IMF thinks such participation can be a good thing in that it can help countries achieve greater financial depth and lower volatility, but that it turns into a risk of higher volatility when this participation exceeds 40% of the total, or at times of global financial stress. Investors then become importers of global shocks, all the more so given that debt flows are highly sensitive to international conditions while equity flows are driven more by local conditions – notably growth in the country in question.
Lastly, the BIS sounds the alarm over an obvious issue: the overall increase in countries’ short-term funding requirements, which it estimates will amount to between 10% and 20% of GDP for the hardest-hit countries. And this is happening in a context where countries that were right on the edge of what international rating agencies consider investment grade risk being downgraded, which could trigger a kind of “rating shock”. That sums up the situation as far as countries are concerned.
Watch out for private sector debt
What about other actors? To start with, let’s consider one of the most worrying – and, unfortunately, the most opaque – areas of risk: the matter of private debt issued by non-financial corporations in emerging countries. The IMF has been sounding the alarm over this issue for several years, with debt equating to over 100% of GDP in many countries: China, obviously, but also Turkey, South Korea, the Czech Republic and others besides. However, this figure needs to be put into perspective by considering only the foreign currency portion of this private debt relative to GDP. When we do this, China disappears from the risk sample, leaving countries like Turkey, Mexico, Chile, the Czech Republic and Malaysia.
However, the BIS also points out what can attenuate the risk arising from this private debt: foreign currency assets held by the same emerging country corporations, which reportedly amount to $1,000 billion deposited with the institution’s correspondent banks. It also believes Hungary, the Czech Republic, Chile and Malaysia each hold foreign currency assets equivalent to over 100% of GDP. And it believes some countries’ regulatory institutions are themselves very careful to ensure that corporations with debt are adequately covered (one example being the Central Bank of Chile). The BIS nevertheless warns that $200 billion is due to be repaid between June and December this year by corporations in Brazil, China, India, Mexico, etc.
Lastly, it is important to point out that all these vulnerability analyses depend, above all, on one thing: how long the crisis lasts. This is where Barry Eichengreen – who came up with the idea of emerging countries’ “original sin” – comes in . He thinks there will be many structural factors at play, such as a lower price equilibrium for oil, reduced trade and restructured value chains. And he calls our attention to another old original sin: the fact that international institutions systematically misread the crisis when it comes to debt, focusing too much on the short term and on boosting liquidity, starting from the assumption that the problem is a temporary one; in reality, what is needed is to think about the long term now, in light of structural trends.
(1) Banque des règlements internationaux – Quaterly review – Juin 2020
(2) FMI – Global financial stability report – Avril 2020
(3) Une incapacité de l'État à emprunter à long terme dans sa propre monnaie, connue dans la littérature sous le nom de péché originel (original sin, Eichengreen et al., 2002)
(4) Managing the Coming Global Debt Crisis, Barry Eichengreen, Project Syndicate, 13 May 2020
Tania Sollogoub - firstname.lastname@example.org
Italy – Economic environment: a look at Q1 2020 GDP
The second estimate of Q1 2020 GDP growth paints a more negative picture of Covid-19's impact on Italian growth. The decline in GDP was 5.3% from the previous quarter, compared to the 4.7% previously estimated by Istat. The growth overhang for 2020 stands at -5.5%.