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The Global Economy, No. 3/2011


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The Global Economy, No. 3/2011: Widening risks in the global economy

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The Global Economy, No. 3/2011

  1. 1. The Global EconomyMonthly letter from Swedbank’s Economic Research Departmentby 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 (%) 17.5In many ways the global economy has developed India 15.0positively in the last year. The recovery has gained 12.5a stronger foothold in the US, Europe and other 10.0 China Percentdeveloped countries at the same time that emergingeconomies have continued to grow at a fast pace 7.5 Braziland with a significant boost from global growth. 5.0 UKGDP growth exceeded 4.5% last year for the 2.5 USportion – about 70% – of the global economy that 0.0 Germany Japanwe forecast. -2.5 jan maj sep jan maj sep jan maj sepBusinesses have reduced costs and become more 08 09 10 Source: Reuters EcoWinefficient. Relatively strong balance sheets and risingearnings now allow them to increase their The crisis in the euro zone is far from over, but nowinvestments and hire again. There is the possibility that expectations that Spain will need a bailout havetherefore that the recovery will continue in the years declined, so have the concerns of a collapse in theahead. 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 PrimeThe risk picture has changed as the focus has Minister José Socrates has resigned and there is noshifted from deflation and a double dip to inflation national consensus in parliament how to tackle theand the risk of stagflation. Escalating commodity budget.prices are the main reason for higher inflation inemerging countries, but also in more developed Since the beginning of the year risks have widenedcountries. 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: Ansvarig utgivare: Cecilia Hermansson, 08-5859 7720. Magnus Alvesson, 08-5859 3341, Jörgen Kennemar, 08-5859 7730
  2. 2. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 3 • 25 March 2011when they occur and which many people find which in turn would slow production for companiesexplanations for afterward, making them seem less that dont have enough a coincidence and more predictable than theyactually were. A more wide-ranging and long-term effect on the global economy could be in terms of public supportThe democratisation process in the Middle East is for nuclear power and how we assess the risk ofan example of this. While there may have been unlikely but powerful events. In Germany, nuclearexpectations that the process would eventually power plants are being taken off line pending ahappen, it was hard to predict when, what would set more thorough investigation of their safety. In theit off and how it would affect the rest of the world. meantime demonstrations have sprung up, mostlyAnother example is the earthquake and tsunami in in Europe, which could change the way people feelJapan. They were also expected, but within a 30- about nuclear energy. In the US there is a debateyear 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 thatfundamentally affect the capital, Tokyo. The impact had already occurred (around 7 on the Richterof the nuclear power problem has to be added to scale), not those that could occur (considerablythe experience we have from similar events, like higher). The question is how much nuclear energyKobe 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 forThe area that was hit represents about 8% of another 50. On top of that, it is considering 110Japans GDP, so the direct effects of the more. How nuclear waste affects Japan and itscatastrophe will be concentrated in Japan and to people is not clear yet, but reports that drinkingonly a lesser extent the global economy. Initially water, seafood and vegetables have to be avoidedJapans GDP will shrink, but in time the region will are creating fear and uncertainty about the affectedhave to be rebuilt, which will stimulate growth, so region’s agricultural and seafood production and thethat the average wont be affected all that much. Its impact on domestic consumption, exports and evenlikely that Japans projected GDP growth of around tourism.1.5% this year will drop to 0 or just a bit above. Onthe other hand, the reconstruction costs will be Global purchasing managers index (PMI global) and thehuge: some estimates say USD 300 billion, or 5% price of oil per barrel in US dollarsof GDP. These resources will be invested over an 80 140extended period of time, beginning later this year. 75 130GDP growth will be higher for a while, not that 70 120Japan will become any richer, since it will simply be 65 PMI output global 110 USD/Barrelreplacing the assets it has lost. 60 100 Index 55 90There is also an impact on the global economy. In 50 80the short term demand will decline from Japan, the 45 70 Oil price brent inworlds third largest economy (if the EU is counted 40 60 USDas separate countries). This could also affect 35 50commodity prices and interest rates, which are 30 40falling. Eventually they will rebound and prices and jan apr jul okt jan apr jul okt jan apr jul okt janrates will rise. Japan may have to transition to other 08 09 10 11 Source: Reuters EcoWinenergy sources, including natural gas and oil. Untilinterest rates rise, Japan, a major capital exporter, Developments in the Middle East are likely to havewill need more capital at home and perhaps will be a lager effect on the global economy through theless interested in financing the current account price of oil. Thus far oil supplies from Libya havedeficits of other countries, particularly the US. As a been replaced by other countries in the region, butresult, the competition for capital, which could grow, uncertainty how the wave of democratisation mayis generating higher interest rates. The catastrophe affect more important oil producers such as Saudiis reinforcing this trend. Another effect, though Arabia is still pushing the price of oil higher. Theprobably more short term, is that the global supply fact that the West will not accept dictators who killchain could break down when Japanese products, their own people and made a unique decision toespecially from the electronics and auto industries, step in may help the democratisation process inare no longer available. Until companies can find other countries. Yemen, Bahrain and Syria havealternative sources, supplies could be affected, oppositions that are demonstrating against their current rulers, continuing the process that started in 2 (4)
