Global Economy in 2014 Needs Successes in Washington: Year Ahead
On Jan. 1, Latvia will adopt the euro, and its lats currency will be no more. Farewell to the bearded Krisjanis Barons, the collector of folk songs who graces the 100-latu note. The Baltic nation is shucking a piece of its heritage because its leaders predict joining Europe’s common currency zone will lead to more trade and prosperity.
There aren’t many other events in 2014 that can be forecast with as much confidence as Latvia’s scheduled adoption of the euro. For decision-makers in global business, some big unknowns await: Will the U.S. economy add jobs or asset bubbles with Janet Yellen running the Federal Reserve? Will German Chancellor Angela Merkel become more generous toward Southern Europe? Can Chinese President Xi Jinping and Premier Li Keqiang repair the slowing engines of the world’s second-largest economy? Can Shinzo Abe, Japan’s prime minister, shrink budget deficits?
Those are among the economic and geopolitical ideas being explored starting today at The Year Ahead: 2014, a two-day conference in Chicago hosted by Bloomberg LP, the parent of Bloomberg News and Bloomberg Businessweek. Wrestling with the hardest questions of the day can help executives make decisions about where and when to deploy people and capital.
Worldwide, 2014 should be better than 2013 but not great. Inflation and interest rates are low in most of the world, oil prices are predicted to fall, companies have cash and there’s pent-up consumer demand. A Barclays measure of global business confidence reached a 31-month high in October, and the Bloomberg U.S. Financial Conditions Index is running at the highest level in record dating to 1994.
Even so, the world is having trouble accelerating after the 2009 worldwide slump. The International Monetary Fund projects global growth in gross domestic product of 3.6 percent in 2014. While that’s up from 2.9 percent this year, it isn’t back to the 5 percent growth rates of 2005 to 2007.
“Global growth is in low gear, the drivers of activity are changing, and downside risks persist,” the organization reported in October.
The best place to start the tour d’horizon is Washington.
The U.S. is the world’s largest economy, and two of the most important global questions involve the Fed and Congress. One is whether Congress and the White House can reach deals with a minimum of fuss in January and February to fund the federal government and raise the debt ceiling; the other is whether Yellen can taper stimulus measures as adroitly as current Chairman Ben Bernanke layered them on.
Success in both missions could lift 2014 growth in the U.S. above the middling 2.6 percent rate foreseen by economists surveyed by Bloomberg News. Failure would hurt the U.S. and reverberate worldwide.
“What we should be mainly focused on is, how do we get the growth engine back,” Austan Goolsbee, a professor at the University of Chicago’s Booth School of Business and former chairman of the White House Council of Economic Advisers, said last month on “The Charlie Rose Show” on PBS and Bloomberg Television. He’s scheduled to speak at the conference today.
One optimist is Federal Reserve Bank of St. Louis President James Bullard, who said at the conference today that U.S. economic growth may accelerate to 3 percent or more in 2014. The U.S. housing market has improved in the last 18 months and Europe is coming out of a recession, he said.
“That will help the global situation,” Bullard said. “The right assessment of 2014 is still to be optimistic.”
Bullard said he doesn’t favor lowering the unemployment threshold at which the central bank would consider raising interest rates. Since December, the Federal Open Market Committee has said it would hold its target interest rate near zero as long as unemployment remained above 6.5 percent, so long as the outlook for inflation didn’t rise above 2.5 percent.
If the Fed were to lower the unemployment threshold, Bullard said, “then how much credibility do you have for the threshold?”
Even with the U.S. emerging as one of the world’s low-cost manufacturing centers, politicians could still mess things up by keeping executives guessing, said Harold Sirkin, a senior partner at Boston Consulting Group.
“The thing that business hates the most, maybe after taxes, is uncertainty,” Sirkin said. Companies aren’t investing and “they don’t want to hire people. If you tell them what the rules of the game are, they’re more likely to respond.”
One path forward goes like this: Fiscal policy becomes less of a drag in 2014. Republicans approve a debt-ceiling increase in February in exchange for some hard-to-predict concession from the White House. By spring, President Barack Obama wins continuing resolutions replacing some scheduled budget caps and sequestration with smaller cuts in other areas. In the November 2014 elections, the GOP loses seats but retains control of the House.
