Global economy: The New Year brings a new agenda. In 2009, as the blue emergency lights flashed, extreme policy-making was permitted: anything to avert depression and deflation. But now recovery has arrived and anything goes won’t be enough to keep markets happy.
A little New Year celebration is warranted. Extreme stimulus has worked. Instead of sliding into depression, the world is picking up speed. China hardly lost it. By sustaining a GDP growth rate of close to 8 per cent it helped avert a deeper global slump. But China has taken big chances to sustain high growth. Its stimulus cost 13 per cent of GDP. Its lending and money growth are rising at annual rates of almost one third.
Across the Pacific, the United States has also taken big monetary and fiscal risks to escape recession. At present, the gamble is paying off. It looks like GDP grew at an annual rate of more than 4 per cent in the fourth quarter of 2009, and private employers may have added jobs in December. Companies, having run down inventories for three years, will soon start to increase production. Banks, though still weak, may be ready to lend more. A still weak, export-stimulating dollar should help.
Strong US growth is possible in 2010, but with it inflation may also rebound strongly. The annual inflation rate jumped to 1.8 per cent in November and could rise to almost 3 per cent in December. The Federal Reserve and the economic consensus don’t expect the uptick to last. Unemployment is high, spare capacity abundant.
But easy money has boosted the prices of oil and other internationally traded commodities. US manufacturers are desperate to pass the higher prices of raw materials through to their customers. If they find demand for their products, they will do so. That, along with the still abundant liquidity, could trigger a round of price and wage increases through the rest of the economy.
Unexpected inflation would mean that the Fed’s lengthy period of extreme generosity is coming to an end. The central bank could be raising rates as soon as the first quarter of 2010, rather than in 2011 as many economists assume.
A US move from loose money to tightening will bring big change and much uncertainty for investors. Flows may retreat from some emerging markets as the dollar carry trade — borrowing in dollars to invest in higher yielding assets — reverses. Equity markets will have to balance their recovery euphoria with a realisation that money won't remain almost free.
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In China the scope for falls in equities, up by three-quarters in 2009, is large. A decline in foreign inflows could provoke a sizeable correction. Meanwhile, the case for domestic monetary tightening is already strong. Excessive lending may be nurturing overcapacity and future banking crises. Still, the greatest dangers on China's risky road may not be when global growth is rebounding, but some years distant.
It is the countries that are failing to rebound that look most vulnerable in 2010. The rapid increase in Greek government bond yields at the end of 2009 is a harbinger. Things look bad in the euro zone. The supply of corporate credit is still shrinking, despite the European Central Bank's churning out of cheap money for banks. Only weak growth is likely in 2010.
That leaves the zone’s weaker links especially vulnerable. Portugal, Ireland, Greece, Italy and Spain seem caught in a deflationary trap. They need to balance their budgets and get their economies and tax revenues going despite having lost competitiveness against France and Germany, and despite a euro which, at a value of $1.43, remains 70 per cent above its lows of a decade ago. Government debt is soaring in each of these countries; and in some of them the interest rate spread over German debt is soaring, too.
And outside the euro zone, the UK , one of the world's biggest economies, also looks set to grow only weakly while its government tries to raise close to 200 billion pounds ($318 billion) in deficit financing. Will the markets cough up? Or will the UK's huge gamble end in crisis and emergency cuts, even before a mid-2010 election?
In 2010, investors will be looking for countries to get off the hospital bed and get moving. Those that can't be quick look vulnerable. From averted global crisis to national crises: it will be progress, of a kind.