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Global macro & geopolitics from a small economy perspective

Currency wars, Cameron on Europe, and deconstructing Davos

David Skilling
25 January 2013

These notes offer brief reflections on a few of the week’s interesting global economic and political developments.

Currency wars
There was renewed talk this week of currency wars and the politicisation of central banks, partly motivated by the monetary policy decisions in Japan. This debate about currency wars has been rolling for a few years now, with concerns raised regularly at the effect of ultra-loose monetary policy on exchange rates. One of the positive surprises since 2008 has been the limited recourse to conventional forms of trade protectionism. But increasingly there is action on the capital account, in the form of exchange rate intervention, capital controls, and restrictions on investment. Some governments see these measures as particularly attractive in the context of austerity and sluggish growth. But in the absence of effective international policy coordination through the G20 or IMF, the risk of a cycle of competitive devaluations increases. The action and debate over the past weeks remind us that the prospect of heightened exchange rate tension should not be taken lightly in a G-Zero world. Many small countries have been on the receiving end of large country monetary policy over the past few years, experiencing substantial upward pressure on their exchange rates, and further pressure and volatility may be on the way if the current trends are not subjected to a measure of global coordination.

Cameron on Europe
David Cameron gave his long-awaited speech on Wednesday on the UK’s relationship with the EU. It was an elegant speech, even if you disagree (as I do) with the ‘renegotiate and referendum’ strategy. And the speech is worth reading for the sharp statement of principles with respect to models of European integration. On one hand is a model of increasingly tight integration to make the eurozone work and to better project global influence. On the other hand is a more networked model in which nations retain substantial autonomy within a looser framework of cooperation and integration – the model David Cameron (and others) support. This is the trade-off between scale and flexibility, a dilemma well-known to small countries. My view is that many of the attributes of smaller economic units – such as economic and political flexibility and speed – will become more valuable in the emerging world. And the ability for economies to pursue different policy approaches is likely to add competitive dynamism and resilience. On some issues scale certainly matters; I think a common currency in Europe is a good idea, for example, and scale helps with pursuing FTAs. But to the extent possible, a more distributed model seems likely to allow Europe to get the best of both scale and dynamism. To the extent that Wednesday’s speech helps to frame a debate on these issues, there may be a silver lining to the process.

Deconstructing Davos
Davos is in full swing as I write. The theme this year is ‘Resilient Dynamism’, the idea (I think) that the world needs to move forward after the crisis in a resilient way. Indeed, the sentiment from Davos suggests that optimism is returning after several years of deep concern – observations are made that the US is now growing and the Eurozone looks better. It is said that Davos is where the conventional wisdom is established. But the conventional wisdom doesn’t have a great track-record over the past decade or two. So in assessing ‘Resilient Dynamism’ we should think carefully about the relative emphasis on resilience and dynamism. Although concerted policy action helped the global economy avoid the abyss, significant risks remain. These risks range from the geopolitical (Japan/China being just one) to the economic risks associated with the unconventional monetary policy and public debt levels (as well as what happens when stimulus is reduced). Unsurprisingly, but plausibly, Nouriel Roubini is talking of gathering downside risks in 2013. So signs of returning optimism should be watched cautiously. They might be a leading indicator of the opposite. For small countries that are particularly exposed to global developments, this suggests that efforts to strengthen their macro policy settings and build resilience become even more important.