Global Economic Outlook 2010

Deloitte

Description

While a global recovery is already underway in many economies, there is considerable uncertainty on what happens next. The first Global Economic Outlook of the new decade looks at the near-term outlook for the world's major economies, while analyzing some of the important issues attracting attention of investors and business leaders in 2010.

Informations

• Publié par: deloitte
• Nombre de lectures: 123
• Langue: English
• Poids de l'ouvrage: 2 Mo

Extrait

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Te Future of te Dollar

Wy te Rise i Gold ad Wat Does It Mea for te Ecoomy?

Emergig Asia  Are we witnessing the seeds of change?

After the Recovery:  New issues emerge

Global Economic Outlook Pulised quarterly y Deloitte Researc Editor-i-cief Ira Kalish Cotriutors Elisabeth Denison Shalabh Kumar Singh Carl Steidtmann Ian Stewart Editorial address 350 South Grand Street Los Angeles, CA 90013 Tel: [phone] [e-mail]

Global Economic Outlook Q1 2010 It is sobering to think that, just one year ago, this publication described the global economy as being in a “crisis of unknown depth and duration.” Today, the depth and duration are known. Although the global recession was deep, a massive multi-governmental response was mostly successful and made the duration of the recession shorter than most analysts expected. Now the uncertainty concerns the strength of the recovery, the future structure of the global economy, and the path of various asset prices including interest rates, exchange rates, commodity prices, and general inflation. There is also uncertainty about what governments and central banks should and will do to exit the expansive paths they have taken. What they do will play a significant role in determining what happens next. In this, our firstGlobal Economic Outlook of the new decade, our economists offer their views on the near-term direction of the world’s major economies. We also look at a few major issues that have attracted the attention of investors and business leaders. First, the massive increase in the stock of U.S. government debt and the balance sheet of the U.S. Federal Reserve has raised concerns about the future of the dollar. In our first article, I offer some thoughts on the dollar including its likely path, the impact of government policy on the dollar, the impact of the dollar on inflation, and the future of the dollar as a reserve currency. My basic conclusion is that the dollar will probably decline; that this is mostly a good thing provided that the decline is orderly; that a decline won’t necessarily be inflationary for the United States; and that the reserve currency role of the dollar is probably not threatened for a long time to come. Shalabh Kumar Singh takes a look at the changing role of the emerging nations of Asia. While they have recovered quickly and more strongly than the developed nations, they have clearly not de-coupled from those countries. Yet something is changing. In the past, these nations depended heavily on exporting to the West in order to generate growth. In the future, more of their growth looks to come from domestic demand, including increased imports from developed countries. To the extent that exports remain a driver of growth, the economic integration of the region will be important, with China acting as an engine of growth for the rest of Asia. Our final topical article, by Carl Steidtmann, concerns the recent upsurge in the price of gold. For those of us who give presentations on the economic outlook, hardly a session goes by without audience members raising questions about gold. The intense interest in gold is driven by the rise in the price, which in turn is driven by the intense interest. This raises the question as to whether a bubble is brewing or fundamental factors are driving the increase. Carl suggests that there are fundamental factors at work. He also notes that, unlike in the past, inflation is not one of them. Instead, he opines that the surge in gold is being driven by concerns about the U.S. dollar, central bank acquisition of gold, the rise of gold exchange traded funds, and increased demand for gold by the rising middle classes of China and India.