Divided government means less contraction because the Republicans can’t win big spending cuts and the Democrats can’t get tax increases. There’s little progress, though, on restraining the long-term growth in entitlement spending.
Over at the Fed on Constitution Avenue, Yellen will face anguishing decisions as soon as she replaces Bernanke as Fed chairman on Feb. 1, assuming she wins confirmation. Years of near-zero interest rates and aggressive Fed bond-buying have failed to engender strong economic growth. Monetary hawks say easy money will create bubbles in assets ranging from housing (again) to farmland to junk bonds.
The Fed is near a tipping point at which stimulus becomes “an agent of financial recklessness,” and “none of us really know where that tipping point is,” Richard Fisher, the president of the Federal Reserve Bank of Dallas, said in October. In 2014, Fisher becomes a voting member of the Federal Open Market Committee -- and a thorn in Yellen’s side.
Bubbles are only one risk. The expansion could lose what little momentum it has next year if Yellen, to prove her inflation-fighting bona fides, goes along with premature withdrawal of stimulus. The decline of the unemployment rate since 2009, to 7.3 percent in October, is misleading because it’s largely the result of people giving up and not being counted among the unemployed, said Scott Clemons, chief investment strategist at Brown Brothers Harriman Wealth Management.
If the expansion since the last recession ended in June 2009 is still intact next summer, the run of growth, modest as it is, will have lasted longer than the average since World War II. To keep it alive, said one investor, it’s almost as likely the Fed will increase stimulus as that it will finally begin its long-anticipated taper.
“Low demand for credit, low inflation and other indicators are signaling that deflation remains a serious threat,” Daniel Arbess, a partner in the investment and advisory firm Perella Weinberg Partners, wrote in an e-mail.
World’s Central Bank
The Fed’s next move matters to everyone because it remains the world’s de facto central bank. Other nations complained when low U.S. rates sent hot money flooding their way in 2008, and they complained again this year when hints of higher U.S. rates reversed the tide.
Yellen won’t focus too much on that turmoil; serving the U.S. economy is complicated enough. The central bank will start tapering the monthly pace of bond buying by $70 billion around March, according to the median estimate of economists surveyed by Bloomberg. Even so, the Fed’s own rate setters don’t foresee nudging up the federal funds rate until 2015, because the U.S. economy remains too weak to withstand it.
All of which argues for caution. At the sprawling Port of Long Beach, California, work is proceeding on a $4 billion expansion that by 2019 will increase capacity by one-third. Port officials aren’t so bullish about the coming year -- they’re projecting only 3 percent volume growth for Long Beach and the neighboring Port of Los Angeles combined, the same as this year.
“We see no clear sign that the recovery is picking up steam in the immediate future,” said Noel Hacegaba, the port’s chief operating officer.
China, the world’s No. 2 economy, won’t grow at its customary pace in 2014, either. Western drugmakers, whose Chinese sales rose 40 percent a year as recently as 2011, might have to settle for 14 percent to 15 percent growth next year, estimates London-based GlobalData.
Economists surveyed by Bloomberg are looking for China’s deceleration to continue in the year ahead, with growth of 7.4 percent, down from 7.6 percent this year. While that may look boringly steady, the seeming ability of China’s leadership to hit its targets masks economic and political volatility.
“Nothing in China is as it appears,” said Gary Burnison, chief executive officer of recruiting company Korn/Ferry International. Burnison, who lived in Shanghai this past summer, is scheduled to speak at the conference later today.
To judge whether President Xi and Premier Li are gaining the upper hand, keep an eye on a few key events in 2014, advises David Hoffman, who lives in Beijing as managing director of the Conference Board’s China Center for Economics and Business. One is the 12th National People’s Congress’s plenary meeting in March. The other is a plenary session of the 18th Central Committee of the Communist Party of China, probably in September or October.
While Li wants to move China from investment to consumption as a source of growth, the pop in growth this fall was achieved the old-fashioned way -- by heavy lending that fueled investment in plants, equipment and infrastructure. The municipality of Beijing, for example, is planning a financial district with 80 skyscrapers, even though its existing Financial Street is only about 15 years old.
“We’re seeing tremendous inertia on the reform front, and the factional divides are very pronounced,” Hoffman said.
