EDITOR’S NOTE — The following remarks were presented at the recent USDA Outlook Conference by Nariman Behravesh, chief economist, HIS Global Insight.
Thank you for inviting me, it’s a great pleasure to be here. I’m going to focus on the big picture today.
The good news right now in terms of the global economy is that things are in pretty good shape. President Clinton referred to the global financial crisis, but for most economies, at least at the macro level, this crisis is over, and especially in the U.S. we’re doing fairly well.
We think, for example, this quarter the U.S. economy will probably grow around 4 percent, which is pretty decent.
Let me just give you the highlights, and then in the 15 or so minutes I’ve got I’ll dig a little bit deeper into some of these issues. First, we are in a multi-speed world. Europe and Japan are in the slow lane. The U.S. is in the middle lane. And the emerging markets are in the fast lane. Just to put things in perspective, we’re probably going to grow about twice as fast as Europe or Japan in the next few years. And the emerging markets will grow twice as fast as we are, so about four times as fast as Europe and Japan.
U.S. growing 3 or 3.5 percent, Europe 1.5 or 2 percent, emerging markets on average about 6 percent a year. This pattern is likely to persist for some time to come. In this environment, commodity prices are going to go up. The only debate is how much. Some of this is very commodity-specific in terms of specific supply and demand conditions, specific policies, and so on.
But that said, the good news for the industrialized economies, including the U.S., is that inflation is not a problem. Now how can you reconcile those two — rising commodity prices and no inflation? First of all, commodities play a fairly small role in the U.S. They play a huge role (that includes food and fuel) in countries like India and China, (maybe half of consumption) and in some countries even more.
In the U.S. we’re only talking about 15 percent of consumption. So rising commodity prices, yes, a problem — I don’t mean to minimize it — but not a huge problem. In fact inflation in the U.S. is going to remain below 2 percent over the next couple of years. So inflation is not a problem in the U.S. This is also true in Europe, and Japan has deflation. In the emerging markets, because food and fuel are a bigger part of the consumer basket, inflation is already a problem and could become worse.
So you have this two-speed/three-speed world in terms of growth. You’ve got the same pattern in terms of inflation.
Inflation a problem in emerging world
So inflation is a problem in the emerging world, but not so much of a problem in the developed world.
This pattern will also dictate what happens to interest rates and to exchange rates. U.S. interest rates are on hold, probably through the end of this year and the same thing in Europe and Japan; whereas, countries like China, Brazil, and India are already raising interest rates and will continue to raise interest rates.
The interest rate patterns will also, in turn dictate, what happens to the exchange rates. The good news for U.S. farmers is that the dollar will continue to depreciate against most currencies over the next few years. A possible exception is the euro, where we could actually see a weakening depending on how this whole sovereign debt problem with Greece and Ireland and Portugal plays out. So the dollar will depreciate with a possible exception of the euro.
A few words about what’s going on in the Middle East. A lot of what’s happened to the oil prices in the last couple days is mostly because of fears — the old story of buy on rumor and sell on the news. There’s a lot of that going on right now. We think a lot of what’s going right now in the oil markets is temporary. We believe oil prices will come back down again, so we don’t have oil prices staying at these levels for much longer.
Let me delve in a little bit deeper into each of these issues. First, a few words on the U.S. The great news is, the U.S. economy is firing on more cylinders, though unfortunately not on all cylinders yet. Housing is still a big problem, but housing is only 6 percent of the economy. The rest of the economy is doing fairly well. Exports are strong, business spending is strong.
Businesses are very optimistic right now. They’ve got a lot of cash; they’ll spend it. Consumers are also much more optimistic now. They are worrying less about a double dip. The employment situation — while it’s still not great — is improving, so that consumer spending which is 70 percent of the economy is doing fairly well. When you put all this together, and you’ve got a U.S. economy that’s growing fairly rapidly.
Europe, as I said, is a different problem. They’ve got major headwinds. The sovereign debt problem I mentioned. A lot of countries are tightening fiscal policy in a way that we’re not, at least not yet. But even Europe is a two-speed region. Northern Europe with the exception of Ireland is growing at 2.5 percent, and southern Europe (Italy, Greece, certainly Spain, and Portugal) is struggling, growing less than 1 percent.
Japan also has major structural problems. I mentioned deflation a couple minutes ago, but they’ve also got the highest debt levels in the developed world. We’ve been focusing on the fact that the U.S. debt to GDP ratio is approaching 100, but in Japan it is already at 200. So Japan’s got major debt issues going forward.
As I’ve already said, emerging markets, on average, are growing at least twice as fast as the U.S. A lot of these countries have very large populations, but they are also catching up with the developed countries. In this context, Asia is still very much the growth leader. It’s not just China; it’s India and Indonesia. Indonesia is growing at about 7 percent. Not a lot of people focus on Indonesia, a big country that is growing rapidly. Asia’s growth is broad-based. Everybody is mesmerized by China, but it’s not just a China story.
In the case of China, the official statistics say 9.6 percent; but China is growing at a 13 percent rate. That explains part of the reason why commodities are doing what they’re doing.
It is important to point out that the issues are different commodity by commodity. There are specific factors with each commodity that relate to inventories, to production, to supply response and, very importantly, to policies. This is particularly true in the case of agriculture.
