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Thursday, July 08, 2010

Croatia: On The Brink of What?

As Croatia enters the final stage of its EU membership talks, it is perhaps a fitting moment to review the other half of the picture, namely where the Croatian economy finds itself, and what the outlook might be for a continuing convergence with the requirements of Euro membership. Understandably, EU officials are fairly cautious about the likely shape and progress of the forthcoming talks (the Union has, after all got rather a lot on its plate at the moment), but Croatian Prime Minister Jadranka Kosor is decidedly more optimistic, since while she recognises that this last phase is likely to be "really difficult and demanding" she still believes that negotiations could be concluded by the end of the year, which would mean that membership in 2012 would become a possibility.

Whatever view you take on the likely progress of the talks, one topic on which it is hard to be optimistic in the short term is outlook for the Croation economy. Despite the fact that the country may not have too many difficulties complying with the original Maastricht Euro membership conditions, the newfound interest among those responsible for EuroGroup decisions for sustainability and longer term competitiveness mean that a country whose economy has as many structural distortions in it as Croatia’s does may well find a growing number of new obstacles thrown across its path.

Reeling Under The Shock

Unsurprisingly, the global economic and financial crisis have taken a significant toll on the Croatian economy. Given the background of a large current account deficit, a high level of external debt, and significant balance sheet exposures to interest and exchange rate risks, the pressure from reduced capital inflows was always going to cause problems, and it did: financial asset prices collapsed, sovereign spreads shot up, and the Zagreb stock market plunged.

As a result of the combined impact of the difficult external conditions which prevailed and the ending of the domestic credit boom Croatia’s GDP fell by some 5.8% in 2009, following a number of years of strong (if not sustainable) growth. Even though in the first three months of this year there were been some tentative signs of recovery the economy was still down by 2.5% on an annual basis.

Personal consumption fell by 4.1%, which was not surprising given that new credit has all but dried up, but more worryingly the drop in fixed capital investment accelerated to an annual 13.9% during the three month period. Government consumption fell for the third consecutive quarter and was down by 1.1%, and the only positive point was the net trade impact, since the export of goods and services rose by 3.6% (following five consecutive quarters of decline) goods and services imports fell by 4.8%.

Exports The Only Realistic Way To Pay Down The Debt

Given the high level of external indebtedness of the Croatian economy (net external debt is currently running at around 95% of GDP) and the sensitivity of the financial markets to fiscal deficits, there is likely to be little in the way of a revival in domestic demand, depending as it does on the availability of credit.

Which leaves exports to pull the cart. But this is where the high level of euroisation of the economy becomes a problem since obtaining export growth after many years where the country has run a substantial trade deficit is hardly going to be easy.

In fact financial euroization even increased during the crisis, and at the end of 2009 about 70 percent of the total bank credit and over 65 percent of bank deposits were either denominated in or indexed to foreign currency. As the IMF note in their latest report price and cost indicators suggest that competitiveness has been deteriorating in recent years and Croatia’s real effective exchange rate is surely overvalued. Yet all those Euro denominated loans make it very difficult for the authorities to contemplate outright devaluation of the kuna, while the prospect of having to manage an internal wage and price correction is hardly an attractive one, as we can see in the Latvian and other cases.

Croatia’s unit labor costs have risen significantly faster than those of its principal trading partners in recent years, due largely to the fact that wages in the private sector were pushed up by rapid wage growth in the public sector. As a result, the overall wage level is high relative to Croatia’s productivity following non-competitive wage setting in a public sector which employs around a quarter of the labor force, not counting public enterprises.

As the IMF note, rigidities in the Croatian economy are substantial, with strong labor regulations constraining labor market flexibility, resulting in high employment in the gray economy, a proliferation of temporary work contracts, both of which reduced employers’ incentives to expand employment during the boom years. The impact of the grey economy is clearly reflected in the disparity between the official unemployment rate (of around 19%) and the EU harmonised one accepted by Eurostat (which shows unemployment to be nearer 10%).

And Then There's Population Ageing To Worry About

Another factor to be taken into account is the rapid ageing of the Croatian population, following many years of very low fertility, and a steady increase of life expectancy. Croatia’s working age (16-65) population peaked in the early 1990s, and is now in long term decline, while the old age dependency ratio is set to rise and rise. Indeed about a quarter of Croatian population are now retired, a fact which also reflects the presence of relatively generous pension and social benefits conditions, benefits which were available during the years of increasing borrowing, but which are surely now hardly sustainable as the time comes to pay back some of the accumulated debt.

