It promises to be interesting.
Yes, the greeting is a little late, but some issues to watch in the year ahead nevertheless:
1. The year of restructuring dangerously? 2015 could be an 'interesting' year with respect to sovereign debt restructuring, including a resurgence of interest in (or at least renewed discussion of) so-called statutory approaches. The potential trigger is Greek elections on January 25, which could see the election of the left-of-centre Syriza party. Syriza has identified debt reduction as a priority — understandably, given that the debt-to-GDP ratio is higher today three years after the IMF-EU-ECB troika arrangement. Although other scenarios are possible, including a muddling-through approach, the way I see it, either Syriza wins and threatens a unilateral reduction and exit from the EU, which could incentivize other EU partners to discuss an orderly restructuring, or there is a "near-death experience" of the euro that leads to negotiation.
The problem that Europe has gotten itself into is that the last time there was a debt restructuring for Greece private creditors were given a substantial "haircut" (or reduction of the net present value of their claims), while official lending through the ECB, in effect, subordinated private claims. If official creditors insist on asserting their preferred creditors status, private creditors don't get paid until official claims are settled. The simple fact is that private creditors are facing a bleak outlook. A subsequent restructuring of private claims would satisfy the second of two conditions for a resurgence of interest in formal approaches to sovereign debt restructuring; the first was the ruling against Argentina in its long-standing dispute with holdout creditors (PDF).
In this respect, private creditors might become vocal advocates of rules of the game that constrain them but also lend some clarity to the process and that reduce the risk of serial haircuts. Such a discussion would take time, of course. In the interim, efforts to establish a Sovereign Debt Forum that would help promote timely, orderly restructuring. While 2015 may be the year of restructuring, it needn't be the year of restructuring dangerously.
2. The year of exchange rate adjustments. Ok, this is pretty obvious in the wake of last week's decision by the Swiss National Bank (SNB) to uncouple the Swiss franc from the euro. The SNB had pegged the franc in order to prevent a steep appreciation in the wake of the euro's near-death experience three years ago.
At that time, capital flows seeking a safe haven from the trauma of euro zone disruption poured into Swiss assets, driving up the franc. To prevent an appreciation that would render Swiss goods uncompetitive, the SNB pegged the exchange rate. That peg was under pressure in recent weeks, however, as the prospect of more turbulence led investors to once more seek a safe haven. As a friend in London put it (hat tip: JA), the SNB's attempt to hold the peg in the face of those inflows was like trying to drink from a fire hose.
A debate is raging in the blogosphere about why the SNB moved: in principle, foreign exchange intervention to prevent an appreciation of your currency is a whole lot easier than intervention aimed at preventing a depreciation. In the later case, once you exhaust your foreign exchange reserves you have no alternative but to let the peg go. In the case of the Swiss franc, however, the SNB was accumulating foreign currencies and growing its balance sheet much like the Fed's quantitative easing (except the SNB was buying foreign currencies rather than bonds). Compare that to the ECB, which initially greatly expanded its balance sheet in response to the global financial crisis, but subsequently reversed itself. Switzerland has avoided the stagnation that has characterized the euro zone.
So, why did the SNB act? Frankly, I'm not sure. But as Gavin Davies points out, SNB governance may have had a role. Concerns about potential losses on its balance sheet should the franc depreciate at some point coupled with the fact that, unlike most central banks, the SNB is partly privately owned and those shareholders were frightened by the potential losses on the expanding balance sheet.
Regardless, the concerns about excessive appreciation that motivated the peg remain. To contain the pressure on the franc, the SNB introduced negative interest rates. Meanwhile, the improvement in the U.S. economy, particularly strong employment gains, have reanimated expectations that the Federal Reserve Board will start raising interest rates. That gap in interest rate will drive exchange rate movements going forward. At the same time, prospects for key emerging markets, particularly China, have deteriorated, resulting in weaker commodity prices and the adjustment of commodity exporter currencies.
The take away is that 2015 might see the wildest gyrations of exchange rates since, say, the collapse of the Bretton Woods system of fixed rates in the early 1970s.
3. Deflation and global adjustment. The conjuncture and interest rate configuration that are driving exchange rate adjustments reflect deflationary pressures in the global economy. This isn't new in 2015 — latent deflationary pressures have been the specter that has haunted the global outlook for the past half decade. But the dramatic decline in oil prices in 2014 will bring deflation out from the shadows. To be sure, the decline in petrol prices will raise consumers' real incomes —the "good" side of deflation. The beneficial effects of higher incomes will be muted, however, if consumers respond by increasing savings. In this event, the danger is a combination of deflationary psychology that defers consumption and continuing stagnation. This paradox of thrift outcome is more likely where economic uncertainty is high. Europe is most at risk; the U.S. probably less so.
What are the implications for the international financial "architecture" or global governance of all this? A follow up post will discuss how the past can provide guidance to policy in the New Age of Uncertainty.