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The annual parade of forecasts for the global economy in 2006 is still focused on the same basic topic as it was last year and the year before - namely the degree of imbalance in the global economy. However, there are two main differences between the debate currently underway regarding the outlook for 2006, and that of preceding years. The first is psychological and the second is substantive.
The psychological difference is that the bears - the school of thought that believes that the imbalances are very severe and that serious trouble is inevitable - are on the defensive. Indeed, the bears have a major credibility problem: For years now they have repeatedly warned, in ever-more lurid terms, of the problems bubbling beneath the surface and the dreadful consequences they will unleash. Yet, year has followed year and not only have these consequences failed to emerge, but the opposite has happened - the global economy has gone from strength to strength. The American economy, in particular, has blown a long and loud raspberry at the pessimists by recording 10 successive quarters of GDP growth in excess of 3% per annum, for the first time since the mid-1980s.
The second point is that the imbalances may be moderating. True, within the American economy all the problematic symptoms are as evident as ever, but on the global scene there are encouraging signs. The European economy is generating a stream of data that point to an ongoing improvement, especially with regard to its main bugbear of consumer spending. Even more importantly, the Japanese economy has come back from the dead and is looking steadily better. The degree to which these two major players are able to take a more active role in driving the global economy is critical, because it allows the US to shed the burden of being the sole large developed economies making a positive contribution to world growth. As for the Chinese economy, it is becoming steadily more important, as noted here last week, and the feared slowdown in its rate of growth has yet to materialize.
Despite these challenges, the bearish camp has not given up. In fact, it seems that its ranks have swollen: a larger number of economists, forecasters and global strategists are saying in their 2006 forecasts that they expect trouble ahead. Of course, in most cases, they are using the kind of cagey and qualified terminology that is expected from economists, who all have not just 'the other hand,' but at least three or four hands to use, and that is demanded from analysts at investment houses. Nevertheless, the message is clear enough, between the lines and often in fairly plain words.
That message is very well put by Michael Hughes, the chief investment officer of Barings Asset Management. Quoting the American economist Hyman Minsky's famous remark that "stability is unstable," Hughes notes "what he meant by that is that the longer things stay the same, the more we expect them to remain the same and the more complacent we get. The result is that when things actually do change, the shock is that much greater."
The problem, as Hughes illustrates, is that the world economy has become very complacent over recent years, leading to an unprecedented degree of convergence in inflation rates, interest rates and other key policy goals. However, he adds, "we believe that tectonic forces are in motion which will bring the long period of convergence of economies to an end." He then proceeds to lay out his analysis supporting that belief and the conclusions arising thereof, primarily that Asia will outperform both the US and Europe for the foreseeable future, that global investors (ie rich Westerners) are still massively underweight Asia and that they should and will bring their investment portfolios more into line with the new realities of the global economy.
The key word, however, is 'belief.' Most people don't want to believe that 'tectonic forces are in motion' and that tsunamis and earthquakes are as inevitable in the financial system as in the geological one. The prolonged stability deriving from years of low interest rates that fed into rising bond markets and soaring real estate markets, has created a strong disincentive against any such belief in change, especially abrupt and painful change. What people want is more of the same. unfortunately what they are going to get is Something Completely Different, which, unlike the Monty Python context of that famous phrase, will be no laughing matter.