Tsunami comes to Davos

“Words fail me,” said Swatch Chief Executive Officer Nick Hayek speaking yesterday, “Today’s SNB action is a tsunami; for the export industry and for tourism, and finally for the entire country.” Hayek was referring to the decision of the Swiss National Bank (SNB) to drop its peg or cap of the Swiss franc with the euro. The SNB had been fixing the exchange rate of the franc at 1.20 to the euro. It was doing this to try and keep Swiss industry competitive with the rest of its Eurozone competitors in France, Germany and Italy. But international companies, financial institutions and investors wanted to hold their cash (ill-gotten gains?) in Swiss francs, the epitomy of safety, so money kept flooding in from euros and other currencies into the franc. The only way the SNB could dam this flood was by using its FX reserves to buy euros as fast as investors bought Swiss francs.

But this meant that the SNB was building up a huge stock of euros on its balance sheet and the euro was still losing value against other currencies. Its stock of euros reached 80% of Swiss GDP. When it became clear that next week the European Central Bank was going to start printing huge amounts of euros to buy Eurozone government bonds in order to weaken the euro even more in an attempt to make France, Germany etc even more competitive in world export markets, the SNB decided that it could not hold the dam anymore, let it be breached and the tsunami came.

The Swiss franc appreciated against the euro by over 30% in a few hours before settling back to a 17% rise. This is a catastrophe for Swiss companies, especially relatively small ones that make their money in euros rather than dollars. Hayek’s company, Swatch, the world’s biggest maker of Swiss watches, dropped 17% in value. Holcim, the world’s biggest cement maker, slid 13%. Even Nestle, the world’s largest food company, which gets about 98% of its revenue from outside Switzerland, declined as much as 11%, the biggest intraday drop in more than 17 years.

The SNB will try to stem the purchase of Swiss francs by investors by charging to hold deposits in Swiss banks. In other words, if you want to have Swiss francs, you won’t get any interest on your deposit; on the contrary, you will pay up to 1.5% a year to the bank for the privilege! This is unprecedented in post-war banking.

The Swiss action is a barometer of the growing deflationary pressures on the major economies. As IMF director general Christine Lagarde put it yesterday, global growth was “still too low, too brittle and too lopsided”. There was a risk, she added, of the Eurozone and Japan getting stuck “in a world of low growth and low inflation for a prolonged period”.

Next week, the global corporate chief executives and politicians meet in the Swiss ski resort of Davos for the annual jamboree where the great and the not-so-good discuss the key problems of world capitalism and strategies for dealing with them. Last year it was inequality and the need for emerging economies to close the gap with advanced economies. This year it is going to be the spectre of deflation and continued slow global growth. The Swiss franc tsunami will concentrate the minds.

The consensus continues to rely on the US economy to lead the way out of the Long Depression. Last week the World Bank cut its forecast for global real GDP growth – yet again. The bank forecast the world economy will grow 3.0% this year and 3.3% in 2016, down from its earlier forecast of 3.4% and 3.5%, respectively. Indeed, this lower forecast relies on the US growing faster than the 2.5% rate in 2014, or 3.2% in 2015.

But it made the point that supposedly stronger US economic growth this year would be unable to compensate for slowing growth and deflation elsewhere; in the Eurozone, Japan and the major emerging economies of Russia, Brazil, China, South Africa and Turkey (only India might grow faster this year).

Global growth reduction

World trade growth continues to fall well behind trend before the Great Recession.

Global trade

The so-called emerging economies are running well below their full potential, according to the World Bank.

EM gap

The slowdown in China threatens to push the economy into deflation there too.

China deflation

A new report by the IMF shows that, while global unemployment is finally back to levels seen before the global financial crisis, global employment is growing at just 1.5% a year, far slower than the 2.0-2.5% growth rate seen before the crisis.

Global unemployment

The new report shows a striking divergence between advanced and emerging economies. Unemployment in advanced economies stood at 7.4% in 2014, far higher than the 5.7% seen in 2007. The Eurozone is largely responsible for that elevated level, with most economies other than Germany struggling to regain ground. And the report clearly underestimates unemployment in the major emerging economies, which is likely to rise during this year, as Russia and Brazil go into recession; and China, Turkey and South Africa slow.

As Mohammed El-Erian, the guru of bond fund managers, put it, the optimism likely to be expressed in Davos is based on some doubtful assumptions: faster US economic growth, no more tsunamis for corporations like that with the Swiss franc, and a stop to the slide into deflation as energy prices drop.

