2010 is ready for the history books and most of us are glad that year is finally in the rearview mirror. Worldwide economic collapse was avoided in 2009 and the global economy stabilized and strengthened some in 2010. However, the pace of recovery was very modest in 2010, constrained by the continued effects of the US recession suppressing demand and curtailing imports, and the EU euro dollar debt crisis diverting hundreds of billions from the capital markets to fund internal emergency loans. With all the conflicting forecasts and lackluster predictions, what will the future hold for 2011? Here’s my forecast for the coming year.
The World View from the US Perspective
Overall, the world economic recovery is very fragile and economic power is rapidly concentrating in just a few nations outside the US; the OPEC oil exporting countries, the European Union, and China.
It’s old news that economic power continues to grow in the oil exporting nations that we send our dollars to. What might be new news is that the much anticipated peak in worldwide output occurred in 2007 and 2008, much sooner than most predictions. China’s emergence as a major crude importer caused worldwide demand to outstrip production capacity for the first time in history, resulting in spot market prices that reached record levels. Remember $150 per barrel crude and its effect on fuel prices?
While many nations export crude, the OPEC cartel in general, and Saudi Arabia in particular, tries to balance their production to have supply exactly meet worldwide demand. OPEC’s goal is to get maximum value for its diminishing resource, while balancing the knowledge that too little supply will drive up prices and push the world economy into recession (which results in lower production and revenue for their member countries). Expect the Saudis to vary their production to try and hold spot market price at $90-$100/bbl to achieve this balance.
However, China’s emergence onto the world stage to compete for available oil supplies means that the era of cheap energy is ending. We just haven’t realized it yet because the Great Recession in the US (the world’s biggest importer) has temporarily reduced its internal consumption and made more supply available on the world market.
In the meantime, China has further increased its crude oil imports, taking up some of the slack. In this scenario the stage is set for an astronomical increase in oil prices when the US economy recovers and returns to importing at previous levels to meet its energy needs.
The OPEC bottom line – The most likely scenario is for a slow, steady increase in crude oil prices throughout 2011 as the global economy gradually recovers.
An alternative scenario is for crude prices to remain essentially stable if demand is suppressed by continuing recession in the United States or China’s real estate bubble bursts, sending it into economic recession (see below for more on this possibility).
The formerly robust European Union is more and more often being viewed as a misfit conglomeration of „have“ and „have not“ countries.
Germany and France are the economic powerhouses of the EU. The economic weaklings are the so-called PIIGS countries, Portugal, Italy, Ireland, Greece, and Spain, whose national budgets have been fueled by huge levels of deficit spending for several decades. In many cases now servicing the associated debt consumes double digit percentages of their national budget (Ireland’s is an astonishing 32%!) and is straining them to the breaking point.
There is substantial fear that these countries could default on their national debt obligations, dragging down the value of the euro dollar and endangering the economies of every EU member. In 2010 Germany led the bailout effort for Greece, which has had to reduce its national budget by a whopping 12%. The reduction in traditional government services and associated layoffs has not been received well by its citizens as news coverage of the many nationwide demonstrations has shown.
Ireland, which offered token resistance to the idea of a EU bailout, was next on the list. Arguably, it’s in the worst financial shape of any of the EU member nations for two reasons. First, many years of deficit spending in concert with so many of it’s sibling EU members.
However, unlike other EU nations, Ireland also had its own real estate bubble growing, which finally (and inevitably) burst. Irish banks began to go insolvent when the values of mortgaged real estate dramatically declined. To quell a rising financial panic the national government then took the bold (and very risky) step of publicly guaranteeing all deposits, after the fact, in order to stave off economic collapse. Unfortunately, the enormous resources required to make good on that guarantee coupled with inadequate regulatory oversight to spot troubled banks before they failed, exceeded even what the Irish government could muster. The Irish government is now sporting a new $100B+ EU loan to bailout its banks and keep the economy functioning.
But, like Greece, the Irish bailout came at a cost of laying off thousands of government workers (further pushing up unemployment), cutting government salaries, and, most unfortunately, cutting the government pensions of those already retired. And also like Greece, Irish citizens are protesting in the streets over the reduction in salaries and services.
The creditworthiness of these countries had declined to the point where they were unable to borrow on the world market (at reasonable interest rates) to fund their governments, and they wouldn’t have been able to borrow at all if they had retained their national currency. Next on the bailout list may be Portugal or Spain.
Note that Great Britain, which still uses the pound sterling and not the euro, is currently running equally high budget deficits, although for fewer years than its European neighbors. It has begun budget reduction efforts driven by 2010 election results, which has resulted in the greatest civil service layoffs since World War II and has reduced this once proud world power, whose national anthem is Rule Britannia, to investigating the sale of the Royal Mail Service to a foreign company and exploring ways of sharing operating costs of its new aircraft carrier with rival France.
Will the value of the euro dollar collapse or be abandoned by some EU members? It’s unlikely in the intermediate term because the weaker nations don’t want to leave a currency backed by economically stronger nations. If stronger nations like Germany and France reverted back to the mark and franc, they would suffer an avalanche of capital inflow from those abandoning the weakened euro to seek currency stability.