  3. 3. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 3 • 25 March 2011Tunisia, Egypt and Libya, but with some more raw materials are needed. When people seedifferences. their job opportunities and incomes improve, no matter where in the world, demand for food and fuelRulers throughout the Middle East are trying to rises as well.bribe their people with higher energy and foodsubsidies, even raising public sector salaries by The second is supply problems, especially in foodseveral hundred percent. Saudi Arabia has the production. Drought and fires have reduced theresources to continue to support its population in supply of crops. There are also questions about thethis way, while guest workers are left out. Not until impact of using crops to produce energy.democracy reaches Saudi Arabia can this politicalrisk 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 inMoreover, 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 thebeen forced out. The region has little experience increased uncertainty whether the easing will leadwith democracy and has religious groups with to higher inflation in the medium term and what youconflicting interests that could lead to civil war. After find is greater interest in gold, for example, wherea period of “stable dictatorships” could come a prices are now at record highs.period of “unstable dictatorships” or “unstabledemocracies” 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 thepredictability with regard to the worlds most Middle East have to be factored in. Right now theimportant 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 theeconomic risks involving the financial and When the global economy is in a period of recoverycommodity markets, monetary and fiscal policies in and demand rises, higher prices can be more easilythe wake of the huge public debt run-up, and crisis tolerated. If prices rise too much, however, there ismanagement in connection with euro zone and US a risk that the recovery could falter. Rising food andbanks. This is due in no small part to the events in energy prices take a bigger chunk out of peoplesthe Middle East, where geopolitical and security wallets, and they spend less. If central banks haverisks are rising following the recent air attacks. to raise interest rates to choke off rising inflation, higher interest expenses will leave less room forIt is also important how politicians manage the other consumption. For companies, input costs inchallenges that governments around the world are production rise, profits shrink and it becomes morefacing, including 1) the US administration and its difficult to invest and hire workers. Lower demandstructural imbalances and medium-term fiscal could also hurt earnings. It would be easier tochallenges, 2) the Chinese administration and an handle such a situation if the recovery were strongoverheated real estate market, 3) the Japanese and robust, but if it is fragile – due in part to fiscalgovernment 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 aEuropean governments and the challenges to greater risk.building strong institutions in the euro zone thatkeep members together and make them Whether oil prices have to reach USD 130-150 acompetitive. barrel to threaten the recovery or it’s enough that they rise above the current rate of USD 115 is hardGrowing focus on commodities and to predict. The higher the price rises above theinflation current level, the greater the risk that the recovery could falter.Commodity prices have risen significantly in the lasthalf year. Commodity trends are analysed by Whats important in is how central banks act. ImportSwedbank through Jörgen Kennemar in his monthly prices usually can’t be slowed by raising benchmarkletter. Here are a few thoughts about the reasons rates, but there is a limit to how patient thesefor the price increases and the effects. central banks can be if import prices push inflation expectations higher and cause workers to demandFirst, commodity prices are rising because demand higher wages. In other words, it is the second-handhas increased as the recovery gains strength. effects that are the biggest concern.When the wheels roll faster and production grows, 3 (4)
  4. 4. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 3 • 25 March 2011In the US, the Federal Reserve is probably more ready to take over. In Europe, it will be a challengeconcerned about weak growth than high inflation, for banks and governments when the ECB is nowhile the European Central Bank (ECB) may start longer buying bonds. Its a question of gettingthinking the opposite. Expectations are that the markets to work normally again at the same timeECB 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 Bankof England will launch a period of rate hikes in the Decision-makers in emerging countries have beenmiddle of the year. Countries that are consolidating slow to introduce austerity in their economictheir budgets more aggressively, like the UK, could policies. Negative real interest rates are still fuellingsee the double dip that fewer experts are now demand, especially for real estate in countries suchpredicting. as China. These countries also have to phase out their stimulus plans and implement measures toExit strategies are a bigger risk than we reduce the risk of overheating and an economicsuspect hard landing.Economic policies during the financial crisis and The fact that the global economy is having to gorecession were highly expansive, with interest rates through rehab in 2011 means that there is a risk ofaround 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 avoidand expansive fiscal policies with lower taxes/VAT a relapse!and more room for spending. The era of financialstimulus has now run its course and economic Cecilia Hermanssondecision-makers face the challenge of tighteningfiscal policies in order to address the problem ofexplosive public debt, at the same time that risinginflation and commodity prices are hastening anormalisation of monetary policies in Europe andperhaps the US.In addition, the quantitative easing in the US willexpire at the end of June when QE2 comes to anend without being replaced by QE3. The recovery,rising inflation and more efficient credit marketsmake it difficult to argue otherwise.Financial, commodity and real estate markets, aswell as a number of product markets, have beenbenefitting from the quantitative easing for sometime. As a result, it is hard to know what the trueprices are in these markets and what will happenwhen quantitative easing is finally phased out andcentral bank balance sheets are trimmed. There isa risk of turbulence, and if that gets too high there isa risk that QE3 will be needed to avoid a majorsetback in the recovery. The US economy has to trymuch harder to manage without a stimulus, andthere is a question whether the private sector isSwedbanks Ekonomiska sekretariat105 34 Stockholm Swedbanks Månadsbrev om den Globala Ekonomin ges ut som en service till våra kunder.tfn 08-5859 7740 Vi tror oss ha använt tillförlitliga källor and bearbetningsrutiner vid utarbetandet analyser, som redovisas in publikationen. Vi kan dock inte garantera analysernas or fullständighet and kan inte ansvara för eventuell felaktighet or brist in grundmaterialet or bearbetningen därav. Läsarna uppmanas att basera eventuella (investerings-)beslut ävenAnsvarig utgivare på annat underlag. Varken Swedbank or dess anställda or andra medarbetare skall kunnaCecilia Hermansson, 08-5859 7720. göras ansvariga för förlust or skada, direkt or indirekt, på grund av eventuella fel or bristerMagnus Alvesson, 08-5859 3341 som redovisas in Swedbanks Månadsbrev.Jörgen Kennemar, 08-5859 7730 4 (4)