Christine St Anne: Policymakers around the world have announced a number of recent initiatives. To make sense of what these decisions mean for the markets, I'm joined by PIMCO'S Saumil Parikh.
Saumil Parikh: Thank you very much, Christine.
St Anne: Saumil, we've seen another round of quantitative easing from the U.S. and the ECB recently announced a bond-buying program. Are these initiatives enough to restore confidence in the markets?
Parikh: Christine, the answer is still to be decided really. The ECB is in a very different stage of addressing financial conditions compared to where the Fed was. We really view quantitative easing or the whole sort of set of unconventional monetary policies that have been put in place by major central banks, in three different phases. So, the first phase is when the private sector and the financial system - the private financial system is undergoing bouts of deleveraging that threaten the very stability of the system itself. You tend to get action by central banks, which is the first phase.
So, the ECB has just put into place what we would call first phase quantitative easing in the sense that they have decided with conditionality to buy unlimited amounts of short-term government bonds. Now, that in itself is not sufficient to ease financial conditions within the Eurozone. If you compare where the ECB is today to where the Federal Reserve is today, the Federal Reserve has gone through two more iterations.
So, not only did the Federal Reserve buy mortgages in 2008, 2009 in the first phase of the Fed's quantitative easing, but the Fed has continued with quantitative easing through the last three-and-a-half years, through phase two, which is the normalization of credit conditions and the phase three, which is the easing of credit conditions well through their fair value or their average levels. So the Federal Reserve is way ahead of the game in terms of the ECB. The ECB is lagging by at least three or four years in terms of relative effectiveness.
St Anne: Saumil, there has been a lot of discussion about a fiscal cliff in the U.S. Can you give us an idea about what that means and is the U.S. government well placed to tackle this challenge?
Parikh: Sure. So, as you know, the public sector balance sheet in the U.S., including the federal, states and local, are collectively running about a 9% of GDP deficit, not cyclically adjusted, just a normal deficit. At the end of 2012, because of the expiration of a variety of longer-term as well as short-term fiscal policy initiatives, some of which go back to the Bush presidency, back to 2001, there is set to be initiation of a 4 percentage point of GDP decline of fiscal stimulus. Both from rising tax rates as well as from the sunset of a variety of spending and countercyclical fiscal policy measures that were put into place over the last two or three years.
So, if policymakers - once the new elections are announced and the new government is formed, if policymakers do not address the extension of these sunsetting fiscal stimulus programs then we are set to have about a $400 billion to $500 billion of fiscal drag being placed on the U.S. economy which would certainly shift the odds of a recession in 2013 to well above 50-50.
St Anne: Saumil, just want to get your views on China. Growth has consistently slowed for the country. Are you confident that the authorities there can manage this new challenge?
Parikh: Yeah. China is going through an interesting transition. There are secular issues that are causing China's slowdown as well as cyclical issues.
In terms of the cyclical, I think it's important to think about China as effectively the world's factory, and two of the major consumers of the world, the European consumers as well as the U.S. consumers are going through their own sort of consumption slowdown. In the U.S. it's because of uncertainty related to the fiscal cliff; in Europe it's because of imposed austerity by both the public sector balance sheet as well as the banking system on the private sector balance sheet.
But in effect, if China is viewed as a world's factory then China's customers are reducing their spending. And China is cyclically going through a large inventory destocking cycle, something that was classically observed in developed economies before globalization took off in the 1990s. So that's the cyclical story. That cyclical slowdown will be managed properly by Chinese authorities. We think China has more than enough tools, both monetary policy and fiscal policy tools, to counteract the cyclical slowdown in the Chinese economy.
The secular issue is what we find much more interesting. We think that China secularly is going to enter into a slower growth phase. So, for the last 10 years, China has averaged somewhere between 8% and 12% annual real growth in its economy and the bulk of that growth has come from rising amounts of investments and rising share of investment as a percentage of GDP.
We think that growth phase, what you would call the easy growth phase of economic development, is now coming to an end and China needs to transition its economy from a capital goods infrastructure heavy growth model towards a domestic consumption and a domestic services and then more an innovation type of economy and that transition is not an easy one. Over the last 50 years or so, there have been several countries that have tried that transition; it's called the middle-income transition, when basically a country goes from $5,000 GDP per capita to $15,000 GDP per capita. And only about five countries have managed it successfully, while maintaining a high growth rate.
So, the secular issue with China is that the growth story that was linked to infrastructure and capital spending is now changing. And China will appear to most outside observers, especially for countries like Australia, as a very different economy for the next 5 to 10 years. So, Chinese demand for commodities, for example, which has been growing at 10%, 15%, 20% a year, will probably not grow faster than 5% or 6% a year from this point forward because the composition of the economy as well as the growth rate of the economy are going to change.
St Anne: Saumil, thanks so much for your insights today.