- Expert Roundup
- CFR fellows and outside experts weigh in to provide a variety of perspectives on a foreign policy topic in the news.
As 2015 dawns, the global economy is navigating choppy seas. Instability in Russia, stagnation in Europe, and uncertainty in China are being offset by a sharp drop in oil prices that the IMF says could boost growth by as much as 0.8 percent above the expected 3.8 percent.
The United States “faces a debt reckoning,” writes Guardian finance and economics editor Heidi Moore. U.S.-consumer debt worth $3.2 trillion and the resurgence of subprime lending are both danger signs for an economy that otherwise appears to be on the mend.
Europe, too, could face trouble in 2015 without major structural reform, argues CFR’s Robert Kahn. Growth and investment remain low, unemployment is “sky-high,” and early elections could once again put Greece “on a collision course with the rest of Europe.”
China, which is in the midst of a delicate rebalancing act, will de-emphasize GDP growth in favor of structural, financial, and energy reform, writes the Paulson Institute’s Damien Ma.
Finally, CFR’s Edward Alden foresees that 2015 could see “breakthroughs in global trade liberalization.” U.S.-led trade agreements with both Asia and Europe promise to boost growth, although they face significant obstacles at home and abroad.
The European Central Bank (ECB) has wielded a monetary policy bazooka—always on the table, but never fired—that has at times been the only thing standing between Europe and the abyss since the beginning of the financial crisis. ECB President Mario Draghi’s 2012 promise to “do whatever it takes” has restored calm and brought down spreads.
Yet growth remains inadequate to address large output gaps and sky-high youth unemployment. The outlook for next year is an uneven recovery with growth averaging just over 1 percent. Low inflation, large amounts of debt, and persistent financial fragmentation provide additional headwinds to growth.
Entering 2015, Europe faces a number of new challenges from both within and abroad. Popular discontent with austerity is growing and fueling rejectionist political movements, and with a number of elections on the calendar—including in Greece, Spain, Portugal, and the UK—there will be ample opportunity for voters to express their displeasure.
In this regard, Greece is once again in the vanguard. The odds are rising that early elections could bring to power the opposition Syriza party, whose platform—a comprehensive debt restructuring, a reversal of structural reforms, and fiscal expansion—would put Greece on a collision course with the rest of Europe. Less commented upon is a European Court of Justice report, expected as early as spring 2014, which could challenge the firefighting capabilities of the ECB to purchase sovereign debt. Such a ruling would risk sidelining the bank at a critical time.
At the same time, the standoff with Russia, combined with soft growth in much of the rest of world, means that external demand cannot be counted on to drive growth which in turn limits the benefits from a weaker euro. A sharp decline in Russian GDP—by at least 5 percent—and reduced investment and trade flows have clearly affected sentiment in the region. Receding hopes for a trade agreement with the United States (the proposed U.S.-EU Transatlantic Trade and Investment Partnership, or TTIP) could further dampen optimism.
To restart growth, Europe needs an all-of-the-above approach, including easier monetary policy, fiscal and structural reforms, and continued efforts to strengthen bank balance sheets. For its part, the ECB looks to be moving slowly toward adopting a program of sovereign bond purchases (like the U.S. Fed’s quantitative easing) that would boost its balance sheet by $1 billion in order to stimulate demand.
Finally, countries must implement long-overdue fiscal and structural reforms in the tax and labor realms. Without more assertive action in 2015, Europe will continue to disappoint its citizens—and the crisis could return.
Does anyone feel comfortable with the rise in debt over the past few years? It’s an overleveraged world, a fact which low interest rates and U.S. economic growth have papered over. But after the 2007–2009 financial crisis, we always look for weaknesses, and 2015 may be the year we have to confront debt again: first by refinancing or negotiating and then, if not, by revisiting the same lack of caution that led to the 2008 crash.
The reckoning will be tough for countries, companies, and consumers.
Economic growth is now slowing in Europe and China, and the receding tide is revealing some structural deficiencies. There are several major risks already emerging: A jolt to the system in the form of falling oil prices at the end of 2014 has exposed weaknesses in sovereign debt, like that of Venezuela, as well as the enormous number of energy companies who have relied heavily on the lowest-rated junk bonds—which make up 22 percent of the market for subprime corporate lending. Standard & Poor’s analyst Diane Vazza noted that the large debts held by oil and gas companies mean defaults are likely to increase in the coming year. This spells trouble for the banks lending to those companies, as well as for the rest of the economy, since data from Deutsche Bank show that the energy sector accounts for one-third of all capital expenditures in the S&P 500.
There are other weaknesses lurking as well. Vazza’s research, which focuses on potential corporate defaults, found that potential downgrades to corporate bonds far outnumbered potential upgrades in a key sector: finance. Banks are hungry for profits, and Congress has passed a budget that would once again allow banks to use the savings of ordinary Americans to back swaps and derivatives trading. The result will likely be more risk-taking from banks. If they have learned to manage that risk, then we have nothing to worry about. But unfortunately, fallibility is the general rule. The challenge will be making sure that this extra risk does not blow up for the second time in a decade.
