Asia holds key to global prospects
The world economy has shown resilience in recent years to survive a series of economic shocks and enjoy the strongest growth rate in 30 years. Despite the upbeat mood, however, I am cautious about the prospects for the world economy. It is imbalanced because it is heavily dependent both on the United States and China and the two economies now provide a downside risk for the rest of the world.
In the past, people around the world used to talk about the U.S. economy as a locomotive, an analogy of a train moving fast that pulled the rest of the world. A better analogy for the U.S. economy now is not a train, but a car. Think of driving your own car. If your foot is on accelerator, the car accelerates. One foot on the brake, the car slows down. If you get it wrong, the car crashes. This is the exact situation of the U.S. economy as if it is driving a car - one foot on the fiscal accelerator and the other foot on the monetary brake. U.S. policymakers have to get it just right.
U.S. Federal Reserve System officials are genuinely positive about the U.S. economy. It has benefited from low interest rates and more particularly they see no big inflation problem. As a result, the Fed raised interest rates. Our view at Standard Chartered Bank has been that U.S. rates will rise to two and a quarter by the end of this year and the Fed will continue to raise the rates as it moves into next year. Our view is that U.S. rates will peak next summer probably around 3 percent. The important message is that U.S. rates will peak at much lower levels in this cycle than in the previous cycle because inflation is not a problem.
American companies have two big issues. First is the oil price shock leading to cost increases. They have difficulty passing on the higher cost to final consumers and therefore their profit margins are being compressed.
The second concern in the corporate sector is, if you look at the world economy, there are a lot better places to invest at cheaper rates than in the U.S. American companies are now in good shape, but a lot depends on what happens with American consumers. Because American consumers spend heavily again next year, maybe American companies would invest again. Again there is another area of uncertainty. There is every likelihood that American consumers could start to spend less and save more as they move into 2005. Why? American consumers have to do the same thing that American companies have done over the last few years to get their balance sheet back in shape: spend less and save more.
What would U.S. policymakers do about the U.S. dollar and the current account deficit? U.S. policymakers' message has been consistent - America believes that the solution to the current account deficit is stronger growth elsewhere. If you have a current account deficit there are three ways to get out of it - stronger growth elsewhere, weaker growth in America or a weak dollar. The reality is a weak dollar by itself does not correct the current account deficit. You need to have either much stronger growth elsewhere or weaker growth in America.
In previous cycles, when the U.S. economy slowed down, Europe picked up or Japan picked up. Now it is different. European growth is strong because of America. Japanese growth is strong because of China. European policymakers' view is that America has achieved growth at the expense of stability. In Europe, they have achieved stability at the expense of growth. Europe doesn't want to change. Europe also faces demographic problems - an aging population.
Let's turn to China. China has provided a huge boost to all regions of the world, particularly Africa and the Middle East and especially Asia. If the Chinese economy slows down, Asia faces difficult times. There has been a great change in respect to China in the last few years. Two years ago, policymakers across Asia talked about a competitive threat from China. Now China is seen as a growth opportunity. The attitude toward China has changed across Asia.
Chinese policymakers are trying to get the temperature of their economy just right. Since the middle of last year, Chinese policymakers have targeted specific measures to slow their economy down focused on certain sectors - aluminum, steel, cement and real estate. They were doing a very successful job. Then it raised interest rates by 27 basis points. That was a significant move. This suggests that Chinese policymakers have increased optimism about the economy and the debate has changed.
I don't think that China is overheating. But China does have a big problem - overinvestment. That's why I believe over the next six months, interest rates will rise further. The last time China had a boom and burst in the early 1990s, the economy suffered. For six years after the boom, the investment fell in China and consumption also slowed. Chinese policymakers learned a lesson from their own past and also are well aware of lessons elsewhere in Asia, particularly in the 1997 Asian economic crisis. At the time of Asian economic crisis, investment in many Asian countries including Korea went above 40 percent of GDP. Chinese investment is now at a level that led to danger signs in other Asian economies in 1997.
For the last two years, financial markets around the world have speculated and bet that China will revalue its currency. Standard Chartered Bank recently released "SCB Chinese Currency Barometer." It measures pressures on the Chinese economy. We have been tracking it internally for the last six months and it has been the best guide to pressures on Chinese currency. Over the last two years, it suggested no need for a change in China's currency policy. Now it suggests that China should revalue its currency. We believe that China will change its currency policy. But gradualism is the key because of all the different factions and influences in the debate. What's important is that debate about the changes in currency policy is now taking place. The way we describe it is economically yes, politically still debating.
What do all these changes mean for Asia and Korea? They mean that Asia holds the key to the prospects for the dollar and to whether the global economy avoids recession in the next two years. Here is a number of factors to back up this statement. First, in terms of currency, what happens to the dollar does not depend only on what happens in America. It depends on what you in Asia want to do. Ten years ago, one third of global currency reserves were held by Asian central banks. Today the figure is two thirds. What happens to the dollar depends on what Asian banks want to do. For the moment Asian central banks seem pretty keen to continue to accumulate dollar assets. They never thought that the dollar would trend weaker. It means that policy in countries like Korea would have to change. If the Korean won remains strong, Korean interest rates could dip further. And the risk is they could dip even more than we expect.
The other issue is vulnerability to shocks. Asian countries have handled oil shocks. But if policymakers in China or America get it wrong, the additional shock will be vulnerability to a global recession in the next two years. On the positive side, however, future global growth really depends on Asia. The world economy is imbalanced, overly dependent on America and China. The only way that the world economy can be more balanced is if over next five years there is stronger demand in Asia. That means higher saving becomes higher demand. It means growth in the small and medium-sized sector in Asia.
Geopolitics also matters. Geopolitics is vitally important in terms of North Korea and the Middle East. China and South Korea have been achieving stability in North Korea. The Middle East is still a problem. What does this mean for Asian businesses and Asian countries? For far too long the Asian region has never spoken with one voice. Different countries tend to say different things. Now there is a clear need to see the Asian region start to speak with one voice. This should serve as a positive for Korea's strategy to become a regional hub.
The world economy has been very resilient in recent years. Asia has also been resilient. None more so than Korea since 1997. But there are still a lot of issues to be addressed. There are threats, fear of hollowing out in China and a demographic problem for Korea. Korea also has too speedy economy. On the opportunity side, Korea has a phenomenal potential in terms of its positioning with respect to China and also tremendous opportunity in terms of its position as a regional hub. When you speak to companies around the world, they are becoming more and more interested in Northeast Asia rather than Southeast Asia. If you achieve stability and peace in North Korea, that will make geopolitics less of an issue and allow people just to focus on the business opportunities that exist here.
This is an abridged version of a recent speech delivered in Seoul by Dr. Gerard Lyons, chief economist at Standard Chartered Bank. - Ed.