The document summarizes risks facing the global economy, including rising commodity prices increasing inflation risks, natural disasters in Japan widening risks, and political changes in the Middle East. While the recovery has gained footing, these risks threaten to undermine continued growth. Inflation concerns have replaced deflation fears as the main risk. The impacts of Japan's earthquake and nuclear issues are still unfolding but will likely slow Japan's growth initially and increase costs of reconstruction.

1. The Global Economy
Monthly letter from Swedbank’s Economic Research Department
by Cecilia Hermansson No. 3 • 25 March 2011
Widening risks in the global economy
• The global economy developed positively last year and the recovery has gained a
better foothold. The overriding risks have shifted from deflation and a double dip to
inflation and stagflation. Rising commodity prices – and the higher inflation and
interest rates that come with them – seem to be the biggest risk to the recovery.
• Risks are also widening as a result of the catastrophe in Japan, the nuclear power
issue and democratisation in the Middle East. These risks are by no means
negligible, but they are comparatively modest. Political risks are critical to how
euro zone manages its crisis. What are needed are institutions that can generate
greater discipline while keeping the region intact.
• The focus this year will be on exit strategies. When quantitative easing is phased
out, the “right prices” will start appearing on markets that have been aided by the
stimulus, including financial services, commodities, real estate and indirectly many
product markets. Introducing fiscal austerity at the same time that central banks
begin raising benchmark rates earlier than they would like to due to the risk of
inflation could undercut the recovery, especially in more developed countries.
Natural disasters and democratisation – Inflation according to consumer price index (CPI)
risks are widening in a number of countries (%)
17.5
In many ways the global economy has developed India
15.0
positively in the last year. The recovery has gained
12.5
a stronger foothold in the US, Europe and other
10.0 China
Percent
developed countries at the same time that emerging
economies have continued to grow at a fast pace 7.5
Brazil
and with a significant boost from global growth. 5.0
UK
GDP growth exceeded 4.5% last year for the 2.5 US
portion – about 70% – of the global economy that 0.0
Germany Japan
we forecast. -2.5
jan maj sep jan maj sep jan maj sep
Businesses have reduced costs and become more 08 09 10 Source: Reuters EcoWin
efficient. Relatively strong balance sheets and rising
earnings now allow them to increase their The crisis in the euro zone is far from over, but now
investments and hire again. There is the possibility that expectations that Spain will need a bailout have
therefore that the recovery will continue in the years declined, so have the concerns of a collapse in the
ahead. But there are also risks that threaten this banking system or the euro. On the other hand,
positive scenario. Portugal is (not surprisingly) inching closer to
needing a bailout, especially now that Prime
The risk picture has changed as the focus has Minister José Socrates has resigned and there is no
shifted from deflation and a double dip to inflation national consensus in parliament how to tackle the
and the risk of stagflation. Escalating commodity budget.
prices are the main reason for higher inflation in
emerging countries, but also in more developed Since the beginning of the year risks have widened
countries. due to what would seem like black swans, i.e.,
unpredictable events that can have a huge impact
Ekonomiska sekretariatet, Swedbank AB (publ), 105 34 Stockholm, tfn 08-5859 1000
E-mail: ek.sekr@swedbank.se www.swedbank.se Ansvarig utgivare: Cecilia Hermansson, 08-5859 7720.
Magnus Alvesson, 08-5859 3341, Jörgen Kennemar, 08-5859 7730

2. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 3 • 25 March 2011
when they occur and which many people find which in turn would slow production for companies
explanations for afterward, making them seem less that don't have enough inventory.
like a coincidence and more predictable than they
actually were. A more wide-ranging and long-term effect on the
global economy could be in terms of public support
The democratisation process in the Middle East is for nuclear power and how we assess the risk of
an example of this. While there may have been unlikely but powerful events. In Germany, nuclear
expectations that the process would eventually power plants are being taken off line pending a
happen, it was hard to predict when, what would set more thorough investigation of their safety. In the
it off and how it would affect the rest of the world. meantime demonstrations have sprung up, mostly
Another example is the earthquake and tsunami in in Europe, which could change the way people feel
Japan. They were also expected, but within a 30- about nuclear energy. In the US there is a debate
year period and hardly with the impact this one has whether current safety precautions are adequate,
had. There are still fears that the “big one” will more since assumptions were based on earthquakes that
fundamentally affect the capital, Tokyo. The impact had already occurred (around 7 on the Richter
of the nuclear power problem has to be added to scale), not those that could occur (considerably
the experience we have from similar events, like higher). The question is how much nuclear energy
Kobe in 1995, which makes comparisons between will grow. The biggest expansion is planned in Asia,
this and previous catastrophes much more difficult. mainly in China and India. China has 13 reactors in
operation, is currently building 27 and has plans for
The area that was hit represents about 8% of another 50. On top of that, it is considering 110
Japan's GDP, so the direct effects of the more. How nuclear waste affects Japan and its
catastrophe will be concentrated in Japan and to people is not clear yet, but reports that drinking
only a lesser extent the global economy. Initially water, seafood and vegetables have to be avoided
Japan's GDP will shrink, but in time the region will are creating fear and uncertainty about the affected
have to be rebuilt, which will stimulate growth, so region’s agricultural and seafood production and the
that the average won't be affected all that much. It's impact on domestic consumption, exports and even
likely that Japan's projected GDP growth of around tourism.
