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The Business Times Singapore Investment Round Table:
The Global Economy’s Ups and Downs

April 12th, 2012

Growth appears to be back on track in the US economy while China and the rest of emerging Asia still retain strong momentum even if Europe has become the “sick man”. But growth could be derailed universally if oil prices continue their upward spiral, especially if Iran is attacked. The Business Times convened its panel of economic and investment experts to assess the risks – on the upside and the downside.

Anthony Rowley: Welcome back, to all of you. Let’s start by looking at a key issue, the geo-political risk to the global economy from the Iran/Israel situation and from rising oil prices?

William Thomson: This is the big one if it goes wrong. Should an attack occur the impact on the global economy would be grim. Oil could reach US$200 a barrel, creating a renewed and deeper recession, and turmoil in the Middle East would worsen. The banking crisis would deepen and some countries would finally exit the euro. Even China and the emerging world would suffer from the high oil prices and exports slow further. But I think the odds of an attack before the November elections in the US are relatively low. (President) Obama is set against an attack and the leadership of the US military is also opposed and only the powerful Israeli lobby supportive. The Israeli PM seems alone in wanting one and is using the issue to force Obama out of the White House.

Kenneth Courtis: A war against Iran would surely lead to vast disruption of global energy markets. As the hawks pound harder and harder on the drums of war, markets have moved to add an increasing risk premium to the price of oil. Where the world economy is currently, and where it is headed this year, oil ought to be trading in the US$70-80/a barrel range. Instead, it is trading at US$105-110 and is poised to move still higher. That difference is the war risk premium. Should Gulf tensions not be reduced, this premium will become a major depressant for the US and the world economy. Yet, the US public is war weary and the Pentagon is war weary. The US administration does not want to participate in yet another war of problematic outcome and unknown duration. So the Obama administration will be doing all it can to dissuade Israel from starting a war with Iran.

Robert Lloyd-George: If oil prices reach US$150 a barrel again as they did in the summer of 2008, there is a significant risk to growth in India, China and the developing world, as well as to Europe. We have to assume that the Israelis will not stand by and allow Iran to obtain a nuclear weapon. The assumption is, therefore, that if they are to take action it will be in the next six months and that this could be the shock which derails the current optimism in world markets.

Ernest Kepper: The world today runs on oil with China, India and other growing markets consuming oil at a faster pace than ever while worldwide production has been stagnant for much of the last decade. In today’s markets, the threat of war creates the ideal backdrop for a massive speculative spike in oil to US$150 by the summer. Futures traders such as banks and hedge funds who have no intention of taking physical delivery but only of turning a paper profit, control some 80 per cent of the energy futures market, and it is this huge inflow of speculative money that creates a self-fulfilling prophecy that is driving up the price of oil. The illusion of global growth will be dissolved as oil prices rise. I expect oil to reach US$150 a barrel by year-end mostly due to low inventory positions. Israel is playing a great game but I don’t expect them to attack Iran this year. I don’t believe the Israelis want a war. Their biggest concern is with economic growth. However, the threat of military intervention remains a serious one.

Rowley: The US economy is looking healthier and the Eurozone a little less sick while China appears to be slowing. What’s the “net, net” of all this for the global economy?

Courtis: I’m looking for a pretty weak 2012 for the mature economies. This holds also for the developed commodity economies. Oil has been strong, largely due to tensions driven by increasing Israeli threats against Iran, but the rest of the energy complex is weak. Similarly, base metals, grains, cotton, livestock, lumber, steel, aluminium and copper are all lower than they were at the start of the year. Weaker natural resource prices are as good an indicator as any of the current state of the world economy.

Lloyd-George: Although the immediate sense of danger from default or sovereign debt problems in Europe and the US has receded, the underlying problem is still there. The willingness of the US Federal Reserve and European Central Bank to continue printing money and supplying liquidity to the banking system is essential to avoiding a deflationary economic slowdown, but the question is how long this process can continue. I’m cautious about the medium-term outlook for the global economy and I believe that the trade deficit which China has just announced, together with the slowdown in its GNP growth forecast to 7.5 per cent is a clear indicator that China will eventually slow to around 5 per cent and although it will continue to import at a rapid pace, its manufacturing boom will slow.

