More than a year after the recession officially ended in the US, Standard & Poor’s expects to see relatively slow growth in the US and Europe. At the same time, faster-growing, emerging economic powers such as China are likely to continue expanding their presence on the world stage. Standard & Poor’s chief economist, David Wyss, shares his outlook for the economies in Asia, particularly China, and his views on liquidity, inflation and interest rates in the region.
What are your thoughts about the amount of liquidity in the global financial system? Is there any way to manage the bubble-and-bust dynamic that we've seen played-out twice in rapid succession during the past decade?
A lot of the problem in the international financial markets was caused by the huge surpluses a group of countries ran up -- particularly China, Japan and the oil-exporting countries -- which had to be invested and were being invested pretty much regardless of risk, as managers sought the highest yield. That led to tremendous mispricing and ignoring of risk, and it created asset bubbles. I think asset bubbles were a major factor in creating the panic that we saw in 2008, because it led people to lend money pretty much regardless of risk.
I think we've learned our lesson, but human nature is such that we'll probably forget it fairly quickly. That means that yes, we are probably going to have another bubble and it will burst. That shouldn't be a surprise. We've had bubbles all through history.
What about capital flows into Asia? Do you expect interest rates to rise further in the region?
Asia’s emerging economies, such as China and India, are rapidly catching up with the US and European economies that are recovering at a relatively slow pace. Capital inflows have returned to Asia, and resurgent exports and domestic demand are supporting a broad recovery. That said, Asia is a net exporter of capital, not an importer. I would expect interest rates to rise further in the region, although the problem really isn’t capital flows as much as strong growth and inflation.
Asia is feasting on a prolonged monetary accommodation, what are the potential risks involved with such massive monetary stimulus?
The risk is inflation, which the Asian economies are beginning to see. The low interest rates in Europe, Japan, and the US are appropriate given the weakness of their economies. Low interest rates are not appropriate in China or India, whose economies have been strong. The region needs to decouple its interest rates from those in developed countries, and this requires decoupling exchange rates.
Looking ahead, what are the main hurdles for the economic development in Asia? How big of a challenge will inflation be in 2011?
I expect growth to remain relatively strong in Asia. Inflation is a problem, but perhaps not the biggest challenge, since it is heavily concentrated in food, energy, and other commodities. Manufacturing prices have been relatively stable. The larger problem for many Asian economies, especially China, will be moving from export-led growth to an economy dominated by domestic demand. China is simply too big relative to the world economy to be so dependent on export growth.
What is your view of the balance of economic power between China and the US?
China is still very small relative to the US. Its economy is only about half the size of the US, with almost four times the population. So it's still a poor country, but it's growing very fast. During 2010, China's growth rate was about 10% and I expect that to slow a little bit this year to about 9%. China is becoming a major source of funding in the developing world because it's looking for investments, particularly in commodity producers because it sees what's happening to commodity prices. China is gaining both political and economic power, and it's something that the US needs to adjust to.
With continuous pressure from the US regarding currency reform, how fast do you expect the renminbi to rise?
China may allow the renminbi to gradually appreciate. Two important objectives of this move will be: to reduce the pressure from strong domestic liquidity; and to boost domestic consumption. The pace of economic growth and the strength of the labour market will determine the speed of appreciation. We expect the policy-guided appreciation of the renminbi to shrink China's current account surplus over the next five to 10 years. But the policy to strengthen the currency will likely stop well before the current account surplus disappears. Unless policies in China change dramatically, the country's savings rate will remain high by international standards.
The upward pressure on the currency could ease with stronger capital outflows. I think China will encourage this by easing capital controls, and by allowing the renminbi to become more of an international currency. The moves recently to allow trading in Hong Kong and outside China are the first steps in this process. When expectations of further appreciation recede, stronger private capital outflows should allow the Chinese exchange rate regime to shift to a managed float system. The pace of structural reforms in the domestic sectors will determine how long the transition from a tightly controlled exchange rate regime will take.
In the past, the internet came along and provided an economic boom. Is there anything more in the shadows that could change the global economy for the better?
What would really help is another spurt of innovation. If we make another major discovery that raised productivity, that would in turn raise real incomes, keep inflation under control, and allow faster growth of the global economy. While technology is very hard to forecast, there are some potentially large innovations out there. There's alternative energy and nanotechnology. Some of the bio-med fields could also have a big impact on future growth. But right now, we're assuming that we get average technological improvements, because on average that's what happens.
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