China looks considerably healthier to Michael Silverstein, who, like Sirkin, is a Boston Consulting Group senior partner.
“There are 300 bureaucrats that basically run China as a meritocracy,” he said. They’re already starting work on the next Five-Year Plan, which will cover 2016 to 2020. “It’ll just blow you away,” Silverstein said. “I think they’re going to get highly specific about the technologies they really want to try to own.” Corruption? “The current government is very intent on knocking that out,” he said.
On currencies, one piece of good news is that imbalances in global trade have been shrinking. American deficits and Chinese surpluses have fallen dramatically since 2007. But even that positive development will cause unnerving reverberations in 2014, predicts Stephen King, HSBC’s global head of economics and asset allocation.
The recently dubbed Fragile Five -- Brazil, India, Indonesia, South Africa and Turkey -- became addicted to inflows of hot money caused in part by the Fed’s easy monetary policy. They ran up trade deficits. Now those deficits are getting smaller, which is healthy in the long run. But they’re dwindling too rapidly and in a sickly way, i.e., through currency depreciation that makes imports unaffordable and through high interest rates that chill demand, King said.
Mathematically, if the Fragile Five are reducing their deficits, some other countries must run bigger deficits or smaller surpluses. If they don’t want to, the risk is a beggar-thy-neighbor currency war.
A big question for 2014: Which country will break out of a mercantilist mindset and accept smaller surpluses? China is moving slowly toward an overall balance in trade despite its huge surplus versus the U.S.
Then come Japan and Germany. Japan’s Abe is in a pickle. He needs to boost growth but can’t afford a big stimulus and is promising a sales tax hike in April. So Abe is counting on igniting growth through higher inflation. That weakens the yen, which suppresses imports.
“It is hard to see any solution to Japan’s problems that does not involve a significantly weaker yen,” Julian Jessop, chief international economist for Capital Economics, wrote in a note to investors.
That leaves Germany, which has run large trade surpluses throughout the European crisis. While Merkel won election to a third four-year term as chancellor in September, her Christian Democratic Union party failed to garner enough votes to form a government by itself. Her most likely partner is the more Eurocentric Social Democratic Party. European growth could accelerate in 2014 if a new German coalition government provides more financial aid to the rest of Europe and agrees to contribute more to recapitalizing weak banks in Spain and Italy.
“This is not far-fetched,” said Andre Sapir, an economist and senior fellow at Bruegel, a Brussels-based think tank. “Germany doesn’t want to go for the major clash and the end of the euro.”
On the other hand, ordinary Germans aren’t feeling a lot of gemutlichkeit -- warm fuzzies -- toward the people of Southern Europe, whom some describe as freeloaders.
Conservative Germans say that if they make life too easy for Greece, Portugal, Italy and Spain, the pressure on them to reform will be removed. If Germany gets too hard-nosed, though, its policies could intensify a populist backlash in debtor nations. A key event to watch is the elections to the European Parliament in May, where anti-European parties threaten a strong showing.
A surprise rate cut by the European Central Bank on Nov. 7 should boost growth. On balance, Sapir is mildly optimistic: “I would see 2014 as a year of transition. But hopefully not a wasted year of transition.”
Once you get past the world’s top four economies, you’re down to countries that are not fully masters of their own fates.
The rest of Europe takes its cue from Germany, although Britain, France and Italy are players, too. The economies of Russia and the Middle East depend on energy prices. Africa, primarily a commodity producer, lives and dies by the swings in prices of raw materials. Ditto for most of South America, although Brazil is a major manufacturer as well.
Southeast Asia and Australia are in China’s orbit, while Canada and Mexico depend on the U.S. India is big but insular. Then there are the trouble spots that could blow up in 2014 --or not: the South China Sea, Kashmir, Yemen and so on.
The U.S. matters the most of all. If it grows, the world will, too. In the eastern U.S., railroad CSX Corp. is running more trains laden with housing construction materials, cars and even crude oil from North Dakota.
“We are feeling more optimistic,” CEO Mike Ward said. Looking at some of the broad indicators in the economy, “we’re really seeing some positive signs.”
If more CEOs climb on board Ward’s optimism train, 2014 could be a strong year after all.
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