High quality global journalism requires investment. Please share this article with others using the link below, do not cut & paste the article. See our Ts&Cs and Copyright Policy for more detail. Email ftsales.support@ft.com to buy additional rights.http://www.ft.com/cms/s/0/36c87c7c-e602-11e1-a430-00144feab49a.html#ixzz23efv8l4c Such is the market’s Pavlovian obsession with every twist and turn in theeurozone saga that it is easy to forget that some of the biggest questions confronting investors are about identity problems. Here are three of the more pressing. Are North America and Europe turning into the new Japan, bringing the prospect of a lost decade? Are the US, UK and Germany safe or unsafe havens? And is France a member of the core or the periphery of the eurozone? Let us take them in turn. Certainly resorting to fiscal stimulus in response to the financial crisis has left the non-Japanese developed world with public sector debt moving uncomfortably in a Japanese direction. Ten-year government bonds in the US, UK and Germany, at respectively 1.72 per cent, 1.6 per cent and 1.47 per cent, are plumbing depths that have hitherto been familiar in the larger economies only to Japanese investors. The history of policy blunders in Japan, including slow motion shifts to unconventional monetary policy after the bursting of the asset price bubble in 1990 and a reluctance to take the measure of the banking crisis, undoubtedly has echoes in the west. There was the near-catastrophic failure last year to reach agreement over the US federal debt ceiling. Meantime, eurozone politicians have done their best in tackling the sovereign debt crisis to make Japanese politicians look decisive, while eurozone regulators have imposed wretchedly unstressful stress tests on undercapitalised banks. There are nonetheless important differences. Despite the low nominal return on Japanese bonds, the real return has been positive for years because of deflation. It remains positive today, when the 0.8 per cent yield on Japanese 10-year bonds remains above current consumer price inflation of around 0.2 per cent. By contrast, comparable US, UK and German bonds all offer negative real returns, while at the short end of the market negative real returns border on the penal, reflecting the attempt to address the debt overhang through financial repression. Note, too, that the so-called “lost” decade was a terminological inexactitude. Over more than two decades the Japanese economy has neither grown nor shrunk, saved from depression by growth in the rest of the world. Today no such support is at hand. Heavily indebted countries in North America and Europe are no longer able to pump prime the world. China is not ready to pick up the gauntlet. Eurozone policymakers are hell bent on a mindless austerity which will make Japan’s recent stagnation look wonderfully benign. And unlike Japan, where social solidarity is still strikingly strong – as demonstrated by the Fukushima disaster last year – the eurozone crisis is rooted by its very nature in lack of solidarity. A prolonged slump in southern Europe, for which structural reform offers a tantalisingly remote remedy, looks set to engender serious civil strife. As for the safety or otherwise of the global investors’ favourite bolt holes, we are in strange territory. The US looks set for a return to fiscal brinkmanship after the presidential election. The UK’s fiscal numbers are deteriorating as theeconomy plunges back into recession. So investors are reversing the logic of bond vigilantism and rewarding fiscal bad behaviour to escape growing default risk in the eurozone. More “virtuous” Germany attracts huge capital flight in exchange for the lowest yields. It is hard to see the US losing its high safety status. It supports the world’s pre-eminent reserve currency, with the deepest and most liquid markets. So even ideologically unsympathetic holders of oversize official reserves, such as China, cannot significantly diversify away from the dollar. With the UK, a more modest version of a similar argument applies. As long as there is a eurozone crisis and potential for a break up, nervous money will continue to flow in. Note, though, that all of that could change if the monetary union shows signs of surviving. Mark Cliffe, group chief economist at ING, rightly argues that this would produce a “survival trade”, leading to massive reconvergence of eurozone yields at the cost of higher yields in formerly safe havens. And France? The country has performed well since monetary union but is nowin relative decline, both politically and economically, vis à vis Germany. There is a competitiveness issue: export performance in terms of share of markets has deteriorated. The appetite for structural reform under François Hollandeappears weak – witness the absurd but symbolic reduction of the retirement age, admittedly for a small number, to 60. Inflexible labour markets will make necessary fiscal consolidation harder. What can be said with certainty is that if France really is a core member and the eurozone breaks up, the competitiveness problem will become infinitely worse as the rump euro appreciates. The writer is an FT columnistMore
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Wednesday, 15 August 2012
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