G-20 Needs To "Man Up" Or Risk Sparking Market Chaos, Citi Warns

Two days ago, the man who now signs your Federal Reserve notes threw cold water on hopes for a so-called “Shanghai Accord.”

Over the past month or so, anticipation has built among market participants for some manner of coordinated policy response at this weekend’s G20 summit in Shanghai. The hoped for agreement would ideally be something akin to the 1985 Plaza Accord between the United States, France, West Germany, Japan, and the United Kingdom, which agreed to weaken the USD to shore up America’s trade deficit and boost economic growth.

Calls for coordinated action come on the heels of a turbulent January in which collapsing crude, RMB jitters, and worries that central banks are out of bullets have sowed fear in the minds of investors. “We remain sellers into strength in coming weeks/months of risk assets at least until a coordinated and aggressive global policy response (e.g. Shanghai Accord) begins to reverse the deterioration in global profit expectations and credit conditions,” BofA said last week, ahead of the summit.

Don’t expect a crisis response in a non-crisis environment,” Lew said in an interview broadcast Wednesday with David Westin of Bloomberg Television. “This is a moment where you’ve got real economies doing better than markets think in some cases.”

Whether or not you agree with Lew’s assessment of “real economies” or not, the message was clear. The US isn’t set to support some kind of joint statement on fiscal stimulus and may not even be willing to be part of a consensus on the need to implement emergency measures to juice global growth and trade.

On Friday, the soundbites are rolling in as the world’s financial heavyweights opine on the state of the decelerating global economy and the turmoil that likely lies ahead for markets. 

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From Reuters

LI KEQIANG, CHINA PREMIER:

"Macroeconomic policy coordination needs to be strengthened. The global economic and financial situation may have become more grim and complex. It is time for countries to stand together to tide over difficulties.

"When formulating national macroeconomic policies, G20 members need to keep in mind not just their own growth, they also need to look after the spillover effects of their policies. They need to increase communication and coordination, and work together to ensure stability of international financial markets.

"Structural reforms need to be carried forward. The international financial crisis showed that quantitative easing policies could hardly remove structural obstacles to growth. They might even lead to more negative externalities. Our focus should rather remain on structural reforms. Countries face different circumstances. What is desirable is innovation, deregulation, more competition and greater openness. This way the economy will grow more vibrant...

"Though economic growth is slowing down, the employment rate is steadily growing, that means our efforts in fostering new drivers to growth and developing a new economy are paying off. We have the confidence to handle the complex situation at home and abroad.

"China will continue with market-oriented and rule-based financial reform. We will cultivate an open and transparent capital market and ensure that it enjoys long-term, steady and healthy development. We will pursue a managed floating rate regime based on market demand and supply, and with reference to a basket of currencies.

"There is no basis for continued depreciation of the RMB exchange rate. It will stay basically stable on an adaptable equilibrium level. China's continued growth and reform and opening up provide a solid basis to support steady performance of its financial markets."

ZHOU XIAOCHUAN, GOVERNOR OF THE PEOPLE'S BANK OF CHINA:

"While the reform direction is clear, managing the reform pace will need windows (of opportunity) and conditions. ... The pace will vary, but the reform will be set to continue and the direction is not changed.

"China will strike a balance between growth, restructuring and risk management.

"China still has some monetary policy space and  tools to answer potential downside risks.

"As for monetary policy...we will not focus on external conditions or capital flows in setting our monetary policy framework. Monetary policy will pay more attention to price-based adjustments instead of quantitative adjustments, that means interest rates will play a more important role.

"At the same time, the signal from interest rates will be clearer... so we are gradually developing an interest rate corridor. We are relying more on a median value of interest rates generated by the central bank's open market operations."

On competitive forex devaluations:

"As for whether the G20 will specifically coordinate exchange rates, it has never done this before. Some people have raised the issue. We need to wait and see how the G20 should discuss it. China has always opposed competitive currency devaluations as a way to boost export competitiveness. China had a nearly $600 bln surplus in mercantile trade last year, so we will not participate in competitive currency depreciation to boost China's exports. The G20 will put emphasis on global structural reforms, and on sustainable growth."

"There is nothing to worry about the country's external payments ability. In order to maintain an appropriate level of foreign exchange reserves, the key is that we have correct macro-policies. The exchange rate policy should be correct; if the exchange rate is not correct, it could lead to capital flows. We also need to watch various changes in the international (market), which could lead to changes in capital flows, especially for emerging economies."

