Download Strong world growth masks medium

Strong world growth masks
medium-term risks
Based on Martin Wolf, ft July 19 2004
This year is now expected to see
something close to a perfectly
synchronised global economic
recovery. According to Consensus
Forecasts, US growth should reach 4.5
per cent and Japan - astonishingly - 4.2
per cent. The UK economy is forecast
to grow by 3.2 per cent and even the
lagging eurozone by 1.7 per cent. The
Asia Pacific region (including Japan) is
forecast to achieve 5.1 per cent growth,
eastern Europe 5.5 per cent and Latin
America 4.6 per cent. Leading the pack
is China, forecast to achieve 8.7 per
cent growth this year. For the world as
a whole, Goldman Sachs forecasts
output growth this year of 4.8 per cent,
up from 3.4 per cent in 2003.
Next year, growth is expected to slow,
but the consensus remains cheerful.
US growth is forecast at 3.8 per cent
and the UK's at 2.7 per cent. The
eurozone is expected to reach 2 per
cent, although Japan's growth is
forecast to tumble to 1.8 per cent. A
soft landing is forecast for China, with
growth falling to 7.7 per cent. Latin
America is forecast to grow at 3.7 per
cent.
The US current account deficit has
risen from about 1.5 per cent of gross
domestic product to over 5 per cent
today. During the recent US slowdown,
the current account deficit has,
remarkably, continued to rise (see
chart). This is the opposite of what one
would normally expect and of
experience in the early 1990s.
A net creditor for most of the 20th
century, the US has seen its net liability
position move from a rough balance in
1988 to minus 24 per cent last year (see
chart). Yet, despite a current account
deficit of 4.9 per cent of GDP in 2003,
net liabilities to the rest of the world fell
as a share of GDP. The tumbling dollar
reduced net liabilities by more than the
current account deficit increased them.
According to the IMF,
between the third
quarter of 2001 and
the fourth quarter of
last year, US real
domestic demand
rose, cumulatively, by
8.9 per cent, while the
UK's increased by 6.9
per cent (see chart).
Over the same period,
Japan's demand rose
by just 2.7 per cent
and the eurozone's by
2 per cent. Germany's
fell by 0.7 per cent.
In 2004, according to
the Organisation for
Economic Co-operation and
Development, the Anglosphere (the US,
UK and Australia, but not Canada in
this case) will run a combined current
account deficit of $636bn, with the US
deficit alone accounting for $555bn
(see chart). No other group of countries
is forecast to run significant deficits.
Asia's current account surplus was
recorded at $322bn.
Between February 2002 (when the
dollar's overall real exchange rate
started to fall) and April 2004, official
foreign currency reserves
(predominantly in dollars) rose by
$1,211bn to $3,277bn (see chart).
Seventy-eight per cent of this massive
rise was in Asia alone, with Japan and
China accounting for 34 per cent and
19 per cent of the overall increase in
reserves, respectively.
In 2002 and 2003, the increased foreign
currency reserves of the Asian
countries totalled $718bn. Of this
$540bn was generated by the current
account surplus, while the other
$178bn represented the recycling of
Asia's private capital inflow.
What do these facts tell us? First, the
US has long been exporting demand
stimulus to the rest of the world.
Second, this new business cycle, with
its set off imbalances is taking off
where the last one ended. Third, at
recent real exchange rates, the US has
been able to generate rapid growth of
domestic output only with still faster
growth in real domestic demand.
Fourth, Asian countries have
intervened massively to prevent the
revaluation of their currencies. Finally,
they have, in this way, also made it
extremely difficult for the US to shift to
greater reliance on foreign demand for
its growth.
The big question for the years ahead is
how far this pattern can be sustained
for another entire cycle and, if not,
what will replace it.
The macroeconomic (im)balances are
far from the only medium-term
challenge to the expansion. Another is
the impact of a second elephant. China
is now big enough to have an
appreciable effect on the dynamism of
the world economy. In the course of
the present cycle, its impact is likely to
become ever larger.
One way in which China will affect the recovery is via instability in the growth of its domestic demand,
which has, unlike that of the US, been investment-led. Investment growth peaked at over 40 per cent in
the year to the first quarter of 2004. This is slowing and will almost certainly slow further, perhaps to as
little as 10 per cent next year. This will, in turn, mean a drastic slowdown in the construction boom.
HSBC suggests that the true economic slowdown could be
from 12 per cent economic growth this year to 7 per cent in
2005.
Yet another way in which China and the rest of Asia affects
the world economy is through relative prices. China and
India drive down the prices of labour-intensive
manufactures and services. Both are also tightening the
world market for oil. The big question here is not the
balance between existing demand and supply but rather
the ability to meet the rising demand that the Asian
expansion and US recovery will generate.
According to the International Energy Agency, China will
generate one-third of global incremental demand for oil
between 2002 and 2004 and the rest of Asia another 15
per cent (see chart). North America generates another 26
per cent. Moreover, the 2.9 per cent increase in global
demand this year is the highest figure since 1980.
As Asian growth continues, the global
balance between demand and supply
will continue to be tight, unless (or
until) a vast increase in investment
takes place. With such tight markets,
relatively modest disruptions could
eaily lead to explosive
ju
mp
s
in
oil
pri
ce
s,
as happened twice in the 1970s. That
might, in turn, feed into the inflationary
spiral that many observers already
fear.
The possible combination of unstable
growth in global demand with large and
rising current account deficits and
shocks to oil markets threaten a third
danger: protectionism. So far this has
been contained. International trade has
also recovered strongly from the
slowdown. But an outright failure to
make progress in the Doha round, a
new US administration and geopolitical
frictions could threaten the present
liberal order.