Looking ahead to the remainder of 2010 the contraction will most likely continue. The IMF forecast in April a miniscule 0.1% growth, but since that time optimism for the global expansion has waned, and in particular demand from many of Croatia’s trading partners is likely to be more muted than anticipated. Investment is unlikely to recover its earlier momentum, burdened as it is by an indebted private sector and a public sector looking to make cut-backs. Private consumption will also remain under the influence of the contraction in consumer credit. While exports should remain supportive, with imports continuing to remain low given the weak domestic demand, goods trade exports may not be as strong as some expect given the weaknesses in the European recovery, while tourism may well be affected by the high levels of unemployment which still exist in many of the relevant countries. Rising fiscal concerns will only add to the slowdown of the EU recovery (given the negative demand impact of the harsher fiscal policies) so a contraction of between 1% and 1.5% in 2010 does not seem unlikely.

In addition Croatia remains vulnerable to contagion risks from adverse market sentiment in the region. This contagion could take the form of tightening financial constraint such as a rise in borrowing costs, or a reduction in cross-border flows. On the other hand the absence of Greek banks in Croatia and the limited real sector linkages with Greece should minimize the risks of direct spillovers from that quarter. The real threat would come from a more generalised crisis across the EU’s Southern and Eastern periphery.

On The Brink Of What?

So, after living for many years on borrowed money and borrowed time, running a significant current account deficit and accumulating a large external debt, Croatians are now likely to be faced with the harsh reality of living in a rapidly ageing society at a time when external competiveness has been severely undermined.

In the short term the economy may have stabilised, but in the longer term the challenges are immense, and should not be underestimated. Like many economies across Eastern Europe, Croatia is going to have to straighten out the structural distortions and pay down its external debt at just the time the oncosts of societal ageing are going to start to bite deep.

In addition a rigid labour market and an overweight public sector pose serious problems for the transition to a dynamic and competitive economy. Many changes are needed, and most Croations are only all too well aware of this fact. But one factor which doesn’t seem to get the attention it deserves is the continuing threat to long term economic stability posed by having such a low (tfr 1.4 – or only two thirds of replacement) birth rate.

To make matters even worse, the wage differential with Croatia's West European neighbours means it is an attractive proposition for many young people to go abroad to work, and while the remittances all those migrant workers send back may be very welcome back home - especially given the difficulties Croatian industry has in selling abroad - a country with fertility well below the replacement rate should not be exporting labour to pay down a current account deficit. The way to settle the debts is to provide work in export industries so people will stay at home, and contribute to the maintenance of the health and pension systems.

Like most societies in Eastern and Southern Europe the Croatia needs to address this other imbalance, and it needs to start to do so soon, since the clock is ticking, and it won’t stop doing so. At this key moment in the country’s history it is hardly difficult to recognise that Croatia is effectively on the brink of something, but whether that something is going to be long term sustainability rather than something that it is better not to think about, well, the answer to that question can only be given by the Croatians themselves.

Sunday, April 18, 2010

Is Estonia's Euro Membership A Done Deal?

Well, if you read this report from Euractiv, citing unnamed EU Commission officials, it is:

"If nothing extraordinary happens, the Commission will give its positive opinion for the accession of Estonia to the euro zone on 12 May," an EU official said, clearing the way for Baltic country to join the euro in 2011.

There just one little snag here: that extraordinary, "fat tail" event seems to have just happened. For the Commission to be able to move forward on Estonia's Euro Membership, the ECB have to agree. And it is here that Estonian journalist Mikk Salu steps in (in Estonian in the newspaper Eesti Päevaleht, summarised in English here) and says "not so fast". Salu reports on a closed-door meeting of the Economic and Monetary Affairs Committee of the European Parliament held last Tuesday (April 13). The meeting had a single-item agenda: Estonia's membership of the Eurozone, and the meeting was attended by ECB Executive Board member Jüergen Stark. According to MEPs who attended the meeting (but did not wish to be identified), Stark was "stark": Estonia is not going to be admitted. The reason given was that in the wake of the recent crisis affecting the Eurozone, new criteria will be introduced - including per capita GDP and competitiveness sustainability - and on these counts Estonia will not qualify.

Salu also spoke to Estonian MEP Ivari Padar, who attended the meeting and confirmed the substance of the discussion, although Padar did try to mediate the situation slightly, saying, "you know, he is a central banker, and central bankers are a conservative lot", etc etc. On phoning the ECB itself and the Commission the only reply he got to a straight question seems to have been "no comment".