GERMAN FINANCE MINISTER WOLFGANG SCHAEUBLE:

"Fiscal as well as monetary policies have reached their limits. If you want the real economy to grow there are no shortcuts which avoid reforms.

"Talking about further stimulus just distracts from the real tasks at hand.

"We therefore do not agree on a G20 fiscal stimulus package as some argue in case outlook risks materialize.

"There is still considerable stimulus in the system: Monetary policy is extremely accommodative to the point that it may even be counterproductive in terms of negative side effects on banks, policies and growth.

"The debt financed growth model has reached its limits. It is even causing new problems, raising debt, causing bubbles and excessive risk taking, zombifying the economy.

"Clearly, today, the indebtedness of the private and public sector, including the high leverage of banks and households, as well as a lack of structural reforms, hinder sustainable growth."

ITALIAN CENTRAL BANK GOVERNOR AND ECB GOVERNING COUNCIL MEMBER IGNAZIO VISCO, IN COMMENTS TO REUTERS:

Visco told Reuters the two-day event was focused on sharing ideas and that formulating a concrete action was not an "objective".

"It is strange to expect a concrete action. A concrete action in terms of policy is done by central banks who have the responsibility vis-a-vis their targets or their mandates - price stability, financial stability. It is the responsibility of fiscal authorities to use the fiscal space where it is important. You cannot decide a major infrastructure for the world."

Visco added that China's slowdown was not totally unexpected, but that a lack of transparency had sharpened its impact. "It is, at the end, more or less what was expected, but the uncertainty around it has been dramatic and dramatised also by the developments in the financial market."

OECD SECRETARY GENERAL ANGEL GURRIA:

Gurria said that the G20 had "talked the talk" but needed to show it could come up with concrete measures after failing to hit growth targets it set in Sydney in 2014.

The G20 nations agreed then to lift their collective GDP growth by at least 2 percentage points above what the current economic policies would achieve over a five-year period.

"We are lagging behind on that relatively modest effort of the 2 percent," said Gurria, adding the group was only about a third of the way to its goal. "We are not in a very good way today; something is either not working very well or is broken."

CHINESE FINANCE MINISTER LOU JIWEI:

"Luckily the Chinese economy has the policy space and also a lot of tough issues ahead of us, so we will do our best to move forward the reform process.

"The space is evolving and changing and countries keep delaying their necessary reform agenda and that might undermine the space for the reform, so they might be standing at the edge of a cliff and have two options - either you fall over the cliff, or you push forward a very painful reform process.

"A person might fall off the cliff, but I don't think a country will fall off the cliff, so we have no option but to push forward the painful reform process, the sooner the better."

"Through concerted effort the world economy has been put back on a recovery track, however, the recovery process has been modest and uneven.

"The top priority on one hand would be to expand aggregate demand, on the other hand, enhance structural reform.

"We will focus on a global economy growth framework, investment infrastructure, international financial architecture, financial sector reforms, international taxation collaboration, anti-terrorism financing, green finance and climate finance. Altogether eight topics."

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Highlights from a speech by IMF Chief Christine Lagarde

Given the fragile state of the current recovery, and the quite considerable downside risks to the global economy, I believe that we need to realize the expected pay-offs from structural reforms earlier than initially anticipated.

So I am calling on all G-20 countries to speed up the implementation of structural reforms that they committed to under the G-20 growth initiative. And I am calling on all our 188 member countries at the IMF to undertake reforms that hold back their growth momentum, and that we have discussed with them in our annual Article IV Consultations.

I am aware that this is a large and demanding agenda. Each economy is different, and so are reform needs in each country. So where to start? What does make most sense, and where should political capital invested first?

To answer these questions, the G-20 has asked the IMF to develop some guiding principles and priorities, and we have been glad to embark on this work. Structural reforms are a macroeconomicpriority, and this is the perspective that the Fund brings to the table, working closely with our institutional partners in responding to this request.

The analytical work and country cases that we presented to our Executive Board in late 2015 suggests that, amid large diversity of individual country experiences, three economic dimensions are particularly important for the successful implementation of structural reforms:

  • A first dimension is a country’s income level. As the saying goes: “don’t try to run before you can walk”. Our research finds that for the more advanced economies, reforms that foster technology and innovation may have the greatest pay-off. For emerging market economies, strengthening property rights and capital markets may be more relevant.
  • A second dimension is the country’s position in the economic cycle. For example, we know that fiscal multipliers are larger when economic growth is below potential. In these situations, spending on infrastructure projects—for example, roads and bridges—is likely to have a larger growth pay-off in the near term.
  • A third dimension is the country’s space for reform, which takes into account the distance from international best practice as well as the resource envelope available to finance reforms.