Consumers, too, are facing a debt reckoning. Even though U.S. households have been paying down debt—and now actually owe less than they’re earning—there is still $3.2 trillion of consumer debt outstanding. And much of that debt is student loans (more than $1.2 trillion), which have a particularly high default rate of 14 percent. At for-profit colleges, the rate is even higher, with one in five student loans in default. Subprime auto loans, too, have followed the same pattern as home mortgages did in 2005 and 2006: Lax borrowing standards have created a great big engine of securitization. The result is that one-third of all auto loans are now subprime. In the past year, securities backed by auto loans came within reach of their 2005 peak value of $108 billion.
In other words, we’ve seen this movie before—but it doesn’t have to have the same ending. Excessive debt remains a challenge, but with care and forethought it can be prevented from shutting down the world economy once more.
As China hops into the Year of the Goat in 2015, it is shaping up to be a year of transitions. Once a high-octane growth machine, China is now shifting into the so-called “new normal” gear of development, in which topline GDP will be deemphasized. In addition, 2015 marks the end of the twelfth Five-Year Plan (FYP) cycle and the beginning of the thirteenth, which ends in 2020—the year by which the country is supposed to have become a “moderately well-off society.”
These themes were echoed loudly at December’s Central Economic Work Conference, an annual high-level meeting that determines policies for the following year. This year’s conference intended to prepare Chinese policymakers and citizens, as well as markets and investors, for the prioritization of structural reform over growth. To reinforce the new paradigm, Beijing is likely to set a growth target of around 7 percent in 2015, down from 2014’s 7.5 percent, while emphasizing other indicators such as employment and social welfare.
Similarly, macroeconomic policies will favor economic reforms over stimulating growth. Relatively tight, though flexible, monetary policy and an increasingly liberalized exchange-rate regime could mean more fluidity in the yuan’s appreciation and depreciation. In contrast with Tokyo, however, Beijing has little reason to drastically depreciate its currency to support exports. In fact, top leaders are keen to promote imports as well as outbound capital flows. Beijing will preempt a collapse in growth with targeted fiscal policy and restrained liquidity tools rather than extensive stimulus. These policies could support new areas of growth in services and other high-value added industries.
Next year will also be crucial for forging ahead with financial reforms announced at the Third Plenum in 2013. For starters, China is likely to implement an explicit deposit insurance. Deepening integration of Chinese stock markets with global markets will continue as well, a process launched in 2014 with the Shanghai-Hong Kong Stock Connect. And more competition will be introduced into the finance sector, with regulators’ December approval of WeBank, a private bank backed by Chinese Internet giant Tencent.
Finally, expect a last-ditch effort to meet China’s energy and carbon targets. The emphasis that the top leadership has placed on meaningfully addressing environmental costs should not be taken lightly, and heavy industry and coal producers will face another tough year. Indeed, as policymakers prepare to unveil the next five-year plan, the new economic blueprint will strongly inform China’s path toward “peak carbon” by 2030. Supporting an energy transition will be crucial for China’s position entering the 2015 climate talks in Paris and beyond.
The coming year could see the biggest breakthroughs in global trade liberalization in more than two decades. It could also produce some of the most spectacular failures. After years of modest accomplishments and repeated setbacks, 2015 looks to be a turning point for trade.
The United States is currently engaged in two of the most ambitious trade negotiations in history. The Trans-Pacific Partnership (TPP) would free up trade with eleven Asia-Pacific countries, including Japan, while the Transatlantic Trade and Investment Partnership (TTIP) would eliminate most remaining trade and regulatory barriers with the European Union. Despite the complicated nature of the multilateral talks, the United States is pushing hard—the Obama administration wants TPP completed and ratified by Congress by the end of 2015. The U.S.-EU trade deal is on a slower track, but both sides are seeking a deal before the 2016 U.S. presidential elections.
Skeptics will recall, of course, that the TPP agreement was supposed to be signed in 2014, and that TTIP was scheduled to be in the final negotiating phase by now. But trade negotiating is a lot harder than it used to be. The World Trade Organization’s Doha round of global talks has been in progress since 2001, but only produced its first agreement, the so-called “Bali package,” in 2013. Meanwhile, big developing countries like China, India, and Brazil have matured into global players in their own right, making it harder to reach deals than it was when the United States and Europe called most of the shots. And among the advanced economies, little low-hanging fruit remains—the trade barriers that persist (in agriculture, for example) are the most fiercely defended by powerful domestic interests.
There are signs of promise. Prime Minister Shinzo Abe’s resounding victory in Japan’s snap election could give him the political capital to make tough concessions in areas such as agriculture and automotives. Elsewhere, the United States and China have agreed to lower tariffs on technology-intensive goods as part of an effort to update the 1996 Information Technology Agreement (ITA).
But obstacles remain, including U.S. domestic politics. The Obama administration will need congressional support in the form of Trade Promotion Authority (TPA), or “fast track” legislation. Republican control of Congress starting in 2015 makes TPA passage more likely, but the effort will continue to face strong opposition from Democrats as well as from some within the GOP. Then there are the civil society concerns: U.S. labor unions are unhappy with the administration for failing to address their priorities, such as currency manipulation, in the TPP, while environmentalist and consumer groups on both sides of the Atlantic fear that TTIP will strengthen corporate rights and weaken health, safety, and environmental standards.
With so many moving parts, both domestically and internationally, the outcomes of the TPP and TTIP negotations are far from certain. But whether in success or failure, trade will be a top foreign policy issue around the world in 2015.