The flood of credit injected into the major economies since 2009 to kickstart economic recovery and return to sustained trend economic growth has failed to do so. The ECB and the Bank of Japan are planning more credit injections, while the US Fed has stopped and now wants to tighten credit and ‘normalise’ interest rates. Global monetary policy is thus at sixes and sevens because of the low and imbalanced rate of growth.

Most important, the hopes of Davos attendees that the US will lead the way are likely to be dashed. All the very latest data from the US suggests that the economy has slowed considerably from its apparently fast pace in Q3 2014 (see my post,
https://thenextrecession.wordpress.com/2015/01/11/the-spectre-of-deflation/).  The US inflation rate, out today, fell to just 0.8% in December.
The US will be unable to hold up the world like Atlas. A deflationary tsunami is weighing it down.

PS don’t forget my facebook site at https://www.facebook.com/pages/Michael-Roberts-blog/925340197491022

11 Responses to “Tsunami comes to Davos”

  1. Daniel Rocha Says:

    Dear Michael,

    I have to bug you a bit, sorry,… the data on Esteban’s paper is not the same as the graph you posted in the other the rate of fall. There is no graph there with the spike around 1905-1910, from 30-45%, neither in the data presented at the end of the paper.

    Are you sure that’s the paper? I still cannot figure out the problem of the spike.

    • michael roberts Says:

      Daniel – The graph I used is Maito’s simple mean world average rate of profit. The data for this are not in Maito’s statistical appendix to his paper but only in his work spreadsheet sent to me (sorry I forgot that). There is a divergence in the world simple mean ROP from his measure of core ROP because, from 1910, Maito includes Argentina in his world average while the Netherlands and Germany drop out temporarily because of the war. This provides a biased upward spike during WW1. That’s probably unreasonable and maybe the core ROP should only be used for war period, which as you point out, does not have a spike from 1910-16 but merely a consolidation, similarly with the UK ROP at that time. After 1916 the trends in the simple mean world ROP and the core ROP are much the same, so the WW1 anomaly becomes irrelevant. Maito does not use a weighted world ROP until 1955 when there are many more countries in the data. I shall try and post the excel spreadsheet on my blog so you can pick it up. I am working on a revised world rate of profit using different sources to see if it confirms Maito’s work. I hope to complete that by the summer or earlier. I still think the simple mean average is useful in the early 20th century because it provides some contribution from EMs in the world average, if biased. Maito is more cautious by excluding that data from his published paper.

  2. Charles A Says:

    What good does it do the people of Greece to stay in the depressed Eurozone? The population of Greece is about the same as that of Cuba, certainly more than Cuba when its people liberated themselves from Batista and U.S. imperialism.

    The knot of problems in the Eurozone makes it even more difficult to believe that Syriza can keep Greece in the zone, promise Eurocapital a balanced budget, yet somehow zig and zag toward a better life for the people.

  3. Mike Ballard Says:

    I’m wondering how much of a problem deflation is going to be for the working class. With productivity increasing every year, lower values for commodities should translate into lower prices for commodities, other than natural resources in high demand and scarce availability. I’m thinking that lower prices for commodities will be not be met with much sadness by workers who are having their wages pushed down by the ever powerful employing class.

    • jeff Says:

      Deflation makes existing debt more expensive, which is terrible for investment and consumer spending.

      • sartesian Says:

        Deflation does not make debt “more expensive.” Deflation may cause interest rates to decline… as it has since 2008.

      • jeff Says:

        Um, yes it does. Not much controversy about this, either.

        The principal on debt doesn’t change even when prices and wages decline. Overall debt therefore effectively increases.

        On the flip side, that’s why some (even in the IMF) are calling for central banks to have targeted inflation above 2%.This might help inflate away the debt load in the West.

      • sartesian Says:

        Wages, and prices may decline, with the net impact being an increase in the real wage. This is exactly what happened during the long deflation after 1873 in the US. Wages declined dramatically over the next twenty years or so, but real wages showed an increase as the prices for housing, food, and clothing, declined more steeply than the wage.

        The impact of interest rates declines on consumer debt is not quite as straight forward as you make it out to be. . The “cost” of the debt is not measured by one’s ability to pay it.

    • sartesian Says:

      The problem with “deflation” is simply a particular iteration of the problem of profitability. So we have plenty of experience with that, none of it “good” for workers. A rich man can always get through poor times better than a poor man.

  4. Warren Says:

    Thank you Michael for this analysis. I’ve read many other sources (FT, Guardian, NYT, etc) trying to work out what was going on with the surprising Swiss decisions, and what effects they might have. None I read had the clarity and succinctness of this blog.
    Cheers.

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