As for our regional outlooks, Carl Steidtmann begins with an optimistic take on the U.S. outlook. He reminds readers that many of today’s indicators are consistent with historically strong economic rebounds. He points to strong equity price gains, a very steep yield curve, strong productivity increases, and some promising details in the latest employment numbers. Despite the relatively rosy outlook, Carl notes that serious risks threaten the future recovery. These include high levels of household debt, possibly onerous government policies, poorly performing bank assets, and the potentially negative consequences of higher oil prices. I Chin f a o fac   e b s a e st l rong w rec   o n ver e y i e n 2 d 01 s 0   , but other issues f l t o ac o in m   g ,    a a b c n c   e a o s r   s d e i t n   g p d   r t i o c i e t S  b h e u al b a d b b l   h e     o a K n u r d m   t a h r  e S   i p n o g t h e . n   t C ia h l i   n f a o   r i   s f   u al t r u e r a e d   y  i s n fi u fl g l a l g ti e o s n ts   d   o t   h w a i t n   g C  t hi o n  i a t   s  w fi i x ll  e s d t   a e r x t  c t h h a e  n p g r e o   c ra e t s e s     p of o   l a ic p y. p   r S e h ci a a la ti b o h n     once the recovery in the West evidences strength. In addition, the Chinese government will wait for Western recovery as well before it reverses its stimulus policies. Although exports will play a significant role in recovery, the big issue for the future will be the extent to which domestic demand replaces exports as the primary driver of growth. Shalabh also examines the outlook for India and concludes that growth will be strong in 2010. He points to the strength of domestic demand, the stability of the financial system, the lagged effects of aggressive monetary policy, and the confidence of foreign investors. On the other hand, Shalabh points out that India still faces risks including global economic weakness, inflationary pressures, and political events. As for Japan, Shalabh notes that the economic recovery is fragile. In fact, he suggests that a double dip is more likely than a sustained recovery. The problems are many. They include declining prices, a rising currency, lack of consumer confidence, inadequate monetary stimulus, and the changing structure of the global economy and its impact on Japan’s exports. Shalabh says that current conditions are eerily similar to those that held back Japan in the 1990s. In her discussion of the Eurozone, Elisabeth Denison notes that although the region is in recovery, much uncertainty remains. This is partly due to the two-track nature of Europe’s recovery. Some countries are doing well while others are struggling with imbalanced public finances

and structural weaknesses. Of particular concern are Italy, Spain, Ireland, and Greece. While the region’s core economies of Germany and France have done better, they still face the challenge of shifting toward more domestic demand-driven growth. Elisabeth notes how the two-track nature of the recovery is creating strains for the euro, for European monetary policy, and for relations between member countries. Ian Stewart examines the outlook for the United Kingdom and concludes that serious problems remain. Although recovery will take hold in 2010, it will likely be weak. The problems include tight credit markets, lingering effects of excessive consumer debt, weak employment markets, and constraints on government spending — especially following a mid-year election. Ian says that the most promising part of the U.K. economy will be exports and manufacturing, owing in part to the weakness of the pound. Finally, I offer some thoughts on Brazil. This country, once the target of derision about its relatively low growth and high inflation, is now enjoying the fruits of a decade of good policy. The country had a mild recession and a quick recovery. The outlook is for strong growth with modest inflation. Moreover, investors in and out of Brazil evidently have confidence in government policy and in the country’s prospects. Risks remain, however. These include the negative effects of a strong currency on exports, the possibility of lower commodity prices, and excessively tight monetary policy.    

Dr. Ira Kalish Director of Global Economics Deloitte Research

Executive summary

Gloal Ecoomic Outlook  1st quarter, 2010

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Topics 1 The future of the dollarWith the massive increase in the stock of U.S. government debt and the balance sheet of the U.S. Federal Reserve, concerns are rising about the future of the dollar: its likely path, the impact of government policy on the dollar, the impact of the dollar on inflation, and the future of the dollar as a reserve currency. 7 Emerging Asia: Are we witnessing the seeds of change?While most of emerging Asia will likely continue to outperform the rest of the world in 2010, they have clearly not de- coupled from those countries. Yet there is change from heavy dependence on exporting to the West to more growth coming from domestic demand, rising trade, and investment flows between emerging Asian economies. 11 Why the rise in gold and what does it mean for the economy? The current surge of interest in the price of gold is, interestingly, happening against a backdrop of very low inflation in the United States and many other developed economies. It’s likely being driven by concerns about the U.S. dollar, central bank acquisition of gold, the rise of gold exchange traded funds, and increased demand for gold by the rising middle classes of China and India.

Geograpies  15 The United States: The upside for growthWhile the short-term outlook is upbeat, the risks to the U.S. economy are quite elevated. Yet 2010 will be a much improved year with sales growth returning and profitability performance surprising many businesses on the upside. 19 China: Growing bigger faster Growing domestic demand coupled with recovery in exports is expected to drive growth through most of 2010, possibly propelling China to replace Japan as the second largest economy in the world this year. Still, risks remain: an existing asset price bubble and potential for future inflation. 23 India: Strengths outweigh weaknesses India’s growth will be strong in 2010 based on strong domestic demand, a stable financial system, and growing foreign investor confidence. There are some concerns, however, including global economic weakness and inflationary pressures.