1.5% this year will drop to 0 or just a bit above. On
the other hand, the reconstruction costs will be Global purchasing managers index (PMI global) and the
huge: some estimates say USD 300 billion, or 5% price of oil per barrel in US dollars
of GDP. These resources will be invested over an 80 140
extended period of time, beginning later this year. 75 130
GDP growth will be higher for a while, not that 70 120
Japan will become any richer, since it will simply be 65
PMI output global 110
USD/Barrel
replacing the assets it has lost. 60 100
Index
55 90
There is also an impact on the global economy. In 50 80
the short term demand will decline from Japan, the 45 70
Oil price brent in
world's third largest economy (if the EU is counted 40 60
USD
as separate countries). This could also affect 35 50
commodity prices and interest rates, which are 30 40
falling. Eventually they will rebound and prices and jan apr jul okt jan apr jul okt jan apr jul okt jan
rates will rise. Japan may have to transition to other 08 09 10 11
Source: Reuters EcoWin
energy sources, including natural gas and oil. Until
interest rates rise, Japan, a major capital exporter, Developments in the Middle East are likely to have
will need more capital at home and perhaps will be a lager effect on the global economy through the
less interested in financing the current account price of oil. Thus far oil supplies from Libya have
deficits of other countries, particularly the US. As a been replaced by other countries in the region, but
result, the competition for capital, which could grow, uncertainty how the wave of democratisation may
is generating higher interest rates. The catastrophe affect more important oil producers such as Saudi
is reinforcing this trend. Another effect, though Arabia is still pushing the price of oil higher. The
probably more short term, is that the global supply fact that the West will not accept dictators who kill
chain could break down when Japanese products, their own people and made a unique decision to
especially from the electronics and auto industries, step in may help the democratisation process in
are no longer available. Until companies can find other countries. Yemen, Bahrain and Syria have
alternative sources, supplies could be affected, oppositions that are demonstrating against their
current rulers, continuing the process that started in
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3. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 3 • 25 March 2011
Tunisia, Egypt and Libya, but with some more raw materials are needed. When people see
differences. their job opportunities and incomes improve, no
matter where in the world, demand for food and fuel
Rulers throughout the Middle East are trying to rises as well.
bribe their people with higher energy and food
subsidies, even raising public sector salaries by The second is supply problems, especially in food
several hundred percent. Saudi Arabia has the production. Drought and fires have reduced the
resources to continue to support its population in supply of crops. There are also questions about the
this way, while guest workers are left out. Not until impact of using crops to produce energy.
democracy reaches Saudi Arabia can this political
risk be discounted, and that could take several The third reason is that the monetary stimulus –
years. especially the quantitative easing, which has
increased liquidity – has led to greater interest in
Moreover, we know very little about the investing in commodities and emerging markets,
governments that take over once former rulers have which has raised commodity prices. Add to that the
been forced out. The region has little experience increased uncertainty whether the easing will lead
with democracy and has religious groups with to higher inflation in the medium term and what you
conflicting interests that could lead to civil war. After find is greater interest in gold, for example, where
a period of “stable dictatorships” could come a prices are now at record highs.
period of “unstable dictatorships” or “unstable
democracies” before we see what we really want – Fourthly, the concerns about oil prices in
“stable democracies” that eventually lead to greater connection with the democratisation process in the
predictability with regard to the world's most Middle East have to be factored in. Right now the
important oil producers. price of oil is outpacing production on a global level,
mainly due to political risks.