Basically, as I said, maybe the ECB are a conservative crowd, but I think it is very hard to see Estonia being admitted to the Euro without ECB backing, and indeed looking at what is happening over in Greece at the moment, and in the German Constitutional Court, I think it is very hard to see any new members at all in the immediate future. Consensus thinking right now seems to be more towards small(er) is more beautiful.

None of this surprises me, indeed when I wrote my last post on Estonia, back in February, it seemed to be an increasingly likely outcome.
But as Fitch pointed out when they raised their Estonia outlook, while eurozone membership looks increasingly possible it is not yet certain. Fitch warned in their report that even if Estonia meat all the formal Maastricht reference criteria for euro entry there is still a risk that the European authorities' interpretation of these same criteria could lead them to reject Estonia's application. According to Fitch, in Estonia's case uncertainty surrounded whether the idea of "sustainable price performance" was going to be consistent with the deflation which is to be expected from such a severe recession, after inflation had so recently been in the double digit range. The agency also added that one-off measures taken by the government to reduce the budget deficit in 2009 could also count against it in the EU authorities' judgment of whether the medium-term budget plans are credible.

The first point is an important one I think, and is reiterated by the ECB's own Jürgen Stark in an interview given to the German magazine Der Spiegel for this weekend: "But when taking on board new members, we will need to take an even closer look, concerning the data and the sustainability of convergence," he is quoted as saying.

Indeed if we go back to the 172 page EU Commission document leaked to the German magazine Der Spiegel last month, the EU Stability and Growth Pact is increasingly going to focus on issues surrounding competitiveness as well as on fiscal deficit ones. That is what the whole deabate over the Greek and Spanish economies which EU leaders are engaging in this week is all about. And any country which is not considered to be in completely good health under the SGP criteria is hardly likely to get the green light from the ECB and Ecofin.

It is obvious that the Estonian economy is still suffering from earlier structural distortions which have not yet been corrected. If we come to the consumer price index, this was only down about 2% in 2009, far short of the deflationary adjustment which will be needed to restore growth and competitiveness.

And to cap it all, for the first time since the start of the financial crisis, Moody's has chosen this, of all, moments to up its ratings outlooks for Lithuania, Latvia and Estonia. The decision was apparently based on the idea that the contraction has been stabilized (which it has), but as we are unfortunately about to see, stabilization and getting back to growth are not one and the same thing. In Estonia's case the more favourable rating was a reflection of the expectation that the country "will soon be able to join the eurozone":

Estonia’s “economy and banking sector are exhibiting signs of a gradual recovery,” Kenneth Orchard, a Moody’s analyst in London, said. “Equally important, the government’s impressive fiscal performance in 2009 means that Estonia is likely to be permitted to adopt the euro next year.”

And if I'm reading this report aright, Latvia just declared a 9% general government fiscal deficit for 2009, well above the 6.7% which was originally estimated. Cry victory if you will, but perhaps it would be prudent to wait till the war is actually over before you cry it too loudly.

Lies, Damn Lies And Statistics In Sweden (of all places).

This post is basically a follow-up to my earlier Just What Is Going On In Sweden? one, and has been stimulated by an article which appeared in Bloomberg earlier in the week, detailing a number of issues which have arisen in conjunction with the Swedish Statistical Office.

The Story So Far

Basically, most of us were, I imagine, pretty shocked to learn at the start of March that Sweden had unexpectedly fallen back into recession in the fourth quarter of last year: we were shocked not only because the news in itself was bad, but also because we had been under the impression that the Swedish economy was recovering nicely. Yet despite all our prior expectations the Swedish statistical office reported that gross domestic product contracted by a seasonally adjusted 0.6 per cent in the fourth quarter of 2009 (when compared with the previous three months), while, in addition, the third-quarter figure was revised to a 0.1 per cent quarterly decline (down from an original 0.2 per cent gain). And two consecutive quarters of contraction meant that, technically speaking, Sweden was well and truly back in recession.

Faulty PMI Readings

But there was more, since if those of us who had been following the performance of the Swedish economy were more astonished than surprised, it was because the Silf Swedbank manufacturing Purchasing Managers Index had been showing not only robust growth for Sweden's industrial sector, but even suggesting it had been experiencing one of the fastest rates of expansion on the entire planet (and for several consecutive months, see chart below).