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Geograpies (cotiued) Japan: Treading waterJapan, despite being the first of the G7 countries to emerge from recession, appears to be the most fragile among these economies, with numerous challenges to its sustainability. It will take at least till mid-2010 to show sustainable recovery. Eurozone: Patchy progressThe Eurozone has officially emerged from recession, but the recovery remains uneven. Industrial countries in the region’s core are setting the pace, while others remain mired in recession. The United Kingdom: A slow recovery beckonsThere’s a slow return to growth in 2010 with exports and manufacturing output driving the U.K. recovery. But the recovery faces headwinds from rising unemployment, limited credit supply, and a squeeze on government spending. Brazil: The toast of South AmericaBrazil, unlike the rest of the world, had a modest recession followed by a quick recovery. Although it still faces risks, the country will most likely see strong economic growth, modest inflation, and continuing global inflow of investment.

Appedix Charts for major countriesGDP growth rates; inflation rates; major currencies vs. the U.S. dollar; yield curves; composite median currency forecasts; composite GDP forecasts; OECD composite leading indicators.

Dr. Ira Kalish is

the Director of

Global Economics at Deloitte Research

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The future of  the dollar

Amidst the good news of global economic recovery, concerns about things that could go wrong are becoming more prevalent. Of particular interest to financial markets is the potential path of the U.S. dollar. Questions have arisen as to the impact of massive U.S. fiscal and monetary stimulus on the value of the dollar, and the impact of the dollar on inflation, interest rates, trade flows, the composition of foreign exchange reserves, the prices of commodities, and the overall economic dominance of the U.S. Given these concerns, it is worthwhile to examine some of the basic questions that are being asked.

But first, consider a few simple facts. The dollar has fallen to sell dollars in order to secure higher returns elsewhere, about 15 percent in value during the past eight months especially in Europe. Thus, the low value of the dollar is against a trade-weighted basket of major currencies. Yet not a new story. Still, investors are concerned about where that brings it roughly back to where it was prior to the we go from here. Hence, these questions: start of the economic crisis. That is because the dollar Figure 1: U.S. Dollar Trade-Weighted Index Jan 1997=100 rose sharply when the crisis began in late 2008. Still, the dollar is near a low point in recent history. Most of the140 drop in the dollar, however, occurred over a seven-year 130 span beginning in 2002. Since then, the dollar has fallen about 40 percent as financial market participants became 120 concerned about the sustainability of the large U.S. trade 110 deficit. They expected that only a considerably lower dollar 100 would boost U.S. exports sufficiently to put the U.S. deficit on a sustainable path. Knowing that other investors had 90 similar expectations, they pushed the dollar down lest h t caught holding over-valued dollars. In addition, 80 t ey ge 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 historically low U.S. interest rates encouraged investors Source: Federal Reserve Bank of St. Louis

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Gloal Ecoomic Outlook  1st quarter, 2010