Political risks are now increasing in addition to the
economic risks involving the financial and When the global economy is in a period of recovery
commodity markets, monetary and fiscal policies in and demand rises, higher prices can be more easily
the wake of the huge public debt run-up, and crisis tolerated. If prices rise too much, however, there is
management in connection with euro zone and US a risk that the recovery could falter. Rising food and
banks. This is due in no small part to the events in energy prices take a bigger chunk out of people's
the Middle East, where geopolitical and security wallets, and they spend less. If central banks have
risks are rising following the recent air attacks. to raise interest rates to choke off rising inflation,
higher interest expenses will leave less room for
It is also important how politicians manage the other consumption. For companies, input costs in
challenges that governments around the world are production rise, profits shrink and it becomes more
facing, including 1) the US administration and its difficult to invest and hire workers. Lower demand
structural imbalances and medium-term fiscal could also hurt earnings. It would be easier to
challenges, 2) the Chinese administration and an handle such a situation if the recovery were strong
overheated real estate market, 3) the Japanese and robust, but if it is fragile – due in part to fiscal
government and the challenges following the austerity, as is true in many European countries –
catastrophe in an already weak economy, and 4) rapidly rising commodity prices could pose a
European governments and the challenges to greater risk.
building strong institutions in the euro zone that
keep members together and make them Whether oil prices have to reach USD 130-150 a
competitive. barrel to threaten the recovery or it’s enough that
they rise above the current rate of USD 115 is hard
Growing focus on commodities and to predict. The higher the price rises above the
inflation current level, the greater the risk that the recovery
could falter.
Commodity prices have risen significantly in the last
half year. Commodity trends are analysed by What's important in is how central banks act. Import
Swedbank through Jörgen Kennemar in his monthly prices usually can’t be slowed by raising benchmark
letter. Here are a few thoughts about the reasons rates, but there is a limit to how patient these
for the price increases and the effects. central banks can be if import prices push inflation
expectations higher and cause workers to demand
First, commodity prices are rising because demand
higher wages. In other words, it is the second-hand
has increased as the recovery gains strength.
effects that are the biggest concern.
When the wheels roll faster and production grows,
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4. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 3 • 25 March 2011
In the US, the Federal Reserve is probably more ready to take over. In Europe, it will be a challenge
concerned about weak growth than high inflation, for banks and governments when the ECB is no
while the European Central Bank (ECB) may start longer buying bonds. It's a question of getting
thinking the opposite. Expectations are that the markets to work normally again at the same time
ECB will raise interest rates as soon as April and that interest rates begin to rise.
then a few more times this year, and that the Bank
of England will launch a period of rate hikes in the Decision-makers in emerging countries have been
middle of the year. Countries that are consolidating slow to introduce austerity in their economic
their budgets more aggressively, like the UK, could policies. Negative real interest rates are still fuelling
see the double dip that fewer experts are now demand, especially for real estate in countries such
predicting. as China. These countries also have to phase out
their stimulus plans and implement measures to
Exit strategies are a bigger risk than we reduce the risk of overheating and an economic
suspect hard landing.
Economic policies during the financial crisis and The fact that the global economy is having to go
recession were highly expansive, with interest rates through rehab in 2011 means that there is a risk of
around zero, bloated balance sheets in central fluctuations in some markets before the “right”
banks to support markets with quantitative easing, prices are found. The key is to stick it out and avoid
and expansive fiscal policies with lower taxes/VAT a relapse!
and more room for spending. The era of financial
stimulus has now run its course and economic Cecilia Hermansson
decision-makers face the challenge of tightening
fiscal policies in order to address the problem of
explosive public debt, at the same time that rising
inflation and commodity prices are hastening a
normalisation of monetary policies in Europe and
perhaps the US.
In addition, the quantitative easing in the US will
expire at the end of June when QE2 comes to an
end without being replaced by QE3. The recovery,
rising inflation and more efficient credit markets
make it difficult to argue otherwise.
Financial, commodity and real estate markets, as
well as a number of product markets, have been
benefitting from the quantitative easing for some
time. As a result, it is hard to know what the true
prices are in these markets and what will happen
when quantitative easing is finally phased out and
central bank balance sheets are trimmed. There is
a risk of turbulence, and if that gets too high there is
a risk that QE3 will be needed to avoid a major
setback in the recovery. The US economy has to try
much harder to manage without a stimulus, and
there is a question whether the private sector is
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Cecilia Hermansson, 08-5859 7720. göras ansvariga för förlust or skada, direkt or indirekt, på grund av eventuella fel or brister
Magnus Alvesson, 08-5859 3341 som redovisas in Swedbanks Månadsbrev.
Jörgen Kennemar, 08-5859 7730
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