Financial Post G7 Record

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Financial Post, Weekly edition, Sat 17 Jun 95, page 14

Keywords: International finance Economic conditions Economic policy Interest rates Statistics Great Britain Canada France Italy Japan United States

BRAVE TALK AMID SIGNS OF SLOWDOWN: Most countries experienced downturns in their economies this year and each is now scrambling to halt inflation and restore growth. France appears to be first in line toward a turnaround, while Germany seeks to stanch its export slump and Japan launches government incentives.

Greg Ip

While the leaders of the G-7 leaders continued to play down the likelihood of recession, there are signs the risk might actually be rising.

''We remain encouraged by the continued strong growth in much of the world's economy,'' they said in their communique released Friday.

''While there has been some slowing, in most of our countries, the conditions for continued growth appear to be in place and inflation is well under control. We will pursue appropriate macroeconomic and structural policies to maintain the momentum of growth.''

But the economy took a back seat to other issues, undeservedly in the view of some.

''A lot of people are talking about International Monetary Fund and World Bank, but what should be high up on the agenda is how to get this world economy in gear and keep it in gear,'' said Ken Courtis, economist for Deutsche Bank in Tokyo. ''Those guys should be much more concerned about it than they are.''

Statistics paint a worrying picture. In the U.S., industrial production declined for the third consecutive month in May, the first time since the last recession. In Canada in the same month, the composite leading index fell, also for the first time since the recession ended in 1991.

In Japan, deflation is taking hold. In Europe, expansion continues, but there are signs it is slowing sharply, and none of the major G-7 economies saw significant manufacturing growth in the first quarter.

''Growth in the [industrialized] economies may have peaked in the second half of 1994,'' said Goldman Sachs & Co. in its latest international outlook. ''Since then, there has been a marked slowdown in activity, reflecting the tightening in monetary conditions and (possibly) the exchange rate shock.''

However, Goldman sees this as a ''temporary pause'' rather than as the start of a major downturn.

The outlook for most countries has been revised down from when the IMF forecast a few months ago that all economies would grow 3% this year or more, except Japan.

Several factors have contributed to this darker future.

The Federal Reserve Board's increase in U.S. interest rates since February 1994 has taken effect faster than expected.

And the continuing fallout from exchange rate misalignments has also taken its toll. Driving Japan's deflation and collapse in exports is the yen's surge against the US$. Similarly, Germany's recovery is being threatened by the strength of the deutschemark. The Mexican peso crisis has affected many economics.

Britain and Italy are dealing with the inflationary fallout of their devalued currencies, while France's defence of the franc has limited the interest rate relief necessary to reach President Jacques Chirac's job creation goals.

Canada faces rising inflation and a weak currency just when interest rate relief is needed most, complicating the Bank of Canada's attempts to lower rates.

The G-7 communique referred to the dangers of wide currency swings, and government and current account deficits.

''Internal and external imbalances, together with unhelpful fluctuations in financial and currency markets, could jeopardize achievement of sustained, non-inflationary growth as well as the continued expansion of international trade.''

The prospect of a recesssion seems odd Q except for the U.S., none of the G-7 economies have returned to full employment, says the Organization for Economic Co-operation and Development. Ordinarily, recessions don't occur until demand over-expands and inflation accelerates.

Recession remains more possible than probable in most forecasts. But economists such as Courtis believe many nations are highly vulnerable because the enormous level of government debt in major countries Q 72% of GDP, up from 42% 15 years ago Q has left countries and governments highly leveraged to interest rates.

Any number of shocks could push rates up.


George Magnus, chief economist at S.G. Warburg in London, says ''Given the historic proximity between the U.S. and U.K. business cycles, the U.K. is going through much the same slowdown perception.''

And indeed, many economic data do suggest the British economy has ground to a halt. Real manufacturing production has declined slightly in the last six months and real retail sales have barely grown. But, Magnux adds, there is considerable suspicion about the accuracy of the official statistics because surveys of business confidence suggest things aren't nearly so bad.

A weak economy jives with the chancellor of the exchequer's decision to keep interest rates stable for the present. But underlying inflation is headed up, now at 3.3% compared to 2.6% last year, and delaying further increases in interest could cost the government its credibility on monetary policy. The Bank of England has official infaltion targets of 1% to 4%, and the perception in the markets is that the government's political interests are overruling the bank's prudence.


Outside Japan, Canada's economy may be the weakest in the G-7 at present, and a couple (albeit a small minority) of economists are talking about recession now.

''We could be in a recession even as we speak,'' said John McCallum, chief economist at the Royal Bank of Canada and a participant at the summit.''We think there will be som resumption (of growth) in the U.S. and that will keep us out of recession. But when you get as low as this, any sudden shock could put us down.'' He added, ''People hardly ever predict recessions.''

Finance Minister Paul Martin dismissed the recession possibility in a briefing Friday, and so far, the consensus of forecasts agree with him.

Most still see the economy growing 3.5% to 4% this year. Much of that, however, is simply the way the arithmetic of growth takes into account the strong finish to 1994. On a quarter-to-quarter basis, growth will be very weak, with the first quarter just 0.7% annualized, the current quarter probably negative, and the last half also weak.


France came to the summit with the highest unemployment rate in the G-7, at 12.2%. That issue governed the recent French presidential election campaign, and it preoccupied President Jacques Chirac at the summit. He pushed successfully for another jobs summit. He also has emphasized the need for more stable exchange rates that better reflect economic fundamentals.