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Wy as te dollar falle lately? The drop in the dollar in the past eight months largely reflects a reversal of the flight to safety that began in September 2008 when global credit markets nearly shut down. The flight to safety entailed a huge increase in the difference between most market interest rates and the rate on risk free assets such as U.S. Treasuries. This difference, or risk spread, rose to levels not seen since the Great Depression as investors became worried about holding any but the safest assets. Since markets deem U.S. government securities to be the safest asset, the demand for dollars rose sharply. Since then, governments and central banks have massively injected liquidity into the banking system, re-capitalized banks, stimulated the market for securitized assets, and increased the transparency of the financial system through stress tests of banks. The result is that risk spreads have not only declined, they have fallen below the level that prevailed prior to the start of the crisis. In other words, the flight to safety is over and investors are well into the process of diversifying their portfolios. That means selling U.S. Treasuries and purchasing riskier assets, including non-dollar denominated assets. Hence, the drop in the dollar back to where it was prior to the crisis. Will te dollar cotiue to fall, ad wy? On a trade-weighted, inflation-adjusted basis, the dollar is now roughly near the low point it reached on a few prior occasions such as 1979 and the late 1990s. Given that fact, some might expect the dollar to rise once again as it did in the past. Yet the principal factor that caused the dollar to rise in the past — tightening monetary policy — is not in effect now nor is it imminent. Instead, there is a strong argument to expect the dollar to fall further. Moreover, it would largely be a good thing. The problem is that, in the past decade, U.S. households and businesses consumed more than they produced, or invested more than they saved (this difference is the current account deficit, similar to the trade deficit). Historically low inflation, combined with massive flows of liquidity into the United States from China, led to very low interest rates. This, in turn, encouraged excessive investment in housing, which caused a rise in housing prices. The housing bubble caused households to feel wealthier, thus negating a need to save. The paucity of saving led to a need to borrow from overseas to fund investment and consumer spending. In the course of such borrowing, the U.S. economy accumulated a large foreign debt, the servicing of which is exacerbating the external (current account) deficit. Moreover, although the private sector has de-leveraged in the face of massive debt, the public sector has taken on new debt in order to offset the negative impact on economic activity.

Going forward, the current account deficit will have to decline lest the debt service payments become unsustainable. This means that consumption will have to shrink relative to production. That could come about from a permanent state of recession, yet this is hardly desirable. It could come about from a sizable increase in saving. Yet although private saving is up, public saving is down in the form of a government budget deficit. Cutting the budget deficit would help with the current account deficit, but doing so will have a negative impact on economic activity as long as the economy is operating below capacity. Moreover, cutting the budget deficit quickly does not seem likely. Instead, cutting the current account deficit will, in part, require a lower valued dollar. This would raise import prices and, thereby, cut the growth of imports. More importantly, it would lower U.S. export prices and, hence, increase U.S. exports (this is already happening). In this scenario, since financial market participants understand that this must happen, they will push the dollar down until they are confident it has reached a level that will render the current account deficit sustainable. Investors will be unwilling to purchase dollars if they expect it to fall. Thus, it will fall until investors are willing to make such purchases. Moreover, expectations of decline will cause investors to diversify their portfolios away from dollars, thereby pushing the dollar down further. On the other hand, fear of the impact of offsetting policy actions will keep the dollar from falling faster. Wat aout te dollar carry trade? Due to the near-zero interest rates in the United States, some investors are borrowing in dollars and purchasing higher yielding assets in other currencies. This “dollar carry trade” can only exist if investors expect that the dollar will not fall sufficiently to offset the higher return on non-dollar assets. Why is there such an expectation? The answer is that some Asian governments (primarily China and Japan) continue to intervene in currency markets to prevent their currencies from rising against the dollar. As long as this persists, the dollar carry trade will be profitable. Yet it brings risks. It is probably the culprit behind the huge rise in equity and property prices in Asia. In other words, easy U.S. monetary policy, rather than causing an asset price bubble at home, is causing a potential bubble overseas. This has policymakers concerned. If China were to allow its currency to rise, the dollar carry trade might shut down leading to a bursting of the asset price bubble in China and huge losses for investors active in the carry trade. If those investors are heavily leveraged, the losses could cascade across the global economy.

Wat impact will U.S. fiscal ad moetary policy ave o te dollar? Many observers are concerned that the aggressive nature of U.S. monetary and fiscal policy will ultimately lead to a run on the dollar. Why? First, aggressive monetary policy has meant extremely low interest rates and a huge increase in the size of the Federal Reserve s balance sheet. The latter has come about due’ to Fed purchases of government bonds, agency bonds, and other securitized assets. This quantitative easing”“ was necessary in order to prevent a destructive drop in the money supply at a time when bank lending seized up and credit markets shut down. The fear, however, is that once financial market behavior returns to normal, all the liquidity created by the Fed will lead to high inflation. If that happens, the dollar would probably fall as investors worry about the declining purchasing power of the dollar. However, there are two problems with this scenario. First, the Fed has powerful tools for mopping up excess liquidity. In fact, the Fed is already planning to use such tools to unwind the large positions it has taken. Also, despite the aggressive monetary policy, the money supply itself has not yet increased at a rapid pace. So it seems unlikely that U.S. inflation will get out of hand anytime soon. Second, even if the Fed fails to act quickly enough to remove liquidity, rising inflation would likely be met by a tightening of monetary policy. The latter would have the effect of increasing the value of the dollar. Second, the large fiscal deficits of the U.S. government could bode ill for the dollar. With large deficits, the U.S. government may need to borrow large sums from foreigners — especially if domestic saving is insufficient. If foreigners are unwilling to lend to the United States at given interest rates, they will either require higher interest rates or a cheaper dollar. Hence, the expectation of large future budget deficits could lead to further downward pressure on the dollar. If, on the other hand, the U.S. government develops a credible plan to reduce future deficits, the dollar would likely be unaffected. Finally, other governments such as those of Western Europe are also facing large budget deficits. Given the larger size and liquidity of the market for U.S. government debt, investors might be less concerned about U.S. deficits than those of other countries. If that were to be true, there could be upward pressure on the dollar.

