In its January update to the World Economic Outlook, the International Monetary Fund (IMF) has upgraded global growth forecast to 3.9% for 2010 and to 4.3% in 2011. This is an improvement from the previous forecasts of 3.1% and 4.2%, respectively. We frame the discussion around the IMF forecast for it reflects consensus opinion and not so much because IMF is any guiltier of egregious forecasting errors than others.
Synchronized global growth led, towards the fag end of the last expansion in 2007, to a steep rise in commodity prices—food and energy. Part of it was speculative, but most of it was not. Just after a year of contraction in the global economy, if global growth turns out to be above potential for two consecutive years, what does it mean for inflationary pressures, particularly in the wake of the unprecedented fiscal and monetary stimulus imparted to the global economy?
IMF forecasts inflation in the developed world at 0.2% both this year and the next. Is that realistic? World economic growth at 4.0% or slightly more would mean a steep rise in commodity prices, even if they do not recapture the heights of 2008, because growth in emerging markets would have to be strong to realize IMF’s growth forecast. That would translate into a higher-than-0.2% headline inflation rate in the so-called advanced nations.
If commodity prices run up swiftly, then emerging economies will have a problem on their hands. On the one hand, they appear reluctant to tighten monetary policy meaningfully. They are not sure of the strength and durability of the global recovery, nor are they highly confident of their own self-sustaining growth. This “reluctance” is likely to deliver strong growth and higher inflation. Belated tightening after the advent of inflation would not only take long to affect inflation, but also damage business and consumer sentiment enough to knock some basis points (if not a percentage point or two) off growth in 2011. Raghuram Rajan noted succinctly in Davos recently that historically emerging economies have not managed demand well (the Financial Times, 28 January).
Recently, the US Bureau of Economic Analysis released fourth quarter economic growth figures. They were stronger than expected, but the chief contributor was the “rise” in inventories. The other big contributor was the rise in net exports due to the collapse in imports. Some question the inconsistency between growth in inventory investment and decline in imports. That apart, the possibility is that inventories may have to be pared back again if final demand does not pick up in 2010. In that sense, not only would the 5.7% real growth in the fourth quarter be unsustainable, it might also subtract from growth in the coming quarters.
What is the outlook for final demand in the US? The number of people on permanent layoffs is higher than at any time in the 43-year history of this data. The housing market is showing no signs of recovery. Confidence among homebuilders has flagged. Small businesses are not feeling optimistic either. The Aruoba-Diebold-Scotti Economic Conditions Index has failed to sustain its improvement from January 2009 beyond July. The National Activity Index of the Federal Reserve Bank of Chicago also fell in December. Hence, a double-dip recession in the US in the second half of the year remains a reasonable prospect.
If, on the other hand, final private demand picks up in advanced nations, particularly in the US, it would halt the improvement in its current account deficit. The rise in private savings rate would be arrested at a time when the public sector is running big deficits. Dependence on foreigners to finance the deficit would return. Global imbalances and exchange rate misalignments would be back on the table. In other words, IMF growth forecasts imply persistent undervaluation of Asian currencies and reserve accumulation.
That does not appear feasible as the rhetoric on either side of the Atlantic on currencies is escalating. President Barack Obama spoke of jobs and doubling of US exports in the next five years. French President Nicolas Sarkozy spoke of the need for a new Bretton Woods arrangement. The odds of exchange rate turbulence have narrowed considerably in recent weeks.
The penultimate word should belong to James Boughton who wrote in a blog post in the global economic forum of IMF: “The history of the 1970s warns us not be overly ambitious in trying to reflate economic activity as the crisis recedes. The boom times that we have lived through are not the norm, and they have not been sustainable. We are not doomed to repeat history, but reaching a new path to a more lasting prosperity is likely to take a major effort and much patience.” Click here to read blog.
That is why Bare Talk is worried that investors and policymakers are overlooking the possibility that 2009 was a pleasant dream. Rogoff and Reinhart could not have laboured in vain.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org