Yet far from expanding, Sweden's manufacturing industry has now been stagnant, and for many months. At least according to data supplied by the Statistics Office to Eurostat (see chart below) it has. Of course, maybe the data the Stats Office has collected about manufacturing output is faulty, but looking at the GDP numbers that seems unlikely, unless of course even the revised GDP numbers need revising...

Yet Another Shoe Drops

And just to show that concerns about the kind of data we have been seeing out of Sweden of late are not unfounded, we have the case of what Cecilia Skingsley, head of macro research Swedbank calls the "shoe adventure". Basically, and as Bloomberg reports, when the Riksbank raised interest rates in September 2008, 11 days before Lehman Brothers collapsed, Sweden's central bankers based their decision on inflation figures from the Statistics Office. Unfortunately, later that month four months of inflation data had to be corrected after the Office discovered that a computer inaccurately calculated a 28 percent increase in shoe prices (although the problem, I imagine, lay with the person who entered the data, rather than a malfunctioning computer). As Cecilia Skingsley points out, apart from the impact on central bank monetary policy, “The shoe adventure meant we ended up with a different price base amount, which in turn affected benefit payouts.” In fact Bloomberg estimate that the mistake cost the government something over 600 million kronor ($84 million) in excess benefit payouts.

Statistics Sweden boasts a proud career which dates all the way back to 1686, when a church law became the basis for the Swedish population census. It released 74 publications last year and 371 press releases, cataloging everything from how many moose are shot annually, to the number of Swedes that are named after a Christmas tree ornament. But for all its venerable history, the office (which employs 1400 people) has evidently seen better days, since over 10 percent of 71 statistical reports published in February and March were corrections of earlier data releases.

And it isn't only the inflation and GDP data which has been causing problems, Figures for local government finances were corrected last month to a deficit of 2.2 billion kronor from a surplus of 2.4 billion kronor. The Swedish government uses these figures to draw up its annual budget.

Another area of contention revolves around central bank rates and home mortgages. The Statistics Office had to correct on Feb. 25 its estimate for the proportion of Swedish households with adjustable-rate mortgages, revising the time series as far back as far as September 2005. The figure for December was adjusted to 58 percent from 48 percent. The revision prompted speculation the Riksbank may have forecast higher-than-necessary interest rates at its February 10 meeting.

All these issues are rather serious, even if some are more important than others, and certainly go to show that statistical issues in Europe extend well beyond those we have seen in the recent highly publicised Greek case. Bloomberg cite many analysts who are rightly angry about the current state of affairs, but let me add my own personal beef about Swedish statistics here: the lamentable state of the SILF Swedbank PMI readings has lead me to suspend Sweden from my monthly global manufacturing report. Quite frankly this sort of faulty measurement only fuels the (largely unjustified) scepticism which tends to surround this kind of qualitative performance measure, yet from what I can see Markit Economics country reports are, by and large, reliable within a reasonable margin of error. Which only makes the Swedish case stand out further, and makes it, at least for my part, incomprehensible that Swedbank haven't felt the need to make some sort of correction/statement on the topic.

China's Recent Trade Deficit: Is What You Yuan What You're Gonna Get?

China is self-evidently both a minefield and a potential graveyard for would-be global economists, the sort of place where reputations are made and lost in the twinkle of a dragon's eye, so I think had better tread rather carefully here. However, having duly noted that only fools rush in, here I go...

China ran its first monthly trade deficit in six years in March, a development which encouraged the country's Commerce Ministry to up the volume a bit on the argument that the need to revalue China's currency was being greatly exaggerated. The debate surrounding renminbi revaluation has also given us one more reason - beyond the recent accusations of the US SEC - to cast a watchful eye over how things are done at Goldman Sachs: the outrageous suggestion from their Chief Economist Jim O’Neill (in this Financial Times article) that if things carry on as they are, China will soon overtake France as the principal destination for German exports (see in depth analysis below).

The problem is, that with the argument having become so politicised, and with so many different interested parties at work, it is fast becoming hard to see wood from the trees, or even the sandals and tee shirts from the high speed trains.

A One-off Deficit?

Looking through the data, it would appear that while China's March performance was undoubtedly a one-off, import growth has been outpacing export growth for some months now. And with imports of commodities surging, and with them commodity prices, it was not really that surprising to find that China swung into a trade deficit of $7.24 billion in March, from a surplus of $7.61 billion in February, according to figures issued by China's Customs agency. Overall imports were up 66% from a year earlier in the moth, with purchases of crude oil and copper at near-record levels in volume terms.