Wat impact will a fallig dollar ave o iflatio i te Uited States? In theory, a falling dollar should be inflationary for the United States, all other things being equal. Yet in practice, a moderate rate of dollar depreciation may not necessarily be inflationary. The principal vehicle by which a falling dollar affects inflation is through its impact on import prices. If the dollar falls, and the foreign currency cost of imported goods remains unchanged, then the dollar cost of purchasing those goods should increase. Yet businesses that export to the United States can change their pricing in order to preserve or gain market share — even at the cost of reducing profit margins. In the longer term, they can shift the location of production in order to take advantage of lower wages or transport costs. For example, many apparel and footwear manufacturers in China are already shifting production from factories in the coastal cities to those in China’s interior where wages are much lower. Hence, they can offset a rising Chinese renminbi by taking advantage of lower wages in alternative locations. Indeed, during the period from 2002 to 2007 when the dollar fell roughly 40 percent against a basket of currencies, import prices in the United States rose roughly 24 percent. Instead, the larger impact of a falling dollar has been on export prices, thereby stimulating the volume of exports.

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Gloal Ecoomic Outlook  1st quarter, 2010

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What impact will a falling dollar have on trade flows? The global economy has been seriously imbalanced during the past decade. This has entailed a large U.S. current account deficit in which the United States has consumed excessively relative to production and borrowed from abroad to make up the difference. At the same time, China and other surplus nations have saved excessively, exporting their excess saving to the United States. As this imbalance has become unsustainable, it will likely unwind, in part through a decline in the value of the dollar. As the dollar falls, U.S. export growth will accelerate. Surplus countries like China, Japan, and Germany will have to shift toward growth based on domestic demand rather than to focus on exports. Failure to do so may condemn these countries to slower economic growth. That is because they will not be able to depend on the U.S. consumer to underwrite their growth. The bottom line is that a falling dollar has the ability to play a major role in reversing the large imbalance in the global economy. The biggest obstacle to this is the fact that, for now, the value of the dollar is not declining against the Chinese renminbi. As such, the dollar is falling against other major currencies. A change in China’s policy in this area would take pressure off of such currencies as the euro and the yen. Wat if tere is a ru o te dollar? Although there is a strong case to be made that a falling dollar is nothing to worry about, and although there are not necessarily fundamental reasons for a large drop in the value of the dollar, strange things can still happen. Financial markets respond not only to fundamentals but to market psychology. Herd trading — where investors follow the behavior of others lest they miss an opportunity or get left holding the bag — happens more frequently than models predict. Most models of financial markets include the assumption that asset price movements follow a normal shaped bell curve in which large movements are low probability events along the long tails of the bell curve. Yet experience has shown that asset markets are often characterized by big tails. That is, large asset price movements come in clusters associated with herd trading. This happens when asset prices rise (bubbles) and when they fall (crashes). The point here is that the dollar could suddenly move rapidly in a particular direction — most likely downward. It could come about if a particular news item confirms fears that already haunt the markets. If that were to happen, the dollar could come under attack. Investors would sell dollars in order to avoid losses, leading to a further decline in the dollar. Difficulty in selling dollars would drive up long-term interest rates in the United States and the economy could

