Economic forecasting is at best an uncertain exercise and at worst an informed guess. In the present economic climate, it is particularly difficult. Global imbalances and discord on currencies, the unfolding Middle East turmoil, problems in some eurozone countries, periodic concerns about the euro, continuing questions about banks and banking, growing inflationary pressures, government and private sector debt – to name just a select few of the current challenges and uncertainties.
Nevertheless, there seems to be more apparent optimism around compared with last year and recent experiences (from 2007 onwards) have been a reminder about how important sentiment can be in shaping the behaviour of markets. In this context, optimism is good ! The global property crash associated with the 2008 crisis clearly began to ease in 2010. Although property prices slid in Spain, house prices stabilised in the US and rose in Britain.
A positive message from 2010 is that informed economic policy does work and that recovery from the crisis is under way. Economic growth is more apparent and is beginning to look sustainable, although experiences are mixed. Last year, for example, the emerging economies (comprising about one-third of global GDP) contributed two-thirds of growth in the global economy.
2011 is likely to be a more complex economic year than 2010. The global economy appears to be moving more strongly out of the crisis, but there are a lot of developing risks (like oil prices) whose outcomes are still uncertain. On balance, the consensus view still appears to be that a ‘double-dip’ is now less likely.
There is cautious optimism that the US economy is developing more strongly than expected a few months back. Divergences in the world’s major economies will remain as central banks in emerging economies (especially Asia) tighten their policies in the face of inflationary pressures. Diverging economic performances are also apparent in the euro area. Here the strong core economies (Germany and France) are in sharp contrast to some of the periphery economies (especially Greece and the rest of the so-called PIGS group). A recurring eurozone problem is that one monetary policy is not suitable for component economies running at different speeds.
The IMF’s world economic outlook update released on January 25th 2011 suggests that the global economy is likely to show a broad recovery in 2011. The IMF has revised its growth forecast up from 4.2 percent to 4.4 percent for 2010/11. However, the Fund cautions about a two-speed recovery with emerging economies growing faster (as they did in 2010) than more advanced ones. US economic growth for 2011 is forecast at 3 percent by the IMF (in October 2010 it was projected at 2.3 percent). The UK’s 2011 growth is projected at 2 percent and the eurozone at 1.5 percent. China is projected to grow at 9.6 per cent and India at 8.4 percent.
The comparative high growth forecasts for the emerging economies bring with them possible downside risks. Inflation, for example, is fuelled by the increased flow of foreign capital into emerging economies. Since these economies account for around 40 percent of global consumption, any slowdown in their rate of growth could have a serious impact on the developing global economy.
The Financial Times (Alice Ross, January 15th/January 16th 2011) cautioned about investors rushing into emerging markets. As the developed economies grew at a comparative slow rate in the 18 months up to December 2010, investors sought higher returns in emerging markets. Emerging markets have displayed a ‘remarkable recovery’ in the wake of the financial crisis. However, the same Financial Times article points out investment advisors are warning that investors may face increased risks in countries like China and Brazil as they seek to contain inflation. Although analysts appear to agree that China remains an attractive investment market (despite its inflationary pressures), investors generally need to be more risk averse in 2011.
Inflation is reappearing as a global problem. To be sure, there are strong global disparities. In the West, the main preoccupation of economic policy has been with debt problems. In China and across Asia, inflationary pressures are rising and policy accordingly needs to tighten. The Economist (5th February 2011) reported that inflation stood at 4.6 per cent in China; 5. 9 per cent in Brazil; and almost 10 per cent in India. Euro-inflation reached 2.4 per cent in January 2011.
Inflation rose to 1.5% in the US at the end of 2010 and the governor of the Bank of England warned in January that it could reach 4.5 per cent in the UK. The Economist concludes that ‘rising inflation is not as worrisome as it appears, at least for now’. But they caution that continued booming growth in some economies and cheap money (lack of monetary policy restraint) will conspire to cause inflation problems in the future.
A related problem is that strong currencies and overheating economies pose a policy dilema. If interest rates are hiked up to curtail inflation, currency values may be driven up even further. Intervening in the foreign exchange market to push currency values down may also boost inflation. Many countries in Latin America, for example, face these challenges in 2011.
The so-called global imbalances, especially those of China and the US, continue to pose a challenge to a sustained global recovery. The Chinese can restrict the renminbi/dollar exchange rate and, in so doing, flows of capital into and out of China. The global imbalances (with the US and China centre stage) are the result of complex (and often strongly debated) causes. But the failure of the G20 meeting in November to solve this stalemate was not reassuring for the 2011 global economy. Business leaders have expressed concerns that a currency war could derail the apparent recovery in trade and economic growth.
A major uncertainty for 2011 is the dramatic scale of revolutionary zeal that is sweeping across the Middle East. Tunisia, Egypt and now Libya have been centre stage, but the revolutionary process has the clear potential to spread. These are complex events that have many potential repercussions for the global economy. Energy, trade and geopolitics are all involved, but immediate concerns focus on oil.
Oil prices are notoriously difficult to predict. But with major changes sweeping over a region that accounts for 40 percent of the world’s oil production and 57 percent of global reserves, there will be consequences for the global economy (and key economic forces, like inflation). In January, Brent crude oil stood at around $96 a barrel. In little over a month and following the dramatic de-throning of Hasni Mubarak, oil moved strongly to $115 a barrel. If oil stopped flowing from Libya and Saudi Arabia did not plug the gap, the upward pressure on price would be reinforced: this is the ‘nightmare scenario’. With analysts already expecting a spike in prices (from $150 to $220 a barrel), this becomes the ‘ultimate worst case scenario’. Unrest in neighbouring Bahrain does not help alleviate the fears of this kind of potential scenario.
This short and selective overview has some mixed messages for 2011. There are clearly risks (like inflation, oil prices, sovereign risks and potential currency wars), but the overall prospects for 2011 still seem pretty buoyant. The 2010 economic recovery seems set to continue into 2011 in uneven and sometimes diverging ways. The West will remain slower, but hopefully sustained, compared with a more buoyant East. Most of the growth (over two-thirds) in 2011 will be from emerging economies.
So far, then, there is cautious optimism for the global economy. The apparent sustained and improving economic scenario for 2011 seems to be grounded in solid results and expectations. At the same time, though, the risks are clearly there and the scale of revolutionary events in key regions like the Middle East may have consequences not yet appreciated. For the present, though, some optimism for the global economy is still warranted.
Professor Bullion