Policy choices will naturally also be shaped by each country's societal preferences. For example, looking at employment, both the Anglo-Saxon and the Nordic “flexicurity” approaches have been successful. But they are based on very different labor market policies.

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Highlights from a speech by BOE governor Mark Carney

The global economy risks becoming trapped in a low growth, low inflation, low interest rate equilibrium.  For the past seven years, growth has serially disappointed—sometimes spectacularly, as in the depths of the global financial and euro crises; more often than not grindingly as past debts weigh on activity (Chart 1).  

This underperformance is principally the product of weaker potential supply growth in virtually all G20 economies. It is a reminder that demand stimulus on its own can do little to counteract longer-term forces of demographic change and productivity growth.  

That is not to suggest that such stimulus is without value or impact.  Accommodative monetary policy can support activity while parts of the economy delever.  Monetary stimulus can avoid hysteresis in the labour market.  And monetary stimulus can buy time for structural adjustments which shift activity from public to private, external to domestic, and declining to rising sectors.  

The time purchased by stimulus has been well spent fixing the fault lines which caused the global financial crisis.  Derivative markets have been made simpler and safer.  Fragile shadow banking activities are being transformed into stronger market-based finance.  And the scourge of too-big-to-fail is ending.  

More fundamentally, global growth has disappointed because the innovation and ambition of global monetary policy has not been matched by structural measures.

In most advanced economies, difficult structural reforms have been deferred.  In parallel, in a number of emerging market economies, the post-crisis period was marked by credit booms reinforced by foreign capital inflows, which are now brutally reversing (Charts 2 and 3).  The international financial and monetary architecture has been tinkered with rather than transformed.  With the forces of fragmentation now rising in many countries, it will be more challenging to build a truly open, global system.  The consequences of such timidity are reflected in the sizeable downside risks which currently plague the global outlook.

These shortcomings also explain much of the sharp fall in global nominal growth since the crisis.  Since 2007, global nominal GDP growth (in dollars) has been cut in half from over 8% to 4% last year, thereby compounding the challenges of private and public deleveraging (Table 1).  In an unforgiving global environment even those economies with resilient private demand, like the UK, must manage policy with vigilance and dexterity.

Renewed appreciation of the weak global outlook appears to have been the underlying cause of recent market turbulence.  The latest freefall in commodity prices – though largely the product of actual and potential supply increases – has reinforced concerns about the sluggishness of global demand.  And a series of relatively small data disappointments for many major G20 economies have added to these worries.  

Necessary changes in the stance of monetary policy removed the complacent assumption that “all bad news is good news” (because it brought renewed stimulus) that many felt underpinned markets.

And as I will discuss in a moment, several commentators are peddling the myth that monetary policy is “out of ammunition.”  Is “the only game in town” over? (ZH: "Peddling fiction)

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"Analysts are more skeptical about the G-20’s ability to coordinate policies to control gyrations in foreign-exchange markets," Bloomberg notes. "Currency traders are enduring the most volatile February in six years, with three-month price swings for the yen surging to 10.6 percent, the highest since March, and a measure of future fluctuations approaching the highest since 2013."

Here's what Citi's Steve Englander says are the likely outcomes should officials be able to come to some kind of consensus:

  • stronger equity markets
  • higher oil and commodity prices
  • higher inflation expectations
  • much stronger EM currencies
  • bond yields back up significantly and yield curve steepens
  • stronger USD vs. JPY, probably versus EUR as well, but far from guaranteed
  • more modest CNY depreciation

"The logic is that significant fiscal thrust would unwind both the growth and inflation pessimism that has hobbled global asset market so far this year," Englander says. 

So what's the bottom line, you ask? Well, according to Citi, it's this: "They won't save the world but probably convince investors that global policymakers are sufficiently on the same page to add to global confidence." 

But what happens if the concluding statement doesn't reflect a consensus or otherwise disappoints? “Keeping the previous language would be very disappointing and would be viewed as either complacent or reflecting policy paralysis,” Englander says. "[They need to] man up and tell member countries that monetary policy should be accompanied by fiscal expansion.”

Right. So "man up" policymakers and demand fiscal stimulus (and helicopter money while you're at it). Or else risk fueling further FX volatility, an equity market selloff, a (further) flight to safety, and heightened fears of a global recession.