come under serious pressure. Policymakers would probably undertake efforts to stabilize currency markets, even if that meant raising short-term interest rates. At the end of the day, the dollar would be stabilized, but at the cost of undercutting U.S. and global economic recovery. This is not a happy or desirable scenario, but it is certainly plausible. Will te dollar e replaced as a reserve currecy? Concerns about the value of the dollar have caused concerns about the future role of the dollar as a reserve currency. First, a few basic facts about reserves: Historically, central banks have maintained a reserve stash of foreign currencies in order to maintain a fixed exchange rate. They would utilize their reserves to intervene in currency markets to prevent their currency’s value from shifting beyond a certain range. They also held reserves in order to cover the cost of imports when export revenue declined. When developed countries switched to a regime of floating exchange rates in 1973, these countries no longer needed sizable reserves. Yet most emerging countries continued to target the value of their currencies. Either they kept their currencies overvalued in order to keep imports cheap, or they kept their currencies undervalued in order to boost their exports. In the 1990s, many emerging countries attempted to keep their currencies overvalued in order to keep capital imports cheap. The result was that countries had to continually sell reserves in order to prevent their currencies from falling in value. When several countries faced nearly depleted reserves, a financial crisis ensued. Countries devalued their currencies, thereby increasing the cost of imports, and raised interest rates in order to quell new inflationary pressures. Since that episode, most major emerging countries have chosen to maintain low-valued currencies in order to generate trade surpluses and thus prevent future crises. The result was that China, Korea, Taiwan, Singapore, and others have accumulated vast supplies of reserves — far beyond the need to cover the cost of imports during a crisis. In fact, these reserves have essentially become investment vehicles for emerging country governments. Many have diverted funds from their reserves for use as sovereign wealth funds. For decades, most countries have held their reserves mostly in the form of U.S. dollars. This was due to the high degree of dollar liquidity, itself a consequence of the large and liquid market for U.S. government bonds. In recent years, as countries have accumulated such vast reserves, they have started the process of diversifying away from dollars. In doing so, they have contributed to the downward movement of the dollar. Such diversification will likely continue as countries view their reserves as investments. Yet the question arises as to whether the dollar’s role as the principal reserve currency is threatened.

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pressure on the dollar. According to some, concern about capital losses on dollars will drive central banks to switch to other currencies. But which currency would they hold? The euro is the most likely candidate. Yet unlike the United States, the Eurozone lacks a single fiscal authority and therefore lacks a large, single market for government bonds. Today, some Eurozone countries face serious concerns about the riskiness of their debts. Thus holding sizable reserves in euros could be problematic in terms of liquidity and sovereign risk. Only when Europe creates a single fiscal authority (unlikely anytime soon) will the euro be a serious contender for dominant reserve currency. Some observers, including members of China’s leadership, suggest the IMF’s Special Drawing Rights (SDRs). Yet these are nearly completely illiquid and are, essentially, a basket of major currencies. Finally, some people have suggested gold. Indeed the central banks of China and India have lately increased their purchases of gold. Yet there is no return on holding gold and its value is historically volatile. Gold’s experience as a reserve currency in the past turned out to be troubled. Moreover, the value of gold is easily manipulated by those who produce it (Russia, South Africa) and those who hold vast reserves already (the U.S. government).

Finally, even if the dollar falters as a reserve currency in the future, it will probably take a very long time for this to occur. It took decades for the British pound to lose its cherished status even after Britain was no longer the world’s dominant economy.

In sum, the role of the dollar as a reserve currency seems unthreatened. Confidence in the dollar was evident when, during the financial crisis that started in September 2008, there was a rush to hold dollars as part of the flight to safety.

Will more trade take place i oter currecies? As long as the dollar is the principal reserve currency, it is likely to remain the principal currency for the denomination of traded goods. The same reasons hold. The dollar is the most liquid currency, the United States has the largest and most liquid financial market, and the market for U.S. government bonds is far larger and more liquid than the markets for any other country’s debt. Although emerging countries have lately engaged in currency swap arrangements in order to encourage trade in their own currencies, it is unlikely that exporters in emerging countries will desire payment in the currencies of other emerging countries.

Why are people worried about this? The answer is that the fear of U.S. inflation as well as concerns about the ability to finance large U.S. deficits creates the potential for downward pressure on the dollar.

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