Thomson: The situation is somewhat better for the moment but still very fragile and growth will remain well below par this year. The US unemployment and under-employment remains sky high with the labour participation rate continuing to fall to record levels. Real median after-tax incomes continue to fall. The budgetary situation is tightening and the Fed, which otherwise might be inclined towards further monetary easing, is feeling pressure in an election year against such actions. In the absence of any external shocks, economic policy will be on hold till after the November election, after which it seems likely fiscal policy will tighten considerably and 2013 could be more challenging than this year.

Kepper: The outlook for economic recovery in the US appears better than in most other regions because of the broad-based nature of the economy. For example, new oil shale and gas fields in North Dakota have grown rapidly and provided many new jobs. The success of Apple with its new products and suppliers is also an economic engine of sorts, affecting not only the US but also Asia. Employment numbers are encouraging and, in short, America can heal itself quicker than many people expected.

Rowley: Certainly the US economy does seem to be on the move again. Could it regain the role of global economic locomotive?

Courtis: Over the last few months, the United States has been generating some 250,000 new jobs a month, which suggests growth of around 3 per cent. Consumer spending continues to trend slightly upward, although for how long remains questionable, given that household debt levels have started rising again. America’s once more expanding trade deficit also indicates a stronger economy even though higher oil prices account for part of this deterioration in the external account. At the same time, numbers for investment and production have been on the weak side, and are suggesting growth in the one per cent range. The real problem for the US comes later this year, when it will face the prospect of tax increases for high-income-earning families, and the social programme and defence spending cuts as a result of the recent debt ceiling renewal negotiations. To counter these powerful downward pressures on the economy, the US will have no choice but to engage QE3 as we move into the later part of the year.

Lloyd-George: The outlook for economic recovery in the US appears better than in most other regions because of the broad-based nature of the economy. New oil shale and gas fields in North Dakota have grown rapidly and provided many new jobs and the success of Apple with its new products and suppliers is also an economic engine of sorts, affecting not only the US but Asia. Employment numbers are encouraging and, in short, America can heal itself quicker than many people expected.

Kepper: With November presidential elections, I expect to see a QE3 introduced sometime in the next three months or so. The Fed cannot afford to raise interest rates as this could increase the costs of borrowing, and higher borrowing costs for US households and businesses will discourage private investment, reducing economic growth and depressing the standard of living. The US economy looks better only because Europe looks so bad. In reality, the US debt mountain is in even worse shape (than those elsewhere) and when it collapses it will fall hard. But as long as Europe’s crisis worsens, the US will look like the better place to invest, which is why the US dollar is starting to rally again. It appears that investor confidence in the US is collapsing as central banks in China, Russia, and Mexico and beyond have begun systematically liquidating their investments in the dollar and US Treasuries. While a US default on its debt is probably the best long-term solution to its debt problem, it is unlikely. It is equally unlikely that US will choose an option of austerity plus higher taxes in an effort to pay the debt down, which would mean cutting military spending, social security and most other government entitlements. This leaves the only other option as runaway inflation which is the easiest one because all US debts are denominated in dollars and US the controls the supply of those, allowing it to print its way out of debt. Printing money inevitably leads to inflation.

Rowley: What about the Eurozone. Is it really over the worst?

Kepper: In truth, nothing has been solved in Europe. There may be a lull in the crisis, but it will soon return. Severe austerity measures do not create growth, so there’s no way Greece can grow its way out of its debt, even after the latest debt write-downs. Austerity measures are imploding the Greek economy, causing the worst social chaos we have seen. Meanwhile, Italy, Portugal and Spain still remain vulnerable. Each and every one of them is just beginning to feel the impact of austerity, causing tensions among countries in Europe. European banks themselves don’t buy any of the solutions. They show no confidence in the continent’s ability to survive the crisis. Rather than lend, they are hoarding cash, and are depositing hundreds of billions with western central banks. With growth slowing sharply, there is a very real chance of a massive bear market collapse in European debt this year. I expect Greece and Portugal to exit the Eurozone within 12 months. High energy prices as well as inflation are making matters worse. I fear the European oil embargo will hurt the EU more than it hurts Iran.

Courtis: Large swathes of the Eurozone are already in recession now, and its southern tier – Greece, Spain, Portugal, as well as Ireland – are in outright depressions. The economies of France, Italy and the UK are sputtering and even Germany has started to see increasing difficulties. The combination of a weak euro and (sterling) pound plus high and still rising oil prices is now adding further to downward pressures across the EU economic area. So don’t hold your breath for an upside surprise in EU economic performance. The risk is on the downside.

