Trading at the Tehran stock exchange: Iran's economy could take off in the near future
Before looking into the crystal ball for 2011, it is useful to reflect for a moment on 2010.
A year ago, it seemed quite likely that world economic growth would surprise onlookers by being better than anticipated. The economies of the so-called Bric countries (Brazil, Russia, India, China) would be the mainstay of the world recovery. As we look back, this has been the case. I expected that monetary policy would remain very accommodating and that interest rates would be kept low, due to the low risk of inflation. That also has, broadly, proved true. But the outlook was not all rosy. One factor that threatened to throw us off course was the trouble in the euro area—which has lived up to expectations.
German GDP growth has to be regarded as one of the biggest surprises of 2010—and a pleasant one. The German export machine pounded on, while German employment remained strong, and there were increasing signs of a more rounded kind of economic expansion, which included robust domestic demand.
In the US, it was not surprising that the economy ended the year strongly. However, it remains something of an mystery as to why the economy suddenly lost its momentum in the period running from the spring through to the summer.
In the rest of the world, the Bric economies and other large growth economies generally delivered as expected. The surprise was the breadth of the expansion elsewhere, such as in Indonesia and Turkey.
In financial markets, there were three big themes for which 2010 will be remembered. The first was quantitative easing (QE), which is the creation of new money by the central bank and its introduction into the financial system, with the aim of boosting the money supply and stimulating growth. The consequences of QE are unknown.
The second was the threat and, in some cases, the reality of excessive government control of capital flows in and out of economies, not least in Asia, where governments have kept a tight grip on exchange rates. China is the most significant example.
The third, of course, was the mess in Europe. Most attention has been focused on the ability of debtor nations to manage their respective burdens. In my opinion, however, the European crisis remains one of structure and governance
LOOKING AHEAD
THE US: I think 2011 may be the year in which the US makes a comeback. Since the midterm congressional elections in November, most US economic indicators have gone from strength to strength—as though someone dropped magic powder out of the sky. Even though the election results led to increased partisanship in Washington, the markets see the outcome as having put pressure on President Obama to move towards the economic centre—and approve of this. In December last year this centrism manifested itself when both parties in the Senate agreed on a bill that among other things cancelled a planned rise in income tax for top-rate taxpayers.
Encouraged by this political deal and positive data, many US analysts raised their forecasts. I think the next two years each offer a good chance of 3 per cent annualised growth in the US—possibly even 4 per cent. This should lead to declining unemployment which in turn would help to ease the worst of the social consequences of the credit crisis.
As a result, the US stock market will continue to rise, probably with another 20 per cent increase. US government bond yields will rise further, although not too dramatically, as inflationary pressures are likely to remain muted. With growth of 3 per cent and inflation close to 2 per cent, yields on ten-year US government bonds of around 5 per cent would be normal. Such a move is not out of the question given the US’s large fiscal deficit. At the end of 2010, bond yields were rising and for them to rise a further 170 basis points (1.7 per cent) in the course of 2011 wouldn’t be that dramatic. But given the possible negative consequences for the housing market, the authorities might try to restrain any excessive rise in yields.
Because of this likely US recovery, on the foreign exchanges, the dollar could rally quite a bit, although US policymakers will be eager to resist a significant increase in its value. Of the alternatives, the yen strikes me still as the currency most vulnerable to a dollar recovery.
Things will not return to pre-crisis normality in the US, as things weren’t really that normal beforehand. The US can’t survive with over-indebted consumers, a low personal savings rate, and a large current account deficit. However, 2011 will be the beginning of a new phase, in which the US has strong GDP growth, led this time by exports and investment.
THE REST OF THE WORLD: GROWTH VERSUS EMERGING MARKETS
Against this background of the US, next year could see the world economy growing by close to 5 per cent.
THE BRICs: The year ahead is likely to be yet another stellar year for Brazil, Russia, India and China. Of these, China’s growth should be 8 per cent or more—quite something for the second largest economy in the world. Chinese levels of consumption will become more important in 2011.
Next year, India could see growth match or even exceed that of China, with the momentum coming from urbanisation and improvements to infrastructure. Risks remain for India, including the threat that its economy may overheat. If strong growth is not matched by more, longer-term capital inflows, this might cause problems for India’s balance of payments.
Brazil will find it tough to match 2010, as the new government struggles to deal with a very strong currency and control excessive government spending. Nonetheless, real GDP growth of around 5 per cent is likely.
Russia might grow as much if not more than Brazil in 2011, as it recovers from the global credit crisis, helped by the strength of oil prices.
