As the European single currency swung between $1.30 and $1.20 last month, Euromoney toured banks whose currency strategists were publishing estimates of it going to $1.15 or lower. In private conversation, it’s soon obvious that many indeed expect the European currency to head for parity with the dollar or even fall through it, especially if the present single-currency bloc holds together, and any system of fiscal transfers between states – which Angela Merkel has so far denounced as an “irresponsible” model – does emerge.
With the US, the UK and the eurozone governments all in the same boat, struggling with high debts, fragile recovery and low growth, the threat of competitive devaluations hangs heavy in the air.
For now all the concerns over sovereign debt sustainability are focused on Europe. The US appears to have done its job. The economy is growing faster than the rate of interest on its debt; its banking system looks much healthier than 12 months ago and the treasury market is benefiting from a flight to quality, driving yields down.
But what if US exporters should struggle to cope with a debased European currency and US growth slows? If the price it has to pay on its debt starts to rise, the US itself could fall back into the same kind of debt trap now ensnaring the eurozone periphery. To pretend otherwise is mere complacency.
Beneath the surface, scepticism abounds among investors about the reliability of all governments’ accounting for their debts. A senior executive at one of the biggest bond fund managers in the US questions why the US government has never fully and unconditionally de jure guaranteed the debts of Fannie Mae and Freddie Mac, even though it is clearly de facto on the hook for them. Is it simply so that the official numbers should not look as bad as they really are? And how should foreign investors in US treasuries think about individual states’ and municipalities’ liabilities as part of the general government debt?
The IMF expects US general government debt, which stood at 70% of GDP before the onset of the financial crisis, to head to 115% of GDP by 2015, with it still likely to be running a budget deficit of 4% of GDP for 2014.
The next summit of the G20 in Toronto later this month is shaping up to be a momentous one. The US senate recently voted unanimously against permitting the IMF to use funds supplied by the US taxpayer to bail out European governments. The prospect of one or both of weak growth and a devalued currency in Europe will heighten tensions much further.
These are not tensions that the US and Europe can resolve between themselves. These countries are the problem. Can the emerging markets be the solution?
Policymakers in Asia are already worrying about capital flight from the developed world destabilizing their domestic financial markets, boosting their currencies and even promoting a dangerous short-term economic boost from injudicious investment. Behind the scenes, that talk is of capital controls.
Maybe the old world is in its last throes. It needs to make a deal over June 26 and June 27 in Toronto with China, Brazil and India to boost domestic demand and revalue their currencies to help the faltering European and even the threatened US economies – whose bonds those emerging country reserve managers are stocked up on – to grow out of their debt burden.
What can the US and Europe offer as their part of the bargain? Handing over much power over the IMF and other multilateral agencies would seem like a good place to start.
