International | Sep 20 2010
This speech was delivered to clients of Standard Chartered at the Shanghai Expo on Thursday 9th September 2010.
By Gerard Lyons, Chief Economist and Group Head of Global Research, Standard Chartered Bank, United Kingdom
Introduction
Good evening. It is a pleasure and a great honour to be here speaking to you this evening, at this magnificent Expo and in this fabulous pavilion. As you may know, this week has seen, amongst other things, UK Day here at the Expo. Tonight it seems appropriate that an international bank head quartered in the UK should be hosting an event in the French Pavilion at this Chinese Expo! Why is this appropriate?
The first great Expo took place in London in 1851. From May to October 1851, Hyde Park provided the venue for the first major world fair. Fairs then became common through the 19th and 20th centuries. The London event was known as, "The 1851 Great Exhibition of the Works of Industry of all Nations". It was organised by HRH Prince Albert, husband of Queen Victoria and, I am pleased to say, by the Royal Society for the Encouragement of Arts Manufacturers and Commerce. Pleased, because I am a Fellow of this Royal Society that still is vibrant today. So the first Expo was held in Britain. But where is the French connection?
Well, the idea was French! Some suggest the origins date back to France in 1798, at the end of the French Revolution. The French then continued with fairs, including the French Industrial Exposition in Paris that ran from 1844-1849. The idea was French. But the UK in 1851 brought it to a higher level and a bigger scale. So, to Shanghai today and the biggest ever Expo.
London's Expo of 1851 was aimed at demonstrating the UK's role as an industrial leader. The Shanghai Expo, like the 2008 Beijing Olympics, is a further sign of China? international emergence, both as an industrial leader and major power.
Britain's Expo of 1851 also had a lasting legacy. It spurred innovation and the profits funded the London based Science Museum, Natural History Museum and the Victoria and Albert Museum. Today's Shanghai Expo is already having a big impact on this city's development. The last eight years have witnessed major urban regeneration. For instance $45 billion was spent on upgrading Shanghai's infrastructure.
From a city that had no metro in 1995, Shanghai now boasts a 260 mile metro, longer even than London's. The Expo is likely to have a lasting legacy, hopefully globally, as well as on Shanghai.
I am sure most, if not all, of us in this room are fully expecting the authorities to succeed in their aim to turn Shanghai by 2020 into a major international financial centre and into a major shipping and trading centre. This city was once the undisputed financial hub of Asia. It can be again.
The slogan of this Expo, "Better City, Better Life", has global implications. And, if anyone needed evidence of the inter-connection of the global economy it is the French – British – Chinese interaction that brings us here to this pavilion this evening.
Tonight I would like to focus briefly on the economic and financial outlook that makes this Expo particularly important. The world economy is facing both significant challenges and great opportunities.
First, I will focus on the economic outlook. Will there be a double dip? How will Asia perform? Second, I will focus on some key policy issues, especially for Asia. Third, and finally, what does it mean for China?
1. The economic outlook
As Jaspal Bindra mentioned in his introductory comments, the world economy is witnessing a shift in the balance of power. This shift is from the West to the East. This shift will be seen over decades, not years. Whilst this shift will be positive for the world, there will be setbacks and periods of economic weakness. The business cycle exists in China and India, as it does in the West.
Moreover, there will be winners and losers. The winners will be countries that have one of three things: financial resources; natural resources; and the ability to compete by adapting and changing. In short: cash, commodities and creativity.
The financial crisis posed a further challenge for the West, as it adjusts to this economic shift. The crisis was triggered by a combination of factors. What is worrying is that three years after the crisis began some of the omens are not good. Instead of agreement on what caused the crisis, there appears to be disagreement. Instead of an international solution there appears to be a desire for different national approaches, even allowing for Basle 3. The diverging policy agenda is worrying. An international approach may be needed in the future. Lest we forget, the global recovery over the last year owes much to the successful coordinated policy response:
fiscal expansion; low interest rates, liquidity injections and help to certain sectors. China's policy response was amongst the most impressive.
