To the Point
Discussion on the economy, by the Chief Economist
Cecilia Hermansson
Group Chief Economist
Economic Research Department
+46-8-5859 7720
cecilia.hermansson@swedbank.se
No. 3
2011 03 31
March 31, 2011
Don’t ignore the white swans!
There has been great focus on black swans lately. The Japanese earthquake, the
tsunami and nuclear power plant accidents could have been foreseen, but not
their exact timing and perhaps not all of the events at the same time. The
democratisation wave in the Middle East was also expected, but how could one
know exactly when it would start, where, and with what force? In that sense,
these events could be characterized as black swans, or as Nassim Nicholas Taleb
writes in his book The Black Swan – the Impact of the Highly Improbable: “A
black swan is a highly improbable event with three principal characteristics: It is
unpredictable; it carries a massive impact; and, after the fact, we concoct an
explanation that makes it appear less random, and more predictable, than it was.”
This version of To the Point is about white swans instead. Why? Because I
believe they will have a greater impact on the world economy. The black swans
mentioned above, or the unknown unknowns, i.e. the things that we don’t know
that we don’t know, may not cause new recessions and financial crises this time.
The impact of both the Japanese disaster and the democratisation process in the
Middle East will prevail for many years; meanwhile, the world economy will
move on. The focus is of course on oil prices, but there are also other factors
driving commodity prices at the moment, such as the higher demand from
emerging markets, which may become even greater over time.
The white swans, on the other hand, are the known knowns, i.e things that we
know that we know, and the known unknowns, i.e the things that we know that we
don’t know, and they could potentially have a much greater impact on global
developments. I am thinking about the sovereign debt crisis in the advanced
economies, and the links to fragile banking systems and a leveraged private
sector. We know about these and in that sense they are clearly white swans. In
Europe, measures are being taken, albeit not always the most optimal ones, but
developments are going in the right direction. In the US, however, there is a
greater ingredient of neglect or ignorance. Everyone knows that debt is building
up like a snowball rolling down a mountain, but few take responsibility for it.
Let’s focus more on the US
The US has the advantage of being a fully fledged union of states, both from a
monetary and a political perspective. The euro-zone, on the other hand, started
with integration on the monetary side, where some countries (France) hope
political integration will follow suit, and where others (Germany) hope such
integration will never be needed.
Today, the sovereign debt ratio to GDP is already higher in the US at close to
100 % (85 % in the euro-zone), and the country also has more problems with
private leveraging and a larger current account deficit. The US has states such as
California, Nevada and Florida; where problems are immense, just like the euro-
zone has Greece, Ireland and Portugal.
The discourse in media and the financial markets is: If and when will the euro
collapse? Which countries will leave the euro- zone, will it be Greece or Germany?
We would never discuss the possibility of Texas breaking free from the troubled
US, leaving with oil and better prospects on its own. When Texas became part of
the US, it actually got a provision in its Constitution allowing it to leave the Union.
To the Point (continued)
March 31, 2011

Chart 1: The Euro/US dollar 1974-2011

Debt is piling up
1,6
So, while the euro-zone is struggling to take care of its problems, the US has
1,5 allowed the budget deficit to grow this year and remain in double digits. The
1,4 medium-term budget plan presented by president Barak Obama is not
1,3 ambitious, and relies too much on the US continuing to show high growth over
1,2 the next decade. His appointed bi-partisan commission was much more
USD/EUR

1,1 ambitious, problem-oriented, and advocated more austerity.

1,0
The US has a history of cutting taxes and raising expenditures. During the
0,9 Clinton era, however, the budget deficit was brought down, interest rates fell
0,8 and the country benefited from more sound fiscal management. At this
0,7 juncture, quantitative easing and low policy interest rates have created an
0,6 environment with monetary stimulus that fosters a less need for fiscal
74 77 80 83 86 89 92 95 98 01 04 07 10
consolidation. Also other reforms, such as house financing, are lingering due to
Source: Reuters EcoWin

the high supply of liquidity. I have heard economists discussing the possibility
of increasing fiscal stimulus even further since interest rates are so low anyway
and it is easy to finance debt. It is important to ensure the recovery is robust,
but by prolonging the plans for creating better fiscal positions in the medium
term, risks are building up which could threaten the economy at a later stage.

A change in sentiment would change a lot

Chart 2: Total capital market debt/GDP and
10 yr government nominal and real rates The US economy is expected to continue to grow, and gradually the
quantitative easing and the monetary policy stance will become less
4,00 17,5
10-year government
<--- Total capital market expansionary. Hopefully, the various markets and actors that have benefited
3,75 debt/GDP
15,0
bond ---> from all the stimuli will handle the shift to being “on their own”. The US,
3,50
12,5 having a stronger momentum, will most likely see the US dollar strengthen
3,25
10-year government
10,0 against the euro and the yen over the next year or so.
3,00 bond (real) --->

7,5 However, if the euro-zone moves into calmer waters, investors and other actors
Percent

2,75

2,50 5,0 on the financial markets could start turning to the US. As the debt ratio moves
2,25 higher and higher, the structural problems with labour, credit and housing
2,5
2,00 remain, and the growth rate will disappoint somewhat compared to
0,0
1,75 expectations. In addition, a stronger dollar will not help the US reduce its
1,50 -2,5 current account deficit, and over time it may be increasingly harder to get
1,25 -5,0 Europeans and Asians to finance it.
55 60 65 70 75 80 85 90 95 00 05 10
Source: Reuters EcoWin If and when sentiment towards the US changes, it will change a lot of other
things as well. The dollar may fall more dramatically, interest rates will start to
rise. Not only is the US affected by its lack of responsibility, other countries
will also face more turbulence and large wealth effects. For Americans, the
issue is also about income distribution now and over time, making it more
difficult for future generations to create a similarly good living standard as their
parents. With an ageing society and increased health costs, the debt ratio will
continue to rise if no action is taken. This means that the US will need to start
working on fiscal consolidation, and step up its ambition level with regard to
the reform agenda. We can see what is coming, the white swan is clearly
visible, and by not doing anything, the impact can be even greater than all the
black swans together ...
Cecilia Hermansson
Economic Research Department
SE-105 34 Stockholm, Sweden
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