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November 2001

Expect delayed recovery not disaster





The US economic recovery will be delayed by the terrorist attacks of 11 September and anthrax scares. But in the wake of the US administration's massive monetary and fiscal policy boost since that tragic day, a V-shaped recovery in 2002 is now likely.
Before September, the US economic slowdown was, to a large degree, simply an inventory liquidation exercise, as corporate America responded to more normal post-bubble demand conditions. That adjustment was close to completion before the terrorists struck. Manufacturing was starting to turn around. Leading indicators had been improving for several months in a row. And consumer spending was being sustained.
But now the consumer will be less confident and thus less willing to spend, and unemployment has started to rise much more quickly as several sectors (airlines, leisure and insurance) accelerate lay-offs. This could undermine aggregate incomes.
       

View graph.
But it's not all bad. The monetary policy response by the Federal Reserve, the Bank of England and even the European Central Bank has been a big stimulant. Global liquidity conditions are excellent as a result. And fiscal policy will further boost US households.
A fast economic recovery in the US, though delayed for three to six months, is now much more likely than before the crisis. And equity markets have started to discount this.
There are risks to this bullish outcome. First, the US personal savings rate has fallen sharply. A rebound in the propensity to save could take dollars out of the real economy. Second, US consumer debt payments are high in relation to income, and the ratio of debt to household financial assets is not as low as it was. And third, global demand is becoming more synchronized. If the US struggles, Europe and Japan will not be strong enough to pull the world out of a nosedive.
But I can't emphasize enough the point I have made before in this column. The US investment bubble was confined to the hi-tech sector. Outside the tech sector, the US investment to output ratio remains stable. (The graphs shows incremental capital ouput ratio - ICOR - measuring investment required per unit of GDP growth. The higher the ICOR the less efficient the investment.) And in contrast to Japan during its bubble, the US continues to generate a lot of growth for every dollar invested in the corporate sector. For shareholders, this drives good returns.
US corporates continue to set the global benchmark for profitability and generate by far the highest return on capital invested. Demand for dollars is driven by this. The US current account deficit is unlikely to be a problem unless US corporate returns on assets collapse. Capital outflows from Asia continue to head for the US. And in this moment of geopolitical crisis, the US is still an economic safe haven. That's why I reckon the US economy will recover ahead of Europe's and Japan's and the dollar will hold its own against the euro and soar against the yen.
Gloom about Europe may be overdone too. Its growth rate is close to the bottom. Inflation is falling. And the ECB will finally begin to cut interest rates aggressively. However, Europe's long-term investment prospects remain weak in the face of reform fatigue. This is still a region of big, inefficient, government. And the busy electoral calendar over the next 12 months in France and Germany means little is going to change structurally.
At least Europe looks in better shape than Japan. Japan's economy is in an awful condition and the government is morally, ideologically and financially bankrupt. The economy is shrinking again and prospects for investment growth don't look good. Core machinery orders are falling sharply. It's true that Japanese corporates are restructuring fast. But that's doing little to support corporate profit growth as demand slides. The recent quarterly survey from the Bank of Japan on business confidence, the Tankan, pointed the way ahead - recession looms.
       

View graph.
The Japanese will replace the Europeans as marginal buyers of US dollar assets because Japan is so sick. Japan's basic balance of payments surplus is gradually disappearing. That's eventually going to drive the yen down against the dollar.
Investors' risk aversion has risen. Emerging-market financial assets will suffer more than most. Credits to emerging-market borrowers have now dried up. Even equity investment inflows are down from the 1999 peak.
The global slowdown has damaged emerging markets via lower exports. Such is the dependence on electronics exports in Malaysia, Singapore and the Philippines that real growth there is suffering most from the slowdown in US demand. At the margin, this is worse news for open countries in Asia than it is for introverted Latin America.
But after the terrorist attacks, tourism and transport business will fall sharply. That hurts Turkey, India and Thailand most. FDI inflows will also decline. Brazil and Argentina can afford this development least.
In contrast, oil wealth has protected Russia from the downturn seen elsewhere. The economy has now become broad based, with output of consumer goods and construction materials growing at double-digit annual rates. Despite the fall in global trade, Russia still generates monthly trade surpluses of more than $3 billion. The current account is expected to top 14% of GDP this year. Foreign exchange reserves are being accumulated at $12 billion a year. They're now equivalent to 12% of GDP and around a quarter of foreign-currency denominated debt.
All in all, that terrible day in September may have delayed global economic recovery into next year, but it will not drive the world into depression.







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