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Premium Event provides global economic outlook

On 21 October, the ECCT arranged a Premium Event lunch featuring guest speaker Klaus Baader, Chief Asia Pacific Economist for Societe Generale. In his presentation at the event, Baader said that he is optimistic on the economic prospects for the United States (US) and Japan and somewhat pessimistic on the outlook for Europe and China.

The decline in oil prices, while bad news for oil-producing countries is good news for consumers and energy-intensive manufacturers everywhere. According to Baader, the US is now at an inflection point given that the private sector has finished deleveraging and demand has already accelerated. That country is now benefiting directly from the shale oil and gas boom, which has helped to make manufacturing much more competitive. SG forecasts GDP growth rates of greater than 3% every year from 2015-2018.

The Federal Reserve's (Fed) Quantitative Easing (QE) policy is set to end this month and the Fed is expected to start raising interest rates in the middle of 2015.

The so-called "baby boom" is unique in history, according to Baader, and it will have a profound impact economically. As baby boomers retire, this will depress labour participation rates. Just a decade ago, the break-even pace of job growth (required to keep the unemployment rate stable) was around 130,000 per month. Today, it is estimated at 80,000-90,000 per month. If job growth continues at the recent clip of about 200,000 per month this will push down on unemployment much faster than it would have in previous cycles. This is why SG projects downside risks for the unemployment rate.

Lower unemployment will also put pressure on wages. Higher wages would be good news for consumption but also bring a risk of higher inflation. The outlook for investment is also good. Cash flow remains strong while rising capacity utilization and expensive equity valuations means that more organic investment has become a more favourable option than share buy-backs. This prediction is backed up by surveys of CFOs and CEOs, who have said that they are ready to increase investments.

Europe remains stuck in a low growth and low inflation funk (conflation). Although Baader does not expect Europe to fall back into recession, he foresees only modest growth, which will be uneven, depending on the country. He attributes the lack of growth in Europe to weak domestic demand and a lack of structural reforms in economies such as Italy and France. He backed up this claim by noting that countries that had implemented reforms (such as labour reforms) in recent years, such as Portugal, Ireland and Spain, had also seen a return to growth while countries that had been slow or unable to introduce reforms, such as Italy and France, have remained moribund.

However, the job of achieving sustainable public finances is not yet done as most governments in Europe continue to spend much more than they take in and many exceed the EU's 3% budget deficit limit. The flow of new loans to the private sector remains negative, but seems to have troughed. This is not a problem unique to Europe as the whole world has become more risk averse since the global financial crisis.

Asia's export driven economies are benefiting from the US recovery. Exports from Asia to the US have been on a rising trend since June 2013. This includes China but that country has other problems. SG expects a sharper deceleration of growth than consensus forecasts for the next few years – 6.8% in 2015, falling steadily to 5.5% by 2018 due to slower but more efficient investment growth. On the one hand this is good news because the investment-driven/capital investment growth model is now outdated, has produced over-capacity in a number of industry sectors and was debt intensive. While China's overall debt, estimated at 200% of GDP is lower than the 300% average in the West, corporate sector debt is high and therefore a risk.

The housing sector has seen too much growth too fast. According to statistics cited by Baader, the number of housing projects under construction and unsold units has been on a steadily rising trend since 2009 and unsold inventory of completed apartments now stands at about 17 months of average monthly sales. While average prices have been declining since 2011, given the inventory overhang, prices are expected to decline further.

Baader expressed optimism about Japan, giving Abenomics the benefit of the doubt, although SG's GDP forecasts 1.8% GDP growth in 2015, falling to 1% in 2016. According to Baader, the main cause of Japan's deflation was corporate sector deleveraging and weak risk-taking which led to a high corporate savings rate. Therefore, strong corporate activity (negative corporate savings) is necessary for Japan to exit from deflation. The depreciation of the yen has helped to end deflation and stagnation. Corporations are flush with cash, unemployment is low at 3.5% and there are signs that earnings are rising, initially thanks to growing overtime and higher bonuses but more recently also base salaries.

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