A new world order
Policy works. Recovery happens. But there is a price to be paid. That may turn out to be the message of 2010.
One key underlying theme is shaping the world economy. That is the shift in the balance of economic and financial power. The countries that succeed in this shift will fit into one of three categories. They will have the financial resources, such as China or, say, Qatar. They will have natural resources, including water, energy and commodities and will include the likes of Brazil, Canada, and many countries across Africa. The third group will be those that have the ability to adapt and change and, in my view, will include the US and the UK.
Whilst this is the longer-term shift we should be aware of, there are more immediate factors also impacting the 2010 outlook: the impact of debt and deleveraging in the West; and exit strategies following the huge policy stimulus unveiled over the last year. Thus the outcome in 2010 depends on the interaction between the fundamentals, policy and confidence. Of these, confidence is the hardest to call. It may well turn out more positive.
The fundamentals and policy issues are more clear-cut. The crisis was triggered by both a systemic failure in the financial system and by an imbalanced global economy. Both need to be fixed. Rebalancing implies the West becomes relatively poorer, spending less and saving more, and that high-surplus regions such as the Middle East and East Asia do the opposite, spending more and saving less. The trouble is, in many cases, this is not the natural response to a crisis. Indeed, across Asia, saving more -- not less -- is the natural reaction to a crisis. Hence, there is a need for Asia to deepen its social safety nets, provide help to small and medium-sized firms, and deepen and broaden its bond markets. All of these are possible, but take time.
Guessing whether the shape of the recovery will be a U, V or W, whilst important, overlooks a key point. Levels matter. The world economy is $61 trillion in size, with the US $14.4 trillion, Japan $4.7 trillion and China $4.4 trillion. The West accounts for two-thirds of the world economy. If the West is not booming the world will not boom. And there is no way the West is going to boom. The old model is broke. Savings will not flow uphill from Asia and the Middle East to fuel debt-binges in the West. This spells change. The US consumer faces sluggish wages, high unemployment, house prices well off their peak and worries about pensions and will no longer drive the world economy.
As a result, it will be an insipid recovery in the West and we expect the global economy to grow 2.7 per cent in 2010, after a 1.9 per cent fall in 2009. This is a modest recovery particularly when one thinks how much has been thrown at the problem. But within this, the strongest growth rates will be seen across emerging economies, particularly Asia, Africa and the Middle East. The pace and scale of change, and the catch up potential is huge. Moreover, Western firms and savers are continuing to look to invest in these faster growing, lower cost economies. We forecast Asian growth accelerating to 7.0 percent in 2010 from 4.5 percent in 2009, with domestic demand-driven economies such as China, India and Indonesia growing by 10.0 percent, 7.5 percent and 5.5 percent, respectively.
But there are challenges, particularly on policy which has driven much of the rebound over the last year. The global policy stimulus has been sizeable, synchronised and successful. However, low interest rates mean that, as in the boom, financial markets are not pricing for risk. Meanwhile, huge fiscal stimulus has added to worries about the implications. Thus there are already calls for policy to be tightened.
In the West, policymakers need to tread carefully. Premature policy tightening would be disastrous. For them inflation is not the problem. Low interest rates need to remain in place for some time. Across the emerging world the challenges are different. Some countries are seeing asset price inflation and fear the consequences of rising commodity prices. But there is a policy dilemma for many countries. If emerging economies such as India or South Korea raise rates then they are likely to see capital inflows, fuelling domestic asset prices. But if they do not raise rates then domestic asset prices, particularly equity and property prices will rise anyway. Eventually those economies seeing stronger domestically-driven growth will raise rates. A key lesson is the need to set monetary policy to suit domestic needs.
The last leg of the policy and rebalancing debate is currencies. Expect to see more countries increase their currency reserves, both as a precautionary measure in case there is another crisis, and also because of intervention to ensure competitiveness. Although countries are worried about the dollar they are reluctant to sell it aggressively, lest it triggers the crisis they fear. I call it passive diversification. As reserves rise, expect to see less and less allocated to the dollar. The dollar is not a one-way bet, although the longer-term trend is weaker. The key in 2010 will the Chinese yuan. Gradualism dictates China's currency policy. From this spring we expect to see appreciation, albeit at a gradual pace. As China moves, others will follow.
A salient lesson of recent years for all economies is that the fundamentals matter. Whether it was the financial crisis itself, or the recent problems in Dubai, one lesson is that if something does not happen immediately, this does not mean that it will not happen at all. Markets that are out of line with long-term trends or economies that appear imbalanced should send alarm bells ringing. In 2010, it would not be a surprise if there were further shocks. But, whatever happens, it is important not to lose sight of the longer-term shift in the balance of power. This has already begun. It has a long way to go.
The writer is the chief economist at Standard Chartered Bank