Risk is on the rise as the US slows down

Jul 2 2008 by Bill Gleeson, Liverpool Daily Post

The latest Merseyside and North Wales Business Prospect, published by the Liverpool Research Group in Macroeconomics, is out this week. Editors Patrick Minford and Peter Stoney review the outlook for the national and local economy

WE HAVE been used to a world dominated by the US, in which the rest of the OECD and the emerging markets all vibrated to the rhythm of America’s economy.

This world is no more.

The US is in a slowdown – not yet a recession but effectively zero growth and possibly going negative – but the rest of the world is booming.

The emerging market economies are mostly growing in a range of 5-11%, while the OECD countries supplying them with capital goods, Japan and Germany predominantly, are finding their capital export sectors are fizzing still.

Primary producer OECD countries like Australia and Canada are also benefiting.

With such a world boom going on, we believe it is unlikely that the OECD countries will slip into recession. Even the US is probably being held out of recession as much by its buoyant exports and the low dollar as by the large drop in interest rates and other government action on mortgages and taxes.

The problem with the current situation is the serious inflation now being unleashed in the emerging market economies.

Emerging countries have poor monetary policies, rely greatly on price and credit controls, often have deficit-generating public sectors and intervene heavily in foreign exchange markets to keep their currencies down. Inflation is nearly 10% in China and moving into double digits across most of these countries. So far their governments have paid scant attention to the issue, arguing that it is worth having inflation for the sake of growth. This position, however, is quite unsustainable; inflation is expensive in both economic and social terms.

So ironically and quite contrary to the views widely seen today, the OECD countries are not doing too badly out of the world boom. Yes, most face a nasty term of trade movement against them, as imported commodities have risen in price. But no, they have no inflation problem other than a temporary one because wage growth is weak given their tight monetary policies. They do not face recession as they continue to participate in the world boom.

IF WE look a year or two ahead, however, things will change sharply as emerging market countries are forced by their own internal politics to confront the inflation dragon.

We know from the early 1980s that the cure of bad embedded inflation is painful and results in a sharp recession until the new tough monetary regime has been understood and accepted. With emerging markets currently leading world growth, the same anti-inflation medicine for them will cause a sharp world slowdown, possibly a world recession – at least unless counter measures are taken by OECD countries.

As the emerging market countries tighten monetary policy, OECD countries must loosen it.

Already we have seen several commodities fall back after profit-taking by hedge funds and other speculative players. This process will become general, and no doubt embrace oil as well.

So this is an environment fraught with risk. Our main forecast is for slower UK growth, no recession, and for a bout of inflation that goes away in 2009. Matters improve from 2010 onwards. But the risks are on the one hand that politicians and public opinion panic and demand a loosening of the inflation target – leading to a resurgence of embedded inflation. Another possibility is that the Bank of England is excessively cautious in the face of a worse slowdown, perhaps led by large house price falls, and a full-blown recession results.

THIS then is the background for our regional forecasts. Nevertheless we still do not see doom and gloom ahead – rather a period of subdued spirits and uncomfortable slowing and even some falls in living standards as rising commodity prices squeeze us.

Our regional forecasts show a slight slowdown in all UK sub-regions during 2008 before recovering in 2009 and 2010. Merseyside cannot escape the UK’s short-term problems of increasing inflation and unemployment, but Liverpool’s economic resurgence is bound to have alleviating effects. The huge Liverpool One retail development linking the city centre more closely with the riverside has synchronised perfectly with the city’s European Capital of Culture status. Of equal if not more importance is the continuing growth of the Port of Liverpool. The ambitious investment plans of port operator Peel Holdings on both sides of the River Mersey should give a significant uplift to Merseyside and its hinterland of North Wales and Cheshire.

Our panel survey reflects this buoyant outlook, with capital investment plans as well as short-term optimism showing positive trends. The Regional Economic Commentary and Diary in this issue corroborate these trends, with female unemployment having registered falls or zero increase since last August.

The dark clouds in Merseyside, however, of above average numbers of Incapacity Benefit claimants, of underachievement among school leavers, and of pockets of inner city deprivation remain as obstinate features.

Much remains to be done before it can be truly said that Merseyside is back to the good old days of a century ago.