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World outlook on the up

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by Peter Switzer

You don’t have to be an economist to know China is delivering big time on the economic growth front and this should provide a bit of a protective blanket for our economy. But the nagging question is — will the rest of the developed world let us down and ruin our party?

The Behravesh view

I recently received an economic assessment of the global economic outlook from Nariman Behravesh, who is the chief economist at IHS Global Insight. And it comes ahead of the upcoming World Economic Forum in Davos, Switzerland.

This is how Behravesh sees the world: “A year ago, we were all staring into the abyss. Now, we are talking about how strong the recovery could be. A year ago, there was a lot of talk about greater government involvement in markets. Now, there seems to be growing resentment against too much intervention (especially in the US). A year ago, one of the big worries was a deflationary spiral. Now there is growing concern that inflation will soon take off.”

He makes the point that we dodged the Great Depression 2.0 and we can thank the aggressive use of fiscal and monetary policies, and the large bank rescue programs. The consequence he rightfully argues was simple — we avoided a horrific financial crisis becoming an equally horrific economic crisis.

Along the way, we saw the global economy still work, China and India continued to grow strongly, the US dollar did not collapse, US bonds had customers and it looks like we have avoided the no growth, zombieland scenario that befell Japan for over a decade after its bubble burst in the 1990s.

Global recovery on track

All of this is great stuff but it his future readings I want to share with you. Here’s a summary:

The global recovery is on track and there is some evidence that it has picked up a little steam in recent weeks.
So far, this is shaping up to be a two-speed global recovery, with high-debt countries and those hardest hit by the financial crisis (including the US and much of Western and Emerging Europe) in the slow lane, and with most emerging regions — especially Asia — in the fast lane.
For developed economies, strong tail winds (policy stimulus, improved financial conditions and pent-up demand) and being partially neutralised by equally strong headwinds (rising unemployment rates, lingering hangovers from housing bubbles and the financial crisis, and the winding down of fiscal stimulus).
Don't be fooled by some strong US and European data that we may see in the coming weeks — inventory rebuilding and temporary stimulus (for example, cash-for-clunkers, incentives for home buyers, and tax breaks to retain workers) will raise growth above the underlying rate of around 2.5 per cent for the US and one per cent to 1.5 per cent for Europe in 2010 and 2011.
Jobs growth always lags the economic recovery; however, the picture may brighten very soon, as there is evidence that companies (especially in the US) may have cut their headcounts by too much — relative to growth expectations.

Risk analysis

Behravesh also critically looked at both risks — upside and downside ones. This is what he found:

The good news is that the risks are fairly evenly balanced, with a roughly one-in-five chance of either a double-dip or a stronger, V-shaped recovery.
Probably the biggest near-term risk is from commodity and/or asset bubbles. Rising commodity prices have less to do with market fundamentals than with 'paper demand' or investment flows. Nevertheless, if the 'search for yield' pushes prices much higher, the fragile recovery in developed economies could be threatened. Similarly, asset bubbles in China could eventually result in a hard landing of that economy.
Sovereign debt crises and continuing financial stress could threaten the European economies. Even if a full-blown sovereign default is averted and the Eurozone remains intact (by far, the most likely scenario) credit conditions could remain tight for an extended period of time, hurting growth prospects.
For some countries premature policy tightening — either because of inflationary concerns or market jitters over rising debt levels — could increase the risks of a Japan-style "lost decade".
In the early stages of a recovery, it is common to underestimate pent-up demand. During the recently-ended deep recession businesses and households postponed major expenditures and remain cautious about the sustainability of the current economic upturn. However, if confidence in the robustness and durability of the recovery increases, then pent-up demand could be released sooner and more powerfully.
Strong productivity growth is another upside risk. The unprecedented robustness of US productivity growth (not all of which was the result of cost cutting) in the late stages of the recession and early stages of the recovery brightens the prospects for sustained above-average growth in both labour productivity and total factor productivity (due to technology and innovation).

Rate rise pace important

As you can see, this learned guy has a pretty positive view on 2010 and the ability of the global economy to get through this potential economic mess.

I also note his point about going too hard too early with tightening policies. I hope the Reserve Bank (RBA) notes this, with too many banking economists again tipping an interest rate rise in February. Rates must rise but the pace of the increase could prove critical. I hope the RBA does not stuff it up.

For advice you can trust, contact Switzer Financial Services.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Thursday, January 21, 2010