The 2011 EU bottom line – The EU will remain intact and (with the exception of Great Britain) will remain committed to the euro. That stability is good for the world recovery. However, EU economies as a whole will underperform because of the hundreds of billions of euros in internal loans that will be diverted to bailout its weaker members. Look for the EU to develop some type of controls to prevent its deficit spending members from continuing to drag down the whole Union. The EU’s potential to be an economic powerhouse will be unfulfilled until the finances of its major members are set in order.
Economic power is rapidly shifting east and military power will soon follow. China is VERY rapidly moving beyond being merely a technologically backward player to becoming a dominant force on the world economic stage. One example of China’s pace of development is its achievement of being only the 3rd nation in the world to place a human being in orbit, a remarkable feat by any measure.
China is awash in the dollars amassed from their long term trade surplus with the US, so many in fact, that they cannot convert them into the yuan, the Chinese national currency, to directly power their economy because dumping such a huge amount of dollars on the open market to buy up the available yuan would severely devalue the dollar (sudden oversupply) and drive up the value of the yuan (sudden scarcity), making Chinese exports much more expensive. Obviously China doesn’t want to impair its export driven economy by making those exports more expensive.
So, what is China doing with all the dollars it’s holding but can’t convert? It’s almost literally buying entire countries and continents!
China is aggressively moving to secure sources of raw minerals to ensure that its economic development can continue. It has invested heavily in Australian mining companies to the point where Australia now derives a significant portion of its GDP from mineral sales to China. China wants to further increase its ownership stake in these Australian corporations, but the Aussie government has refused to allow further investment leading to majority ownership, fearing a complete takeover of its national mineral wealth.
China is also investing heavily in natural resources across the African continent. Africa has very few large cap mining corporations on the continent (DeBeers of South Africa being one of the few exceptions), so China is dealing directly with each country’s national government to negotiate exclusive deals to develop their mineral wealth.
For African nations, in exchange for the exclusive right (key words) to exploit their mineral resources China offers to use its financial and technological muscle to rapidly develop the mines, often located in remote areas, and associated infrastructure like rail lines and ports, along with guarantees to employ a large segment of a nation’s population in each mine’s operation.
This rags-to-riches promise is obviously attractive to impoverished governments with limited economic means to develop their mineral resources on their own, but it comes at a terrible price. So far the workforce for these mines has indeed been hired locally, but their new work situation is far from Utopian. In most cases they „work for the company store“ as was common in the USA a century ago, are charged exorbitant rent for living in barracks far from home, and make nearly every purchase at high price from local retailers wholly owned by the company. As you might suspect, little is left to send home to the family after meeting these expenses.
Meanwhile, management remains firmly in the hands of the Chinese corporations, effectively preventing African nationals from gaining management experience and improving the intellectual capital of their country.
The effect of all this activity will be to eventually drive up the cost of strategic minerals worldwide as China locks up the remaining mineral resources essentially at the cost of extraction.
Finally, China is in the midst of its own housing bubble fueled by rampant real estate speculation, very similar to what the US experienced early in this century. The rapidly growing Chinese middle class has very few financial instruments to invest in, but real estate is available to anyone with sufficient cash to fund the purchase. In a Chinese version of Flip This House, individuals and extended families are investing in real estate for the sole purpose of the prospect of selling in the near future at substantial profit.
After watching the fallout when the bubble burst on the American market, Chinese officials recognize the dangers and are taking steps in their command-and-control economy to cool things off. Recently, foreigners have been limited to a purchase of a single home in China, the government is urging banks to curtail credit used for real estate purchases (not expected to have much of an effect since most purchases are 100% cash), and is talking about limiting the number of houses, apartments, or condos that their citizens can own at one time.
If the Chinese real estate bubble bursts causing a huge loss of personal net worth like the American bubble did, you can expect China’s internal consumption to dramatically decline, reducing the volume of consumer goods that China imports from around the world. A dramatic reduction in Chinese imports could tip the world back into recession as exporting nations lose the jobs and revenue exporting to China provides.
The 2011 China bottom line – China’s consumption of world resources has reached the point where it affects worldwide market pricing and availability. If China’s economy continues to perform well in the coming year, it will compete more aggressively on the open market for limited global resources.
Much depends on whether the government can reign in internal real estate speculation. The most probable scenario is that China will successfully cool off the overheated housing market that threatens its economy. However, if the real estate bubble bursts, then China’s new middle class will lose a significant portion of its wealth, driving down internal consumption. Dramatically reduced imports of luxury goods and high end manufactured products will impact the global recovery and could produce another global recession.
The 2011 World Economic Forecast
Most likely scenario – Slow, steady economic improvement as the EU powerhouses (Germany and France) continue to fund bailouts of its heavily indebted partners in the euro dollar and China avoids its own economic recession by deflating its real estate bubble.
Alternative scenario – Worldwide recession if several European nations abandon the euro dollar and revert to their own sovereign national currencies or China’s real estate bubble bursts, seriously reducing its internal consumption and the imports it drives. The recession could be severe in this scenario, since the United States‘ own economic recovery will not have progressed to the point where it can make up for the reduced demand on the world market. The countries who will be least affected and could emerge as new economic superpowers would be Germany, France, and the OPEC countries who have amassed decades of oil trade surplus funds.
I share my economic forecast for the US in 2011 Economic Forecast – Part 2: The United States (US).
Which scenario will come to pass? It’s hard to tell because we haven’t been here before, but I’ve shared my best guess. Do you think I nailed it or do you have a different opinion? I look forward to your thoughtful comments, insight, and opinions.