It will be bad or good - not average

Jul 28 2010 by Andrew Miller, The Journal

FOR the first time since the global economy started its recovery last spring, the world is split - more or less evenly. On the one hand are those who fear that the high-water mark of the pick-up is behind us, and that things can only get worse from here.

On the other, many believe that even if growth slows a bit, it will not be the end of the world. We think there are three main issues that will determine which path we now go down.

The first is the economic health and intentions of the US consumer. In recent months, there have been increasing worries that they might give up the ghost on spending. Employment is lower than it was at the comparable stages of previous recoveries. And real wages are the lowest they have ever been at this stage of a recovery. Given that there’s no offset from fiscal or non-wage incomes, households’ overall purchasing power is about two years behind where it normally is at this stage of a pick-up – and actually lower than when the pick-up began. So quite understandably, US consumers are proving hesitant to open up their wallets. And a mixed outlook for the housing market and equities prices – two key drivers of household confidence levels – won’t help either.

The second issue is the viability of European Monetary Union (EMU). The single currency means that the less-competitive countries in Europe can’t devalue their way out of their problems. And dramatic fiscal tightening in many countries will simply add to the stress – leading to a jump in debt-to- GDP ratios thanks to the inevitable decline in the denominator. As a result, it looks likely that policymakers’ hopes of muddling through on EMU may be misplaced. Eventually, EMU will have to morph into a new type of currency union – an EMU but in a (Star Trek-style) “not as we know it” form.

A third, probably less important problem, is inflation in Asia. Higher inflation in China is a symptom of an economy that has been growing at above-potential pace for too long. (It looks to have run out of spare capacity.) So the authorities may have to slam on the monetary policy brakes more harshly than generally expected, thus depriving the global economy of one very important engine of growth.

All these uncertainties mean it’s hard to suggest a single macroeconomic forecast for the global economy.

On a three-month view, the chances of the global economy muddling through are quite high, although chances of an ugly scenario increase if you look forward a year or so.

But muddling through on the macro- economic front, however, won’t necessarily lead to a middling performance on the markets front. With investors remaining nervous, stock markets are more likely to do very well, or very badly, than record only modest rates of growth.

:: Andrew Miller is regional office head at Barclays Wealth