Grand Experiments

Will the United Kingdom's Aggressive Programme of Fiscal Austerity or the U.S. Push for Growth Be More Successful?: Although it will take a few years to determine which approach will be more effective, the comparison is a little unfair because the U.S. economy is much larger (with a higher growth potential) and the U.S. dollar is still the “safe haven” currency. Any significant action on the U.S. deficit problem seems unlikely before the 2012 presidential election.

Will the Chinese Renminbi Become a Major Reserve Currency Soon?: China’s leadership seems keen on elevating the status of the renminbi. However, these ambitions are at odds with the Chinese government’s desire to tightly control the appreciation of the renminbi. In the end, although China’s currency is becoming more internationalised, it will be many years before the renminbi achieves the status of the dollar, euro, yen, sterling, or Swiss franc.

End Games

When Will the (Inevitable) Restructuring of Eurozone Sovereign Debt Occur?: Renewed financial jitters vis-à-vis the Eurozone’s sovereign debt problems have begun to focus minds on the next phase of crisis management. This will very likely include a debt restructuring plan, with “haircuts” for investors and further aid for the European banks holding much of this debt. Financial markets may force such an outcome as early as this year. That said, even a “fringe breakaway” scenario for the Eurozone is still quite unlikely.

Will China Be Able to Avoid a Hard Landing in the Next Few Years?: The Chinese government’s response to the global financial crisis consisted mostly of encouraging state-owned banks to make massive loans to local governments. Unfortunately, a large share of these funds was used for real estate investments. Quite alarming are statistics that show that the value of housing relative to GDP in China is now at the levels reached in Japan in 1990, before its bubble burst.

World Economic Outlook

The World Outlook—More Upbeat News, But Also More Volatility: The more cheerful economic news during the past couple of months points to a stronger global recovery this year. As a result, IHS Global Insight has revised its world growth forecast for 2011 upwards from 3.4% to 3.7%. Meanwhile, financial and commodity markets have been volatile. This volatility could develop into major headwinds for the world economy.

United States—Things Are Definitely Looking Up: Since November, most of the U.S. economic data have shown a marked improvement in growth prospects—with the major exception of housing (which contributes only 6% to GDP). The recent tax cut extension and stimulus package will, alone, add as much as 0.6 percentage point to growth this year and reduce policy uncertainty.

Europe and Japan—On Track for Slower Growth: The recoveries in both the Eurozone and the United Kingdom are likely to lose energy in the first half of this year because of fiscal austerity programmes and higher interest rates due to market fears about sovereign defaults/restructuring. Japan’s growth is also set to slow with the end of consumer incentives, which boosted growth in the middle of last year.

China—Minimal Slowing Because of Provincial Defiance: After slowing briefly, most indicators of Chinese growth are showing renewed strength. Some of the explanation for this has to do with the fact that provincial governments are not on board with slower growth. More troubling are accusations that local officials are foiling attempts to cool the property markets. This means that even a soft landing is becoming less likely in 2011.

Other Emerging Markets—Still Rolling Along: Most of Asia remains on a robust growth path. Indeed, India is on track to grow by at least 8% for the next few years. The outlook for other Asian countries, including the Philippines, Singapore, South Korea, Taiwan, and Thailand, has also improved. In other emerging regions (especially Latin America, Africa, and Central Asia), strong global demand and rising commodity prices are helping growth prospects, but creating inflation headaches.

Commodity Prices Are on an Upward Path—the Only Debate Is about the Slope: The recent commodity price increases have been broadly based, affecting nearly every industrial sector except semiconductors. Although specific factors (inventories, speculative demand, etc.) will determine the extent of price rises for specific commodities, double-digit price increases seem the most likely outcome for most raw materials.

Rising Food Prices Are Hurting the World's Poor: Food prices are at or close to the record highs reached in 2008. This is hurting the world’s poorer countries. In the United States and Europe, households spend roughly 10–12% of their budgets on food. In China and India about half goes to food. In the poorest countries of the world, the percentage is closer to 75%. Also, part of the recent inflation increases in emerging markets is due to food.

On the Horns of a Dilemma—Emerging Markets' Central Banks Are Trying to Keep Both Currencies and Inflation from Rising: Strong economic growth and rising commodity prices are pushing inflation and currencies up for many emerging markets. This suggests that central banks in the emerging world should be tightening monetary policy and raising interest rates. However, such a move would attract even more “hot” capital inflows, further pushing up exchange rates and hurting competitiveness.

Talk of Currency "Wars" Is Exaggerated: Recent accusations about the United States and China manipulating their currencies are (at least partially) off the mark. Even though China tightly controls the rate at which the renminbi appreciates, escalating inflation means that China is also losing competitiveness. Furthermore, notwithstanding the temptation to label the Federal Reserve’s second quantitative easing (QE II) programme as currency manipulation, the U.S. dollar has recently appreciated against some key currencies.

Despite Increased Volatility in Financial and Commodity Markets, Business Sentiment Is Improving: Almost all measures of business sentiment have improved since the autumn. This can be seen in a majority of recent purchasing managers’ indexes worldwide (even in the Eurozone), as fears of a double dip have receded. The upbeat mood is spreading from large companies to smaller ones.

                       Real GDP Growth (% Changes)

                        2008    2009    2010   2011   2012   2013

United States      0.0      -2.6     2.9      3.2     2.9     3.1

Eurozone             0.4      -4.1     1.7      1.5     1.6      1.7

United Kingdom -0.1     -4.9     1.6      1.8     2.2      2.5

Japan                -1.2     -6.3    4.4       1.2     1.5     1.9

China                      9.6      9.1    10.1      9.5     8.8     8.9

India                      5.1      6.8     8.5       8.3     8.5     8.6

Brazil                    5.2      -0.6    7.5       4.9      5.5    5.2

Russia                 5.6      -7.9    4.0       4.3      3.7      3.6

World                  1.8      -1.9    4.1       3.7     3.8       4.0