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World Economic Update

Speakers: James D. Grant, Owner and Editor, Grant's Interest Rate Observer
Richard C. Koo, Chief Economist, Nomura Research Institute
Ronald Temple, Managing Director and Portfolio Manager/Analyst, Lazard Asset Management
Presider: Sebastian Mallaby, Director, Maurice R. Greenberg Center for Geoeconomic Studies; Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations
December 8, 2010

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The Obama administration's agreement with congressional Republicans to extend Bush-era tax cuts has raised expectations among analysts that it will spur U.S. economic growth, while feeding questions about Washington's ability to tackle the longer-term problem of soaring U.S. debt. The news pushed up the U.S. government's borrowing costs (FT). Benchmark yields on Wednesday were the highest in six months in part because of concern in debt markets that the tax plan will deepen the budget deficit.

At a December 8 CFR meeting, Ronald Temple, portfolio manager and analyst at Lazard Asset Management, said while the Obama administration's move toward extending tax cuts is positive in the short term, the government needs to present a credible plan for deleveraging itself.

"I think what the bond market is really worried about is the government keeps piling on more and more debt, and yet there's no strategy," Temple said. "The good news is, we're ticking off quite a few of these boxes and resolving uncertainty, which allows businesses to invest and investors to commit capital. The challenge is we actually have to make sure that as a country, we can de-lever in a manageable way without the bond market forcing us to do that, as we're seeing in the euro zone right now."

Richard Koo, chief economist of Nomura Research Institute, called the tax agreement "far better than nothing" but said the prospect of extending the Bush tax cuts "doesn't mean we'll come out of the recession. It just won't make it any worse."

Koo repeated his call for maintaining fiscal stimulus, saying one of the key lessons of Japan's 1990s period of stagnation is that "fiscal stimulus will have to be maintained until private-sector balance sheets are repaired, so when the private sector becomes forward looking again."

He added: "The deleveraging world that [Japan found itself] in starting around 1995, and the world that the United States is in at the moment, is [one where] you bring rates down to zero. No one's borrowing money because everybody wants to repair their balance sheets that are under water after what happened through bursting of the bubble."

Richard Grant, editor of Grant's Interest Rate Observer newsletter, offered a different take: "I think we might consider the problem to be not necessarily one of inherent deleveraging, but rather maybe the interplay between markets and governmental entities that wish to stop market adjustments." He said: "[T]he more dynamic an economy, the more free play is given to the price mechanism, the more markets are allowed to re-price errors fast. To that extent, we are closer to escaping this ever-so-dreary, gray threat of deleveraging and stagnation."

Nomura's Koo noted the competitive edge China appears to have so far in this economic recovery period. He said China, as a dictatorship, has been better suited to instituting massive, sustained stimulus than many democracies in the developed world. This places it, he says, in an increasingly more robust geopolitical position, with a confident, more nationalistic public.

Koo said: "After the Senkaku island problem with Japan, I'm beginning to feel that maybe the Chinese [believe] Obama is going to cut fiscal stimulus -- or the U.S. will cut fiscal stimulus, the U.S. will be weaker going forward, less aircraft carriers, less Marines; Japan the same thing, South Korea same thing." He said all of this could feed greater Chinese military assertiveness but added: "The solution to that is not to prod China to do some incorrect policies. The solution is for us to have the correct policies so that that kind of gap won't develop."

This series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

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