G-20 Growth Masks Income to Inflation Fissures Exposed by Egypt

G-20 Growth Masks Income Inflation Fissures Exposed Egypt
Mohamed El-Erian, chief executive officer of Pacific Investment Management Co. Photographer: Ramin Talaie/Bloomberg

The global economic recovery now gathering pace is deepening income inequalities in both advanced and emerging nations, threatening to undermine policy makers’ efforts to repair their finances and fix currency misalignments.

As the uprisings in Tunisia and Egypt demonstrate, income disparities exacerbated by accelerating food and energy prices are proving a risk to a worldwide rally in equities. Egypt’s benchmark EGX30 Index fell 16 percent in one week amid the uprising. Economist Ed Yardeni says such geopolitical tensions pose the greatest risk to emerging-market stocks.

“The message that goes out from Egypt to the rest of the world is that governments have to get ahead of the process,” Mohamed El-Erian, chief executive officer at Pacific Investment Management Co. in Newport Beach, California, told Bloomberg Television’s “Surveillance Midday” with Tom Keene on Feb. 10. “There are many countries today around the world that are dealing with food inflation, that are dealing with high youth unemployment, that are dealing with income inequality.”

The test for governments is balancing the need to spur growth with demands to cut debt that surged with the financial crisis. The risk is that they resort to protectionism and currency management, while delaying budget-deficit reduction, as short-term remedies. Such concerns loom over two days of talks among central bankers and finance ministers from the Group of 20 nations starting Feb 18 in Paris.

‘Strong, Balanced’

French Finance Minister Christine Lagarde said Feb. 14 that the group aims to encourage “strong, balanced and equitable” expansion. International Monetary Fund Managing Director Dominique Strauss-Kahn, citing record high global unemployment and widening income inequality, said Feb. 1 “it is not the recovery we wanted.”

Efforts to sustain the expansion may deepen divisions among the G-20 nations that constitute about 80 percent of the global economy. Few back French President Nicolas Sarkozy’s push to curb derivatives trading as a way to contain commodity-price volatility. Members also disagree about what’s driving capital flows into emerging markets and how they should be treated.

The schisms threaten the efforts of G-20 governments to address imbalances in budgets and trade gaps, said Tim Adams, a former U.S. Treasury undersecretary. Emerging market economies may dole out more subsidies for energy and food, while those such as China which control their exchange rates will keep arguing that doing so protects their societies, he said.

“It will all have an impact on fiscal, monetary and currency policies,” said Adams, now a managing director of the Lindsey Group, an investment advisory firm in Fairfax, Virginia.

‘More Threatening’

For now, geopolitical frictions “are more threatening” to emerging markets than developed ones, said Ed Yardeni, chief investment strategist at Yardeni Research Inc., who coined the term “bond vigilantes” to describe how investors can punish profligate governments.

The MSCI Index of emerging-market stocks gained 63 percent in the past five years against the 1.8 percent advance in the index of developed-nation equities.

The 18-day protests in Egypt, where 40 percent live near the poverty line, that resulted in the ouster of President Hosni Mubarak underscore the elevated political risk that investors ignore at their peril, says Stephen Lewis, chief economist at Monument Securities Ltd., a London-based broker.

Income disparities are not just an issue for developing markets, according to data he’s assembled. The Gini coefficient, a measure of income inequality, rose in the U.S. to 46.8 in 2009 from 39.4 in 1970. Over the same period, comparable figures show an increase from about 25 in Japan and the U.K. to 39 and 36 respectively, he found.

‘Lessons of Indequality’

“We’re seeing in North Africa and the Middle East some of the lessons of inequality, but the tensions are also there in advanced economies and coming to the surface in a way markets aren’t yet discounting,” said Lewis.

Income differences are reflected in retailers’ shares, said Lewis. Tiffany & Co. and Burberry Group Plc are among those benefiting with an appeal to rich shoppers as the recovery gathers steam driven by emerging markets. Meantime, Marks & Spencer Group Plc says mounting pressure on U.K. consumers will make business tougher and Wal-Mart Stores Inc. reports “everyday Americans” are living pay check to pay check.

Masking growing disparities within countries is the narrowing of wealth imbalances among nations. Credit Suisse Group AG research shows the share of global wealth held by the richest 10 percent has slipped to below 83 percent from 85 percent, while the middle segment now contains 1 billion people with almost 60 percent located in the Asia Pacific.

Income Gaps

While income gaps narrowed during the credit crisis as employment and the value of equities and property sank, they are reopening again, aggravated by unemployment and surging food, energy and commodity prices. Food prices rose to another record last month amid higher dairy, sugar and grain costs and the World Bank yesterday reported that climb has pushed 44 million more people into “extreme” poverty. The price of oil last month reached its highest since 2008.

“The large run-up in inequality is the problem of the next decade,” Kenneth Rogoff, a former chief economist at the IMF who now teaches at Harvard University, said in an interview. “The recovery is disproportionally benefiting the wealthy and there is a growing risk of instability in most of the G-20 countries.”

AAA at Risk

Rich nations may be looking to slow deficit reduction until hiring improves. Moody’s Investors Service said the risk of a negative outlook on its Aaa rating for U.S. debt remains as President Barack Obama pushes a budget that will leave the budget deficit above 3 percent of gross domestic product until 2017 from as high as 10.9 percent in the current fiscal year. Among his proposals, Obama wants aid for state unemployment programs burdened by debt because of high jobless rates.

The income gaps will continue to grow, said Simon Johnson, another former IMF chief economist and Bloomberg contributor, who draws a distinction with how banks have emerged from the crisis recording profits and distributing bonuses while hiring remains weak. The Geneva-based International Labor Organization last month predicted global unemployment of 6.1 percent this year from about 5.5 percent in 2007 and called tackling youth joblessness a world priority.

“The top 1 percent are making out like bandits and the bottom 15 percent are doing very badly,” said Johnson, who now teaches at Massachusetts Institute of Technology. “Where are the jobs?”

Declining Trade

Another risk is a period of stagnant globalization last witnessed in the 1970s and early 1980s as governments levy taxes on foreign products to protect domestic interests, said Paul Donovan, deputy head of global economics at UBS AG in London. Trade as a share of global GDP dropped to about 21 percent last year from a peak of 24 percent in 2008 and data from Global Trade Alert show G-20 governments have imposed more than 700 protectionist measures since November 2008.

The unrest in Africa and the Middle East proves “it pays to minimize reasons for popular discontent,” said Donovan. “Protectionism is creeping back onto the global agenda.”

The ultimate result may be what New York-based economist Nouriel Roubini and Ian Bremmer of the Eurasia Group investment consultancy call a “G-Zero” world, in which no country has the power to dominate the international agenda and focuses on preserving its own economic well-being.

“This is not a G-20 world,” Bremmer and Roubini wrote in the latest Foreign Affairs magazine. “The result will be intensified conflict on the international stage.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE