International EconomIc Outlook – A Light on the Hill

By Martin Fowler

Posted: 4th November 2013 14:40

The pace of global growth has broadly accelerated since our July commentary.  The United States has added over two million jobs in the past year and robust corporate profits have driven share-markets higher.  The slowdown in China has at least been temporarily reversed with another round of stimulus reviving the rate of growth to above 7.5%.  In addition, the Eurozone came out of recession in the June quarter.
 
United States
 
The US recovery has broadly been driven by a lean and profitable corporate sector that has benefited from low interest rates, a favourable exchange rate, a flexible labour market and cheaper energy costs courtesy of the coal seam gas boom.  This has helped sustain the recovery since the Global Financial Crisis (GFC).  Nevertheless, the recovery has been one of the weakest in history due to the significant wealth erosion caused during the GFC.  This is perhaps best exemplified by looking at real household disposable incomes which remain around 9% below their 1999 peaks.  But the recovery has finally gained sufficient self-sustainability for the Federal Reserve to consider winding back its Quantitative Easing (QE) program if unemployment, currently at 7.3%, falls to at least 6.8%.  This of course is a positive development but also means that the US must now more aggressively reduce its huge government debt burden which will ensure that growth remains below trend for many years to come. 
 
Emerging Markets
 
The very announcement that the United States would begin 'tapering' its QE policy has had unintended consequences on emerging markets.  Growth has slowed sharply in many countries (including India, Indonesia, and Brazil) as funds have begun to be repatriated to developed markets on the expectation of higher returns.  These outflows have been especially problematic for those countries that rely on foreign funds to finance large current account deficits. 
 
Eurozone
 
The Eurozone has confounded most expectations in recent months by returning to growth in the June quarter.  Germany remains the strongest performer but manufacturing data shows that the recovery in Ireland is gathering pace and that Italy and Spain moved out of contraction in August.  While the data suggests the recovery is becoming more broad based, it remains off a very low base ( total output in the EZ remains 2.9% lower than it was at its peak in 2008) which means that the strength of the recovery remains very weak.  This becomes more obvious when the dire unemployment figures have yet to show any signs of improvement.  Meanwhile the region’s sovereign debt problems remain acute and progress towards a more definitive solution remains uncomfortably slow.  The risk of further significant financial market instability arising from these problems remains ever present. 
 
China
 
After slowing from 7.7% growth in the March quarter to 7.5% in the June quarter, expectations were high that the transition from an investment-led economy to a consumption-led economy would cause the growth rate to continue to slow.  Yet recent stimulus measures seemed to have halted the trend, with industrial production showing a marked improvement in August (+10.4%pa). 
 
Nonetheless, we believe the recent improvement is likely to be short-lived.  Much of China's growth since the GFC has been financed by a debt binge by local governments (via special purpose entities) and State Owned Enterprises (SOE’s), part of which was spent on unproductive infrastructure that is underutilised and unprofitable.  It is understood that a number of local governments are now struggling to make the interest repayments on monies borrowed, making a bailout by the Central Government almost inevitable in coming years.  Similarly, debts by many SOE's are also understood to be very high and their profits falling rapidly as a result of increasing interest commitments.  Of course this can only lead to a period of deleveraging by SOE's and local governments alike that, in all likelihood, will significantly reduce the growth potential of China’s economy. 
 
Conclusion
 
It is now just over five years ago when in September 2008 the global financial crisis reached its peak with the collapse of Lehman Brothers.  Since that time most of the world’s largest economies have been on life support, propped up by aggressive monetary policy initiatives orchestrated by Central Banks.  What was true then remains true today.  Central Banks cannot repair household or corporate balance sheets, restore the sustainability of government finances or enact necessary structural reforms to restore sustainable growth.  All that Central Banks can do is provide sufficient monetary support to borrow time and hope that governments, corporates and households use that time wisely.  Time is not yet running out, but much more work needs to be done. 
 
Martin Fowler is a director of Moore Stephens Sydney Wealth Management where he provides financial advice to high net wealth individuals and conducts research into the social impact of economic policy.  He is also a director of Whitefield Limited, an investment company listed on the Australian Stock Exchange.
 
Martin can be contacted by phone on +61 2 8236 7700 or alternatively via email at 
mjfowler@moorestephens.com.au

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