The State of the world economy

While most weekly published articles indicate that the world economy still faces an uphill battle, there is a case to be made that the state of the world economy actually depends on where in the world you are. “While countries in the West face increasing debt to GDP ratios, developing countries from the East are becoming more competitive on the world stage,” says Paul Stewart, managing director of Plexus Asset Management.

In the most recent SocGen global economic outlook¹ the world economy is divided into four stages of progression, namely “no bubble, leverage cycle, bubble burst and deleveraging”. Various countries were plotted to show in which stage they are (see accompanying Diagram A).

The countries in the no-bubble stage, namely Germany, South Korea, Taiwan, Canada, Australia and New Zealand, are experiencing what is considered more normal economic conditions where debt slowly increases as confidence rises and no major monetary or fiscal policy manipulations are required.

The leverage cycle is the stage where investment, especially in fixed assets, is the main focus. Accelerated investment and productivity are currently predominant in Brazil, China, India, Hong Kong and Singapore. As debt starts to increase, monetary policy starts to implement measures to curb excessive debt and tries to keep inflation in check. This is especially evident in the recent steps taken by the Chinese banking authorities.

If spending continues unchecked, a bubble-burst scenario evolves. While many countries have been exposed to this scenario over the past few years, Ireland, Greece and to a lesser extent the UK are still hovering in this stage. This is when the realisation hits that asset prices have moved too high and too fast and price declines occur. Demand for debt falls away and quantitative easing is required to prevent further declines.

In the deleveraging stage, as experienced in Spain, USA, France, Japan and Italy, the main focus is bringing about financial stability by introducing measures to reduce debt. An important aspect of this stage is that exports become an important driver of growth and relative exchange rate weakness is desired.

“This explanation clearly shows that depending on where you are, the economic conditions experienced can be substantially different,” says Stewart. “It thus becomes increasingly important for policy makers to identify the economic stage of a country before measures are implemented to bring about improvements.”

Another spin-off of identifying the economic condition experienced in each country at any one time is the question of decoupling. This asks whether countries are less dependent on each other in terms of their economic prosperity. Can some countries do well while others struggle?

“Before the liquidity crisis a few years ago, the question of decoupling arose as developing countries continued to be more productive that their developed counterparts,” says Stewart. “However, as liquidity was drained from the system the whole world experienced a slowdown and countries with solid balance sheets were hurt as liquidity was sought in any form. As a result, the decoupling scenario seemed to be swept under the carpet.”

Now, as certain markets have recovered while others are still struggling, the question arises again. The accompanying graph shows actual GDP growth of different countries in 2009 and forecast numbers for 2010 to 2012.

“The current and forecast production numbers suggest that developing nations will continue to prosper even as the developed nations experience periods of mediocre growth,” says Stewart. “This makes a strong argument that the decoupling scenario is alive and was only briefly interrupted as liquidity concerns spread across the world.”

According to Stewart, it is thus clear that the state of the world economy depends on perspective. “A Chinese factory owner who has an order book bigger than his productive capacity thinks the world is a wonderful place and prosperity will continue for a long time,” he says. “On the other hand, an Irish banker that needs a government bail-out gets very little shut-eye as concerns about keeping his job keep him up at night. More than ever the answer to the question of the state of the world economy is… well, it depends!”