Weather a big problem
There are two special factors here — the first is of course weather which has been a big problem for a lot of agricultural commodities in Russia, Latin America and now in China. Second, bad policies have a also been a problem. I can’t emphasize this enough: there are a lot of bad food policies in the U.S. and other parts of the world that are compounding the food problem. I’ll highlight one example, export restraints on food from Russia and India. The combination of bad weather and bad policies has been the major driving force behind the recent rapid rise in food prices.
On oil prices, I mentioned that we expect the recent spike to be a temporary spike, unless there are major disruptions in Libyan oil production which we doubt. President Clinton talked about oil independence in terms of ethanol policies — but the big game-changer here is not ethanol but unconventional sources of natural gas — shale gas, tight sands and so on. I think this is what is going to change things for the U.S., not ethanol policies frankly.
With respect to the Middle East and North Africa, we are at one of the crossroads in history. The great news is, the transition in Egypt was a peaceful one. Looks like the one in Bahrain may also be peaceful. Unfortunately, the Libyan situation is not playing out peacefully — it is splitting the country. Our best guess is that Gaddafi will step down, but there may be more bloodshed before that happens.
The big countries to worry about are Iran and Saudi Arabia. We’re more worried about instability in Iran because of what happened a year and a half ago, and its very poor economic situation. We’re less worried about Saudi Arabia. Some of you may have seen today’s headline. The king has given a gift to the Saudis of $36 billion. Basically, he’s trying to buy them off. He may succeed.
The Saudis have a lot of money to throw at this problem, so I’m less worried about Saudi Arabia although I think the markets are a little jittery about it. The Saudis will also have to make some meaningful changes in terms of their constitution.
Bottom line: there’s lots of instability in the region, but it’s very unlikely that oil prices will go to $120 or $130 or where they were in 2008.
Meanwhile, inflation is not a problem in the U.S. Let me explain why. With an unemployment rate of around 9 percent, how can we possibly get wage inflation? There are huge amounts of excess capacity in the U.S, so how can we possibly get price inflation? The same is true in Europe and Japan. But we are running out of capacity in countries like China, Brazil, and India, so inflation is a bigger problem there. From that perspective, we are seeing two worlds — a low growth/no inflation world — what I call the “crawling economies” — and a high-growth/high-inflation world — what I call the “galloping economies”.
Even though food and fuel inflation is pushing up headline inflation, core inflation in the U.S. and Europe is still below 1 percent.
Why should we care about core inflation? Core inflation is inflation without food and fuel. People say, what relevance does core inflation have? There is one use for it. It measures the spillovers from food and fuel inflation to the rest of the economy. The good news now (as in 2008) is that there are no spillovers. That’s really good news. And that’s what the fed cares about.
A bigger headache
In places like China, India, and Brazil inflation is a bigger headache. As a result, central banks in the U.S., Europe and Japan are in no hurry to raise historically low interest rates. Whereas in many emerging markets we are already starting to see interest rates rising — in some cases quite substantially.
The outlook for the U.S. dollar is being determined by the global trends I have already mentioned. The U.S. is a relatively slow-growing economy compared to the emerging markets. Interest rates are on hold; whereas they are rising in the emerging world. Predictably this will exert downward pressure on the dollar.
I mentioned earlier that the only exception to this trend is the euro, because of the sovereign debt problems in Europe. The dollar will fall against most emerging market currencies, including the Chinese currency, which has risen 25 percent against the dollar in the last five years, about 5 percent a year. We expect it to continue that path for some time.
People extrapolate from the current weakness of the dollar and assert that the dollar is no longer going to be the reserve principal currency of the world. This is nonsense. There is no alternative to the dollar, at least for the next 5 to 10 years.
I often joke and say, the dollar is still the best looking horse in the glue factory. Yes, we’ve got our problems, but a lot of other countries have even bigger problems than we do. People talk about the Chinese currency or the IMF’s special drawing rights (SDRs) as alternatives to the dollar, but there are major problems with each of these. At least for the foreseeable future, the dollar will remain the premier reserve currency in the world.
I will spend the last few minutes on risks. Obviously there are a lot of risks facing the global economy. The good news is that we’re in a decent growth situation. If an oil crisis is going to hit, this is not a bad time for it to hit given that the growth momentum is strong. We can absorb this.
Here is a rule of thumb: every sustained $10 increase in the price of oil cuts our growth by about .2 of 1 percent. That’s not very much. If we’re growing 4 percent, that means we only grow 3.8 percent.
Still, the commodity price situation is one thing to worry about.
The turmoil in Europe in terms of sovereign debt is another thing to worry about. Something very few people are focused on is a property bubble in China. China could have a bust on its hands next year or the year after. Too much liquidity, too much credit and too rapid a rise in real estate prices are unsustainable. Estimates are about a third of Chinese apartment buildings are empty. That is not a good situation.
On the other hand, it’s important to say that not all of the surprises are necessarily on the downside. There are some significant upside risks as well — stronger growth in U.S. consumer spending, stronger growth in U.S. productivity, more business optimism, more spending. The good news is that the probability distribution around our forecast is a little more symmetrical. So the upside and downside risks are balanced.
Bottom line I think we’re doing okay, more than okay. In fact in the U.S. this quarter we’ll probably see 4 percent growth. Unless oil prices go a lot higher than they are right now the current Middle East turmoil is not going to be a problem for the United States.