World economy: There are reasons for our optimism

The Cayman Business Outlook each year presents global economic trends and their local implications for the Cayman Islands. This year the outlook was cautiously optimistic.  

 

Former editor in chief of the economist Bill Emmott declared despite the apocalyptic scenarios presented in the world media about the euro, Iran, the oil price or sovereign debt, there are reasons for optimism. 

The sense of optimism or pessimism in the world economy is largely geographic, he said. And while the media commentary on the economy has not improved, the markets have. 

Rather than giving a forecast for 2013, Emmott discussed the hopes, fears and likelihoods for the year. 

  

US economy  

In terms of “what might go right this year”, he noted that US firms have been accumulating cash and cut their debt levels. Although they have so far not spent this cash adequately on investments, investors are placing bets in the markets that this is about to change.  

Even the political posturing around the fiscal cliff in the US suggested there will be some form of agreement. This might not be a grand bargain, but it will reduce some of the fog around US policy and debt sustainability is within reach. The easing of the gridlock in turn would lead to a recovery in economic growth, he said. 

In addition there are some indications of progress on legislation, such as US immigration reform. The growing sense of clarity in US policy is likely to produce “some uptick, some revival” in business investment, said Emmott. 

Meanwhile the deflation concern that existed during the crisis, which lead companies to hoard cash and reduce debt, has been removed by the commitment of the Federal Reserve to do whatever it takes to support the economy. In Europe, the euro area has not collapsed and there is an easing of the debt crisis. 

In pockets of the market there are positive signs as well. Falling energy prices, house price increases, the energy investment boom in the US and the return of manufacturing facilities from Asia to the US all give reason to be more optimistic. 

Citing Keynes terminology of the “animal spirit of entrepreneurs”, Emmott said signs are that US businesses will become more aggressive again this year.  

 

Oil price  

Oil is an important facilitator in the global economy. Last year the development of the oil price was deceptive, said Emmott. It appeared remarkably stable, but despite some easing the average price was relatively high. 

Although oil is the most political of markets, strongly influenced by the OPEC cartel and sensitive to potential conflicts, supply and demand do matter, he explained. General trends indicate some relieve on oil price pressure this year. 

On the supply side, the US is increasing its production and so are Iraq, Libya, Brazil and some African states. At the same time demand for oil is feeling steadier with China, India and Brazil growing more slowly than in recent years.  

The main global inflationary force coming from the developing world has also eased, noted Emmott. Therefore, overall there is hope that oil will be trading down. 

 

Europe and Japan  

Europe is trapped in a cycle of recession, high sovereign debt and austerity programmes that are reinforcing the recession. In Emmott’s opinion, this cycle has been driven considerably by creditor nations such as Germany, where there is suspicion in the electorate about the ability of debtor nations to repay. The resulting paralysis makes it likely that there will be no sudden solution. 

But Emmott said some of the political tension is likely to clear. In Italy, elections on 24 February give hope for modest liberal reform and the belief is growing that an additional debt write-off for Greece is needed. Elections in Germany in October may result in a new coalition, a shift in German policy relinquishing the totally austerity-focused strategy and a positive new framework. 

Political dysfunctionality is also expected to end in Japan, where elections have produced a decisive majority in parliament determined to put an end to deflation. 

If the world’s four largest economies, US, Europe, China and Japan, are trending up, it should bode well for the global economy, Emmott concluded.  

 

Fears  

The dangers to these positive developments are all political with potential conflicts in Iran, a spread of the Arab uprising to the Gulf and in the East China Sea between China and Japan over islands held by Japan. 

Former US Secretary of Defense William Cohen used his keynote speech at the Cayman Business Outlook to describe some of the macropolitical conflict areas in the context of a multipolar world, where traditional US defence policy strategies no longer work.  

In light of isolationist tendencies within the Republican and Democratic Parties, Cohen said, “We cannot walk away from the world; the world is not going to walk away from us.” 

The US approach of “shape, respond and prepare” remains the basic philosophy of the US administration in international affairs but the military defence strategy of “deter, defend and defeat” has to be adapted because asymmetric threats like terrorism are not deterred by the most powerful military on the planet, said Cohen. And Iraq and Afghanistan have offered lots of lessons about the US military’s limitations.  

“How do you deter suicide bombers or those seeking nuclear weapons?” he asked. 

In the case of Iran, which for 17 years has maintained a covert nuclear programme, there are three options, Cohen outlined. 

First there are sanctions, which he believes, are “really biting” and making it difficult for the regime in Iran. Second, the US could go to war with all its unintended consequences, including the galvanisation of the Muslim world against the United States. “It is not easy and not permanent,” he warned. Finally, the world could live with the bomb, but other countries in the region would feel compelled to acquire nuclear weapons to defend themselves against an Iranian threat. And the likelihood of a nuclear incident would increase. 

Cohen believes the key to solving the crisis is held by China, given that China is dependent on Iranian oil and not as resented by Iran as other players. “China is in the best position to influence Iran,” he said.  

China itself has seen 35 years of the most amazing transformation of any country in the world, Cohen noted. “It is inspirational and scary. The question is how are they going to use this power?”  

As part of its fourth modernisation, China is investing $100 billion annually, which in China goes a lot further than in the US, Cohen stated. 

In a first step China is going to become a maritime power and China has already purchased an aircraft carrier, which is largely symbolic, he argued, as one today could be five in five years and 10 ten years from now. 

In Asia, where China has already replaced the US as the No. 1 trading partner of the Association of South East Asian Nations, Barack Obama’s strategy is to rebalance. “We are going to have a greater presence, commercially, diplomatically and somewhat militarily. [The ASEAN countries] want us there but not too vigorously.” 

So the US is building relations with the Philippines, Japan, India and Australia. The real question, however, is how the US is going to pay for it, he said. 

emmott

Emmott

cohen

Cohen

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