In fact Chinese officials had been signalling for some weeks that March could produce a rather exceptional trade deficit, a development they highlighted to show how China's strong growth has been boosting its purchases from other countries. But beyond the March reading, China's trade surpluses have been shrinking as the government stimulus plan, and extensive bank lending, have boosted domestic demand, and indeed the cumulative trade surplus for the first quarter of 2010 fell 77% from a year earlier to hit $14.49 billion.

On the other hand, according to the Chinese customs department, the March deficit mainly comes from trade with Taiwan, Japan and South Korea, while large surpluses continued with the U.S. and the European Union.

Evidently one month's data is unlikely to convince anybody, and especially when there is so much doubt surrounding the sustainability of China's domestic consumption growth, so the March data is surely unlikely to silence the deafening roar of international criticism of China's trade policies, and indeed European voices are now increasingly being added to US ones.

Evidently March's exports may well have lower than normal as factories took their time reopening after the February Lunar New Year holiday. Exports were up in March, but the rate of increase fell to 24.3% from a year earlier, as compared to the 31.4% annual growth registered in the first two months of the year, although it is hard to tell how much of this weakening was a Lunar New Year effect, and how much the development reflected domestic demand weaknesses among China's main customers.

Looking at the trade balance chart (above), it is clear there is normally a dip in February/March, and this year we may have simply seen an exaggerated version of what is really an annual phenomenon. Certainly, till we see a bit more data it will be hard to separate a stimulus-based surge from the trend.

China: The New Import Powerhouse?

Separating surge from trend however does seem to have turned into something of a problem for Goldman Sachs Chief Economist Jim O’Neill, since he argued recently (in a widely quoted piece) that:

"As far as China’s involvement with the rest of the world goes, the real story since the worst of the crisis is not China’s recovering exports but China’s strong imports. The forthcoming trade release – interestingly due a few days before the Treasury report – is likely to demonstrate enormous import growth again, absolutely and relative to exports. This is seen not just in Chinese data, but in those from many other important trading nations. Indeed, quite remarkably, Germany’s trade with China is showing such strong growth that by spring next year, on current trends, it might exceed that with France".

This is quote a claim, and evidently impressed both Tyler Cowan at Marginal Revolution, and the Economist Free Exchange Blog, since they quote precisely this extract in support of their argument that the threat to global economic stability represented by China's trade surplus is being rather overdone (which may or may not be the case), and they obviously take his China overtaking France claim as good.

As a student of German export performance, I however did not. The most important point to bear in mind is that Germany basically missed out on the first wave of China import growth (with the market being largely dominated by Japan). To give an indication, in 2008 German exports to the Czech Republic and to China were of about the same order of magnitude, a data point which is reasonably suggestive of the extent to which German export growth 2005 - 2008 was dependent on growth in Central and Eastern Europe (both inside and outside the EU). Growth in this market has, of course, now come screeching to a halt, hence the renewed German interest in China, and in general terms, non-European export destinations - which is one reason why, at the end of the day, the sharp drop in the value of the Euro has been as much to Germany's advantage as it has to that of any other Eurogroup country.

So the key point to note is that German exports to China started from a comparatively low base, and hence even a sudden sharp surge does not make that much of a dent in the rankings list.

So just what are the facts? Well, according to the most recent release from the German Federal Statistical Office, German exports to China were worth 36.5 billion euros in 2009. Which means that, compared to 2008, exports to China were up around 7%, while total German exports declined 18.4% during the same period. So evidently the importance of German exports to China has been growing, but nothing like as much as O'Neil claims. Really!

Given that German exports to China have been running at something like 40% of exports to France, I thought I would take a look at the actual data. There are two available sources for such information: the German Statistics Office, and the OECD. Here is will use the OECD data. As can be seen in the first chart, there can be no doubt that German exports to China have been growing steadily and impressively over the last 3 years, but it is equally evident that they are still well, well short of those to France, and by no stretch of the imagination could it be thought feasible that China will overtake France as an export destination in the near future.

The second chart puts things in a longer term perspective, and what stands out is the fact that while German exports to China have followed a steady path, while those to France slumped significantly in 2008 as a result of the global economic crisis. So what this means is that exports to France are unusually low (and thus it is impossible to talk of trend), while those to China are unusually (and possibly unsustainably) high, given the impact of the stimulus programme. So to extract his "trend" (which is in no case valid) Goldman Sachs' Chief Economist seems to be assuming a worst case scenario for France and a best case one for China: hardly a balanced methodology. Or does Jim O'Neil really want to tell us he is discounting the possibility of a sustained recovery in demand in the OECD economies? Even without the benefits of our own "proprietary indicators", simple testimony of the naked eye should tell us he is wrong here.

