Abstract: At a recent seminar cohosted by CF40 and Nomura Research Institute (NRI), experts pointed out three new trends with global economic growth: 1) The external sustainability of the US economy is questionable; 2) An era of global high inflation and high interest rate is coming; 3) Risks of economic and financial deglobalization are increasing.
I. THE EXTERNAL SUSTAINABILITY OF THE US ECONOMY IS QUESTIONABLE
Yu Yongding, Academician at the Chinese Academy of Social Sciences (CASS), pointed out that ever since 1985 when the United States began to record net external debt, the total amount has been on a continuous upward ride, reaching over 18 trillion USD today. Risks associated with the country’s long-standing current account deficit and tremendous external debt have ignited global discussion of the “external sustainability” of the US economy. Analysis of the sustainability of the net external debt of the US is essentially to depict the dynamic path of its net debt to GDP ratio which is determined by four factors: the difference between gross private savings and gross private investment, fiscal deficit, investment income deficit, and GDP growth.
First, the gap between gross private savings and gross private investment in the US has been narrowing. Despite its huge trade deficit, the US has long maintained a stable gap between private savings and private investment at around 1 trillion USD. But this gap has widened sharply since Covid-19 broke out in 2020. A year later, with private savings declining, the savings-investment gap narrowed again. Given the macroeconomic situation in the US and policy adjustments by the Federal Reserve, US private spending is expected to rise and the share of total private savings in GDP will reduce, while the total private investment to GDP ratio may well remain at around the same level. Hence, in the coming years, the gap between gross private savings and gross private investment could narrow down to less than 2% of GDP.
Second, federal deficit keeps increasing. The US recorded fiscal deficits of 3 trillion and 2.8 trillion USD in 2020 and 2021 respectively, the highest after World War II. The Congressional Budget Office (CBO) estimates that the US will have an average fiscal deficit of 1.6 trillion USD in 2023-2031 and the deficit to GDP ratio will fall and then rise from 3.9% in 2022 to a projected 6.1% in 2032, significantly higher than the average over the past fifty years. Based on this assumption, the fiscal deficit to GDP ratio over the next decade will stay at around 5%.
Third, US overseas investment revenue keeps falling and may well enter the negative territory. The US has always recorded positive investment income in its balance of payments mainly because a very large proportion of its external debt is long- and short-term Treasury bonds with extremely low yields held by foreign central banks. In February, the US and its allies decided to freeze the Russian central bank’s foreign exchange reserves of 300 billion USD. Such weaponization moves have forced other countries to reexamine the security of their foreign exchange reserves and overseas assets. If China, Japan and other countries reduce the share of US financial assets in their portfolios, it would leave the US with no choice but to allow Treasury yields to rise further given the surging inflation and monetary policy adjustments. If the cost on external debts climbs up, it could slash the proceeds from overseas investment if not push it into the negative territory.
The analysis suggests that over the next decade, the net debt to GDP ratio in the US could rise above the current level of 87.7% to nearly 100%. If one day the US fails to pay back its debts with via trade surplus or capital account deficit, the US government will have to default, depreciate the dollar or bear inflation to get out of trouble. China, Japan and other east Asian economies need to prepare for the potential impact in advance.
II. AN ERA OF GLOBAL HIGH INFLATION AND HIGH INTEREST RATES IS COMING
Ryozo Himino, former Commissioner of the Financial Services Agency (FSA) of Japan, reviewed monetary tightening moves taken by central banks in advanced economies this year, including the US which has elevated the base rate three times by an accumulated 1.5% and the European Central Bank (ECB) that is planning on rolling back the negative interest rate policy that has been in place since 2014. As deflation gives way to inflation, the world will move to an era of high interest rates from the previous low-rates. In a time of high inflation and high interest rates, Japan faces a host of challenges including whether the deposit-centered Japanese households can afford a decent old-age life, how much burden would higher real interest rates place on Japanese businesses and governments with already mounting debts, and whether technological innovation alone is enough to cover a higher cost of living including that brought about by global warming.
According to Kazuo Momma, former Assistant Governor of the Bank of Japan, the Japanese economy is still faced with huge uncertainties today, including risks brought by the Covid pandemic, the conflict between Russia and Ukraine, and soaring commodity prices. Even so, driven by the service sector, the Japanese economy is recovering modestly from the pandemic. Due to the suppressed demand, household savings in Japan increased by 50 trillion yen, accounting for 10% of Japan's GDP, a very impressive phenomenon. The high level of savings will provide support to consumption in the future, such as the catering services, tourism, etc.
At the same time, prices are also rising. In April, the year-on-year growth of Japan's core CPI, excluding fresh food, reached 2.1%, surpassing 2% for the first time since the consumption tax was raised in March 2015. However, the price increase this time was caused by the rise in the prices of imported commodities such as crude oil, food and raw materials, rather than domestic demand. The cost-push inflation is usually unsustainable and can last for about a year at most. After next year, the inflation in Japan is very likely to drop to a level lower than 1% with the pass-on effect gradually fading away. In this sense, it’s very unlikely that Japan will roll back its ultra-loose monetary policy. The Bank of Japan will stick to its loose monetary policy, keeping short-term interest rates at -0.1% and 10-year Japanese Government Bond (JGB) yields around zero until when the year-on-year CPI growth can stabilize at a level above 2%.
The divergence of monetary policies between Japan and other advanced economies has put enormous pressure on the yen exchange rate and Japanese bonds. The yen, long seen as a safe-haven currency, has fallen to a 24-year low and 10-year JGB yields have surged. However, yen depreciation is determined by market forces. Rather than ruminating on its pros and cons, Japan might as well take advantage of the currency depreciation to make some changes that are beneficial to its economy in the long run. For example, Japan's economic security bill aims at building a resilient supply chain, reducing the cost of domestic manufacturing, and promoting the return of manufacturing and R&D to Japan.
III. HEIGHTENED RISKS OF ECONOMIC AND FINANCIAL DEGLOBALIZATION
Himino Ryozo note that the trend of deglobalization began to emerge after the subprime mortgage crisis in 2008. Landmark events such as the adoption of “America First” policy during the Trump administration, Brexit, and various financial regulation movements raised the concern that the world is seeing the “beginning of the end of financial globalization”. The Covid-19 shocks to industrial and supply chains in 2020 and the Russia-Ukraine conflict in 2022 followed by the Western financial sanctions have made financial deglobalization a long-term trend. No matter how the conflict and sanctions on Russia will end, countries around the world will consider the possibility of being sanctioned, and compare the costs and the benefits of globalization. Hence decision-making in a globalized world will be replete with all kinds of worries.
Currently, deglobalization also unfolds in different ways. It has shifted the approach from “bottom-up” to “top-down”, or from nationalist and anti-establishment to government-led and geopolitical-based. When the world is moving away from globalization towards division and fragmentation, the choices of China and the US will play a decisive role. If globalization comes to an end, how should the world cope with climate change and global warming? How do we establish international rules? What is the role G20 and G7? To answer these questions, all countries should take a geopolitical perspective.
Yu Yongding pointed out that the global economy will encounter a series of new challenges. What makes this round of challenges different is that geopolitics has become an important, even the most important factor that affects governments’ economic and financial policy decisions. Governments worldwide will face completely new issues in many fields including the international monetary system, international reserve currency, and international financial cooperation.
This is a policy brief compiled based on the recent 13th CF40-NRI Finance Roundtable themed “Global Governance and the Chinese & Japanese Economy in A Changing Landscape”. The views expressed herein are the speakers’ own and do not represent those of CF40 or any other organizations.