Lloyd-George: It is difficult to see how Greece, Spain, Portugal and Ireland can grow their way out of their debt problems. On the other hand, Germany has had tremendous success in exporting its quality automobiles and other products to new markets to China, the Middle East and beyond. It is, therefore, perhaps easier to predict a “two speed” Europe in terms of economic growth.

Thomson: Growth in Europe is absent except in the Germanic core. Fortunately the new leader of the ECB Mario Draghi has been more creative than his predecessor. But the social situation is extremely fragile in the “Club Med” countries with unemployment at depression levels and youth unemployment at over 50 per cent in some. We also have to see how repercussions from the Greek default feed through the banking system. I still expect an eventual Greek exit from the euro but I believe the authorities have had sufficient time to prepare and avoid another post-Lehman systemic crisis. Still, it could be a close call and go either way.

Rowley: How serious is the slowdown in China, and what about the rest of Asia?

Courtis: The (current) situation places enormous importance on what happens in the key emerging BRIC economic giants – Brazil, India, Indonesia and China. The four of them, together with other emerging markets, will make up virtually 80 per cent of the net real growth in the world economy in 2012. China, of course, is the key as it alone will account directly for half of that growth; half of the remainder will be related to China through the continuing surge of Chinese imports. Virtually every country in Asia enjoys a strong trade surplus with China. On top of that, China has become the leading foreign direct investor in emerging markets. China’s economy has run ahead at a blistering speed since early last decade, with neither a substantial pause nor broad reform and inevitably significant imbalances have developed. The drop in consumer income and household consumption relative to GDP, the tightening grip on the economy of large state company monopolies, increasingly stretched local government finances, regional disparities, labour skills, runaway residential real estate prices, issues of price stability, are all part of the result. The government imposed a strong policy squeeze, which has had the effect of moderating growth back to the 8 per cent level, reducing the consumer inflation rate and of putting a lid on residential real estate prices. The squeeze peaked late last year and between now and mid-summer I expect to see a good portion of it reversed. The result will be an accelerating Chinese economy over the end of the year. The problem for China is not so much growth in the short term but the increasingly urgent need to re-engage very substantial supply side reforms. If it does not do so, the result will be that it will become difficult to keep the economy on a stable course.

Kepper: I think the biggest impact on China’s economy this year is that it’s in a year of political transition, and we can expect it to be aggressive and stimulate the economy. The currency is currently strengthening, exports are decreasing but we can expect the currency to stabilise and we can also expect growth targets of 7.5 per cent to be met with a surprise on the upside. However, in the short run, China’s GDP growth will likely continue to fall. GDP growth will most likely be balanced by growth-model changes to support consumers. China will move away from state-owned enterprises which require massive capital investment and export subsidies to companies that operate in the red or on wafer-thin margins. These reforms will, in turn, eliminate the need to recycle surpluses and keep buying US Treasuries in order to keep the currency suppressed, because a stronger Yuan will increase consumer wealth relatively, making the transition to a new model more efficient,

Asian-block nations have suppressed the value of their currencies over the last several years, thanks to China’s currency suppression and growth model. So they will be relieved if China signals that it is serious about making a transition that empowers its consumers. Thus, China’s change in its growth model will likely be reinforced strongly across the region. Stronger Asian consumer demand and stronger Asian currencies mean that Western consumer goods will flow more freely to Asia and the US and European trade balance could improve. However, this scenario could be disturbed by contagion to emerging markets from the European debt crisis, a financial crisis in China as debt grows to dangerous levels and unrest is met with more internal crackdowns, or if the US remains mired in a never-ending-war policy and does little to improve its fiscal deficits.


Kenneth Courtis: Former vice-chairman, Goldman Sachs (Asia) and co-founder of Themes Investment Management

Ernest Kepper: President, Asia Strategic Investment Associates, Japan

Robert Lloyd-George: Chairman, Lloyd-George Investment Management, Hong Kong

William Thomson: Chairman of Private Capital, Hong Kong, director of Finavestment, London


Anthony Rowley: Tokyo Correspondent, The Business Times

April 12th, 2012

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