Which is a pity, since stripped of its exaggerated claims, his substantive argument may not have been entirely false. Also we should not forget that Germany imports Chinese products (55.4 billion euros worth in 2009, as compared to the 36.5 billion euros worth of exports), and ran a trade deficit of 18.9 billion euros last year (or roughly 50% of the total value of exports) while Germany ran a trade surplus of some 27 billion euros with France.

Whatever You Yuan

In fact the impact of a revaluation in the renminbi may be much more complex than many seem to be assuming, and one good example of the kind of perverse consequences we may see is offered us in a really interesting research note from Alexandre Schwartsman (Bank Santander, Brazil) entitled "What Do You Yuan?"
There is an ongoing debate about how China should handle its currency in face of both political pressures and signs that inflation may be accelerating. Such challenges raise the possibility of the resumption of yuan appreciation trend that prevailed between 2005 and 2008. Of course, we claim no special knowledge on whether or when Chinese authorities will decide on the issue, but in our opinion, eventual decisions on that could have considerable implications for Brazil.

We do not think, however, that the direct effects through the trade channel are the most important part of the story. While it is true that China has become the largest market for Brazilian exports, we rush to note that it still represents only 13% of Brazilian exports (which, in turn, are equivalent to about 12% of Brazilian GDP). Moreover, even its current status as the main customer for Brazilian exports is threatened at the margin by the recovery of exports to the U.S. and Argentina.

Indeed, we believe the main channel of transmission to Brazil is likely to be through commodity prices. We argue, with the help of a small theoretical model, that a stronger yuan should imply higher commodity prices in dollar terms. In fact, it is possible to show that, if dollar commodity prices do not change in response to a stronger yuan, there would be excess demand for commodities, which would eventually drive their dollar prices up.
The economic intuition which lies behind Schwartsman's argument is really very simple, but the logic is also quite compelling. Basically, it depends on two points:

i) China domestic demand growth is more energy intensive than the OECD average
ii) China is large enough to be (to some extent) a price setter, and not simply a price taker.

Put another way, the income elasticity of energy consumption in China is greater than it is in the developed part of the Rest Of the World. This also applies to the energy component of agricultural produce, with important positive consequences for countries like Brazil. That is to say, China consumes energy directly, and indirectly, via the energy input which goes into the food production (fertilizers for soya beans in Brazil, for example) that it outsources. So there is a direct, and an indirect impact.

The net consequence of this, is that the Santander analyst expects the dollar price of commodities like oil to rise sharply on the back of any significant yuan revaluation, making China richer (in relative terms), and logically the developed world poorer. Again, and put in other words, the terms of trade are about to change against Europe, the US and Japan, and possibly bigtime, as the Yuan and other emerging market currencies rise. On the other hand, Brazil and other resource rich emerging economies stand to benefit, equally bigtime, in what will be one of the largest rebalancings of the global economy seen in many a long year. The main losers, it seems to me, will be the long-term structurally unemployed we now have in the developed world, and those living in poor countries with few natural resources.

Where Do We Go From Here?

Where we go from here on the China trade front is now very hard to tell. Evidently, on the one hand, evidence continues to mount that more flexibility in yuan parities in in the pipeline. But will the much sought after revaluation really do all that heavy lifting that is being expected of it? After all, Germany's currency was effectively revalued upwards on joining the Euro, and the country then spent several years putting downward pressure on cost elements, with the result that the German trade surplus was even larger (as a % of GDP) in 2008 than it was in 1998. And China's almost unique demographic trajectory also suggests that promoting internal consumption as a growth driver may be up against significant constraints. Life Cycle Theory Nobel Franco Modigliani, in what was his final published paper (2005) - The Chinese Saving Puzzle and the Life-Cycle Hypothesis - drew attention to this oft neglected dimension which evidently forms part of the problem. At the very least, some simple economic theory suggests that all may not be as simple here as it seems at first sight.

On the other hand Chinese officials, far from showing signs of alarm at March's deficit, generally seem to have welcomed the development. According to Zheng Yuesheng, director of Statistics at China's customs office, "This kind of deficit is healthy as it happened while both imports and exports experienced rapid growth," and in any event, as he also points out, China will undoubtedly continue to run (smaller) trade surpluses over the long term. This, at least, has the benefit of being a realistic, and pragmatic assessment of the situation. All we need now is for a bit of this realism and pragmatism to work its way steadily westwards.