By Martin Hutchinson
Markets were cheered Wednesday when the International Monetary Fund (IMF) projected global growth of 2.5% for 2010, a slight increase from its earlier forecast of 1.9% growth.
That’s good news for investors – but consumers in the United States and investors focused on it may not see much benefit.
The IMF forecast for the United States does not sound like a lot of fun: The organization is projecting growth of only 0.8% for this country next year. That forecast runs contrary to currently optimistic rhetoric about the recession bottoming out, and may account for the stock market’s weakness over the past year or so as the very real prospects of a sustained economic bottom begins to sink in with investors.
My own view is that the IMF is about right for 2010, largely because the U.S. economy may not yet have bottomed. While economic indicators have certainly improved from their dreadful levels of the first quarter, forward-looking signals – such as consumer confidence – are still at very low levels, indeed. And that signals a moderate decline, rather than stabilization of economic output.
What’s more, the U.S. federal government is running deficits far beyond the records ever seen in peacetime. That has already had an effect on the bond markets, which have seen a substantial rise in yields from a low of 2.07% in December to around 3.4% currently – not a usual feature of an economy whose gross domestic product (GDP) is declining substantially. That suggests that the normal healthy bounce from the bottom of recession may be muted by financing difficulties from the huge federal deficits, with the economy continuing to decline for longer than expected and recovering only feebly thereafter.
In that context, the Obama administration’s $787 billion stimulus may have been misguided, based as it was on economic theories that make very little sense. Such a large amount of extra federal spending has to come from somewhere, and if the government is running a budget deficit, that shortfall has to be borrowed. While a country with a modest fiscal deficit can afford a certain amount of stimulus, that’s not the case for a country whose budget was already in deficit by more than $1 trillion – or 7% of GDP – when President Barack Obama came into office.
By enlarging the deficit so much, the administration may well have destabilized the bond market, preventing the rapid turnaround in the economy that could otherwise have been expected. As a side effect, the stimulus may also have made it more difficult to pass President’s Obama’s hoped-for packages on global warming and healthcare, making it counterproductive politically as well as economically.
Beyond the U.S. borders, the outlook is somewhat brighter. Some countries – such as Britain, for instance – are in much the same mess as the United States, with excessive deficits and a money-printing central bank. Indeed in Britain, the central bank has for the last three months been buying enough government bonds to monetize the entire British budget deficit, reducing the upwards push on bond yields, but managing to re-ignite the British housing market, which had become even more overvalued than its also-overvalued U.S. counterpart.
The IMF forecast for Britain is worse than the projection for the United States – a decline of 4.2% in 2009 GDP, and a rise of only 0.2% in 2010. That looks about right, though some of the 2009 decline may be pushed into 2010 by the Bank of England’s actions.
In China, the picture is unclear. The IMF estimates growth of 7.5% in 2009 and 8.5% in 2010, by far the best performance of any major economy, but this both takes Chinese statistics at face value and underestimates the risks facing China’s economy.
Bank lending in China was more than $800 billion in the first quarter and was again running at record levels in June; it is thus likely that China is over-indulging in real estate projects with no tenants, as well as subsidies for hopelessly unprofitable state enterprises. This means there is a substantial downside risk for China’s growth, and 2010 may be much less pretty than 2009.
This is also true for India, where the IMF estimates 5.4% growth in 2009 and 6.5% in 2010, but does not take account of the out-of-control expansion in Indian government spending – up by 36% this year to spawn a deficit in excess of 10% of GDP.
In the past, India’s economic expansions have at times been choked off by credit crunches that surface when government deficits cannot be financed. This time around the same outcome is likely. As with China, I would expect 2010 to be much less likely than 2009.
Finally, there are two countries I believe the IMF is being overly pessimistic about: Brazil and Germany.
For Brazil, the IMF is forecasting a 1.3% GDP decline in 2009, followed by 2.5% growth in 2010. This looks too low. Brazil’s trend growth rate is around 5%, and it has little trouble selling its commodity-and-energy exports when China’s demand is still growing.
Furthermore, Brazil’s budget deficit is modest and its interest rates are just below 10% — still substantially above the country’s inflation rate of 4% to 5%. I would thus expect Brazil to considerably outperform the IMF’s forecast, showing little net decline in 2009 GDP and growth close to its 5% trend in 2010, with domestic demand joining exports as a source of strength.
Finally, the IMF is exceptionally pessimistic on Germany, forecasting a 6.2% decline in 2009 GDP and a further 0.6% decline in 2010. Since German industrial production rose by 3.7% in May and its trade surplus rose to a record 10.3 billion euros (about USD $14.4 billion), this is far too pessimistic.
Germany has been notably cautious in its stimulus, and the German budget deficit is still only around 3% of GDP. Consequently, that key European nation is likely to find expansion easy to finance, and will outperform significantly the rest of the EU in the months ahead, showing a brisk recovery from its sharp downturn. I would expect Germany’s 2009 GDP decline overall to be a mere 2%-3% and its 2010 growth to be substantial, at least 2.0%-2.5%.
The IMF and I agree that the world economy is once again decoupling, with 2010 growth much stronger outside the financial-services-oriented economies of Britain and the United States. However, we disagree on where growth would be strongest; my picks would be Brazil and Germany, not the IMF’s fashionable China and India.
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News and Related Story Links:
The Wall Street Journal:
IMF Boosts 2010 Economic Outlook.
Money Morning Market Analysis:
What Shape Will the U.S. Recession Take: U, W or ‘Bloody L?’
Money Morning News Analysis:
Markets Slide on Consumer Confidence, Unemployment Reports.