The outlook for the French economy is better than that of most G-7 countries this year. ''We are at a completely different stage of the cycle'' from North America, said Philippe Ries, chief economics editor for Agence-France Presse. The economy will probably grow about 3% both this year and next.

Whether that will result in extra jobs is another question. Chirac has promised to cut payroll taxes and subsidize hiring of the long-term unemployed. But he also intends to sharply raise the minimum wage, which is likely to discourage hiring, and raise the value- added tax to reduce the government budget deficit, now standing at 6% of GDP, second largest in the G-7 after Italy.


Germany's pride in the strong Deutschemark is beginning to have a price. Business conditions in Europe's industrial powerhouse have deteriorated sharply since the beginning of the year. Industrial production has begun to slow, and surveys have shown a sharp deterioration in business confidence.

George Magnus, chief economist at S.G. Warburg in London, says the drop in confidence reflects slowing demand in North America and the strength of the mark.

Exports have led Germany's recovery, but because of the mark's rise, ''that export expansion is slowing,'' said Ken Courtis, economist for Deutsche Bank. While many economists see a pronounced slowing of the German economy this year, there is no consensus that the Bundesbank, Germany's central bank, will cut interest rates to help. It has cut interest rates already in recognition of declining inflation, but the economic slowdown is recent and the bank may remain concerned that past economic growth is feeding wage settlements and inflation in general.


Italy is facing the most pronounced inflation problem in the G-7, mostly thanks to the dramatic devaluation of the lira in the past 2] years, and the resulting boom in exports. Inflation has risen to 5.5% from an average of 3.8% last year, and could be headed higher. This has prompted a fairly quick tightening in monetary policy by the Bank of Italy Q it raised rates 75 basis points in late May in response.

This poses a serious problem for the government, which is struggling to contain its runaway budget deficit. Interest payments on the national debt are the biggest component therein.

The government has responded with some significant measures aimed at cutting the budget deficit, including pension reform, a product of a special agreement with the country's unions.

How much further the government of Lamberto Dini is likely to go is open to question.

Unaffiliated with any particular party, Dini is essentially heading a caretaker government until elections are held this fall.


The R-word is not mere scaremongering when used in Japan.

''We're in a recession,'' asserts Ken Courtis, Deutsche Bank's Japan economist. The only question is whether it gets deeper. The economy is rapidly deflating. Although the latest data put inflation at -0.2% in April, Courtis thinks it could be -2% or more. That means while bond yields are about 3%, in real (i.e. inflation-adjusted) terms, they are 5% or more. Deflation is crushing asset prices and saddling the banking system with mountains of bad debts that have wiped out other profits. With the stock market also falling, banks' unrealized stock profits are disappearing, eroding their capital base.

In response, the Japanese government has launched a number of initiatives, including a 5.5-trillion-yen (US$65-billion) tax cut and additional infrastructure spending to boost growth. Courtis says Japan's role as the biggest lender to the G-7 debtor countries means that if Japanese banks must repatriate profitable investments abroad, they might have to sell U.S. bonds, which would drive interest rates up and the US$ down.


A year ago, the U.S. was the envy of the G-7. Unemployment had fallen to its lowest level in five years, inflation was declining, and growth was second only to Canada's.

Almost the opposite is true now. The U.S. economy has come to a screeching halt. Industrial production is sliding, unemployment has started to rise, and there is now widespread belief that the Federal Reserve Board will cut interest rates at its next policy meeting.

The turnaround has surprised many observers, who expected the economy to resist the pull of higher interest rates for another year. J.P. Morgan Bank, previously one of the most bullish forecasters of the U.S. economy, has now revised its forecast of growth this year down to 3.1% from 3.8%, although it now thinks 1996 will be stronger. The slowdown is being characterized as a pause for manufacturers to run down inventories, implying ''a mild, not severe, downturn,'' says Morgan.

Although Morgan expects the Fed to keep interest rates steady for the rest of the year, the market thinks the Fed will cut them.


		     1994   1995     1996

   Inflation %        2.4    3.5      3.5

   Unepmloy %         9.3    8.1      7.4

   Currenct account  -0.3    0.8       0

   balance US$bil


		      1994   1995     1996

Inflation % 0.2 2.2 2.5

Unemploy % 10.4 9.4 9.2

Currenct account -18.2 -14.3 -13.2

balance US$bil


1994 1995 1996

Inflation % 1.7 1.9 2.3

Unemploy % 12.5 12.1 11.7

Currenct account 9.8 8.7 6

balance US$bil

GERMANY (Western)

1994 1995 1996

Inflation % 3 2.3 2.6

Unemploy % 9.6 9.2 8.8

Currenct account -23.8 -18.7 -17.4

balance US$bil


1994 1995 1996

Inflation % 3.9 5 4.5

Unemploy % 11.5 11.4 11

Currenct account 13.6 15.7 17.6

balance US$bil


1994 1995 1996

Inflation % 0.7 0.4 0.8

Unemploy % 2.9 3 3.1

Currenct account 129 120 90

balance US$bil


1994 1995 1996

Inflation % 2.6 3.1 3.5

Unemploy % 6.1 5.6 5.7

Current account -156 -172 -151

balance US$bil

This information is provided by the Financial Post.
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Revised: June 3, 1995

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