This year could also be one in which economists and investors finally learn to distinguish between genuine modern “growth economies” and those that are still emerging. While many of these distinctions are somewhat arbitrary, I maintain that the four Bric economies and also Indonesia, South Korea, Mexico and Turkey are “growth economies.” All eight are already 1 per cent or more of global GDP each and are likely to see their share grow. They are, economically speaking, substantial countries where investors can operate with increasing flexibility and will remain key contributors to the world economic cycle in their own right.
Goldman Sachs maintains annual Growth Environment Scores (GES) to monitor national economic performance. The GES scores are a good guide to productivity, sustainable growth and perhaps even wealth. Scores range from 0 to 10, with the higher score being a reflection of more sustainable growth. The scores are available for just over 180 countries. Interestingly as a sign of the changing times, South Korea’s GES score (7.5), the highest of the so-called Next 11 Group, is not only above that of the US (6.9), but also now higher than Germany’s (7.4). Of the Bric countries, Brazil (5.4) is currently the highest, just above China. Of the Brics, India scores the lowest.
Further afield: Nigeria, the Philippines, and perhaps even Iran, could also reach “growth economy” status in the future. While other developing economies have the potential to grow strongly and have many attractions, they should generally be regarded as still “emerging.”
EUROPE: The year ahead is likely to see a lot more dilemmas surrounding the indebted countries and the structure of the European monetary union. I don’t think this is truly a crisis of debt, but one of leadership and governance. The debt position (and deficit) of the euro area is much better than that of the US, Britain and Japan. The US fiscal position is comparable to that of Portugal, but the US is not facing the same dilemmas, as investors have faith in the structure of US governance and economic leadership, things that are easier for a single nation than for the euro zone.
Portugal’s problems are similar to those of Greece, Ireland, possibly Spain and Italy and, in some circumstances, even France. Will these economies receive support if they falter? At some stage the answer is going to be “yes,” as German politicians have made clear their loyalty to Europe. But if German taxpayers are called upon for more money, things could get messy.
Finally, in Britain, the tough spending cuts might restrain growth in 2011. However, at the end of 2010, evidence remained that the momentum of recovery might be sufficient to help the economy through.
On balance, though, the coalition might be lucky. The fiscal tightening carries risks, but the improving US economic environment and the strength of demand in the Bric economies, together with the weakness of the pound, give Britain a competitive edge.
Also in Prospect's investment special:
Alistair Darling: what is financial literacy?
John Kay shows Max Hastings how to invest
Charles Batchelor: Where to put your money
Best and worst investments
Jim Rogers: The Chinese century
Vicky Pryce: Stop the Greek exit
Before looking into the crystal ball for 2011, it is useful to reflect for a moment on 2010.
A year ago, it seemed quite likely that world economic growth would surprise onlookers by being better than anticipated. The economies of the so-called Bric countries (Brazil, Russia, India, China) would be the mainstay of the world recovery. As we look back, this has been the case. I expected that monetary policy would remain very accommodating and that interest rates would be kept low, due to the low risk of inflation. That also has, broadly, proved true. But the outlook was not all rosy. One factor that threatened to throw us off course was the trouble in the euro area—which has lived up to expectations.
German GDP growth has to be regarded as one of the biggest surprises of 2010—and a pleasant one. The German export machine pounded on, while German employment remained strong, and there were increasing signs of a more rounded kind of economic expansion, which included robust domestic demand.
In the US, it was not surprising that the economy ended the year strongly. However, it remains something of an mystery as to why the economy suddenly lost its momentum in the period running from the spring through to the summer.
In the rest of the world, the Bric economies and other large growth economies generally delivered as expected. The surprise was the breadth of the expansion elsewhere, such as in Indonesia and Turkey.
In financial markets, there were three big themes for which 2010 will be remembered. The first was quantitative easing (QE), which is the creation of new money by the central bank and its introduction into the financial system, with the aim of boosting the money supply and stimulating growth. The consequences of QE are unknown.
The second was the threat and, in some cases, the reality of excessive government control of capital flows in and out of economies, not least in Asia, where governments have kept a tight grip on exchange rates. China is the most significant example.
The third, of course, was the mess in Europe. Most attention has been focused on the ability of debtor nations to manage their respective burdens. In my opinion, however, the European crisis remains one of structure and governance
LOOKING AHEAD
THE US: I think 2011 may be the year in which the US makes a comeback. Since the midterm congressional elections in November, most US economic indicators have gone from strength to strength—as though someone dropped magic powder out of the sky. Even though the election results led to increased partisanship in Washington, the markets see the outcome as having put pressure on President Obama to move towards the economic centre—and approve of this. In December last year this centrism manifested itself when both parties in the Senate agreed on a bill that among other things cancelled a planned rise in income tax for top-rate taxpayers.
Encouraged by this political deal and positive data, many US analysts raised their forecasts. I think the next two years each offer a good chance of 3 per cent annualised growth in the US—possibly even 4 per cent. This should lead to declining unemployment which in turn would help to ease the worst of the social consequences of the credit crisis.
As a result, the US stock market will continue to rise, probably with another 20 per cent increase. US government bond yields will rise further, although not too dramatically, as inflationary pressures are likely to remain muted. With growth of 3 per cent and inflation close to 2 per cent, yields on ten-year US government bonds of around 5 per cent would be normal. Such a move is not out of the question given the US’s large fiscal deficit. At the end of 2010, bond yields were rising and for them to rise a further 170 basis points (1.7 per cent) in the course of 2011 wouldn’t be that dramatic. But given the possible negative consequences for the housing market, the authorities might try to restrain any excessive rise in yields.
Because of this likely US recovery, on the foreign exchanges, the dollar could rally quite a bit, although US policymakers will be eager to resist a significant increase in its value. Of the alternatives, the yen strikes me still as the currency most vulnerable to a dollar recovery.
Things will not return to pre-crisis normality in the US, as things weren’t really that normal beforehand. The US can’t survive with over-indebted consumers, a low personal savings rate, and a large current account deficit. However, 2011 will be the beginning of a new phase, in which the US has strong GDP growth, led this time by exports and investment.
THE REST OF THE WORLD: GROWTH VERSUS EMERGING MARKETS
Against this background of the US, next year could see the world economy growing by close to 5 per cent.
THE BRICs: The year ahead is likely to be yet another stellar year for Brazil, Russia, India and China. Of these, China’s growth should be 8 per cent or more—quite something for the second largest economy in the world. Chinese levels of consumption will become more important in 2011.
Next year, India could see growth match or even exceed that of China, with the momentum coming from urbanisation and improvements to infrastructure. Risks remain for India, including the threat that its economy may overheat. If strong growth is not matched by more, longer-term capital inflows, this might cause problems for India’s balance of payments.
Brazil will find it tough to match 2010, as the new government struggles to deal with a very strong currency and control excessive government spending. Nonetheless, real GDP growth of around 5 per cent is likely.
Russia might grow as much if not more than Brazil in 2011, as it recovers from the global credit crisis, helped by the strength of oil prices.
This year could also be one in which economists and investors finally learn to distinguish between genuine modern “growth economies” and those that are still emerging. While many of these distinctions are somewhat arbitrary, I maintain that the four Bric economies and also Indonesia, South Korea, Mexico and Turkey are “growth economies.” All eight are already 1 per cent or more of global GDP each and are likely to see their share grow. They are, economically speaking, substantial countries where investors can operate with increasing flexibility and will remain key contributors to the world economic cycle in their own right.
Goldman Sachs maintains annual Growth Environment Scores (GES) to monitor national economic performance. The GES scores are a good guide to productivity, sustainable growth and perhaps even wealth. Scores range from 0 to 10, with the higher score being a reflection of more sustainable growth. The scores are available for just over 180 countries. Interestingly as a sign of the changing times, South Korea’s GES score (7.5), the highest of the so-called Next 11 Group, is not only above that of the US (6.9), but also now higher than Germany’s (7.4). Of the Bric countries, Brazil (5.4) is currently the highest, just above China. Of the Brics, India scores the lowest.
Further afield: Nigeria, the Philippines, and perhaps even Iran, could also reach “growth economy” status in the future. While other developing economies have the potential to grow strongly and have many attractions, they should generally be regarded as still “emerging.”
EUROPE: The year ahead is likely to see a lot more dilemmas surrounding the indebted countries and the structure of the European monetary union. I don’t think this is truly a crisis of debt, but one of leadership and governance. The debt position (and deficit) of the euro area is much better than that of the US, Britain and Japan. The US fiscal position is comparable to that of Portugal, but the US is not facing the same dilemmas, as investors have faith in the structure of US governance and economic leadership, things that are easier for a single nation than for the euro zone.
Portugal’s problems are similar to those of Greece, Ireland, possibly Spain and Italy and, in some circumstances, even France. Will these economies receive support if they falter? At some stage the answer is going to be “yes,” as German politicians have made clear their loyalty to Europe. But if German taxpayers are called upon for more money, things could get messy.
Finally, in Britain, the tough spending cuts might restrain growth in 2011. However, at the end of 2010, evidence remained that the momentum of recovery might be sufficient to help the economy through.
On balance, though, the coalition might be lucky. The fiscal tightening carries risks, but the improving US economic environment and the strength of demand in the Bric economies, together with the weakness of the pound, give Britain a competitive edge.
Also in Prospect's investment special:
Alistair Darling: what is financial literacy?
John Kay shows Max Hastings how to invest
Charles Batchelor: Where to put your money
Best and worst investments
Jim Rogers: The Chinese century
Vicky Pryce: Stop the Greek exit