Now the policy stimulus of last year is wearing off. A slowdown in the world economy was always likely in the second half of this year. This slowdown is now being seen. And one of the key questions is what will happen to private sector demand.
Let's consider the outlook for the West. It is a tale of two worlds. A buoyant East contrasts with a weaker West. But, even in the West, there are differences. In continental Europe, exporting firms are in better shape than those selling domestically. Germany, Europe's biggest economy, is doing well, benefiting from buoyant exports, especially to China. And Germany does not have a legacy of debt. In contrast, the so-called PIGS countries of Portugal, Ireland, Greece and Spain face recession. Overall, our view is Europe will grow 2% next year, but it is a diverging picture.
Likewise in the US and the UK, it is a diverging picture too. The UK is in a stronger shape than the US, but faces similar challenges with a weak recovery.
The situation in America is dire. Again, it is a tale of two worlds. Big banks and big firms are in good shape. But small, regional banks and small firms starved of credit are in poor shape. There are few jobs. And those firms with the money to invest are looking to invest in Asia. We think the US will grow 2.5% this year, only 1% next.
After an era of boom, the West is in a period of austerity, as deleveraging takes place with people and firms paying down debt. This is a necessary but painful process. The West needs to adjust by spending less, saving more. This is a weak recovery. It is not a double dip. A double dip – where we slip back into recession – is possible. But it is not guaranteed. A double dip would be triggered by one of three things: a policy mistake, such as policy being tightened, and that is why it is vital interest rates stay low; or by a shock, such as higher oil prices because of an escalation of tensions in the Middle East; or by a loss of confidence. The trouble is that for many in the USA the rebound may be so weak it may not feel like a recovery. Hence confidence could remain fragile for some time, leaving the economy vulnerable.
The outlook depends on the interaction between the fundamentals, policy and confidence. In the West, the fundamentals are poor, fiscal policy is being tightened and confidence is fragile. Hence a sluggish recovery. But it is a recovery. In contrast, the outlook in Asia is better. Far better.
The world economy boomed before the crisis. And it will boom in the future. This year and next it is not booming but Asia is outperforming. Over the last decade the world economy grew from US$31 trillion in size to US$61 trillion before the crisis. After the crisis it fell to about US$58 trillion. Now it is rebounding. The USA is US$14.2 trillion dollars. In Asia, China is about US$5.0 trillion, Japan US$4.9 trillion, ASEAN is US$1.7 trillion and India US$1.25 trillion. Add in South Korea and others, including Pakistan, and Asia is about the same size as the US, over US$14 trillion. So the Asian region itself is as big as the US economy.
The export focussed nature of this region means it is not immune from what happens in the US. But whereas the US is likely to experience a period of stagnation, Asia, in contrast, is experiencing a recovery that appears sustainable. China and India may both grow by 8.5% next year. Asia will drive more of global growth. But Asia, too, will face challenges. What are these and how will they impact policy?
2. Policy issues
In the second part, I will focus on the policy issues. Naturally, in the West, the issues are very different. Deflation, not inflation is the challenge. Wages are not rising and there is little pricing power. Whilst firms may face higher imported costs, they will find it hard to pass this onto consumers. Instead profit margins may suffer. Also, worries about sovereign debt is forcing countries, especially in Europe, to tighten fiscal policy. The implication is the need to keep interest rates low. As in Japan's crisis, bond yields have already fallen, will stay low and could decline further.
I do not think the US or West will suffer a lost decade like Japan, because policymakers know the risks, and because economies are adjusting, trying to address structural challenges. But there may be a lost few years, with a weak recovery.
The dollar has benefited as a safe haven during the crisis, but its longer-term outlook is poor. The euro, perhaps, faces the biggest challenge. No country wishes to leave the eurozone but this could change. In a couple of years a small number may feel it is in their interests to do so. Thus one should not dismiss some of the underlying tensions. After all, if the euro is to survive it needs to become a political union. So the euro will remain but its future membership could change.
Here in Asia, inflation, not deflation, is a bigger worry. Rising food prices and stubborn energy prices is the main concern. Hence central banks are raising rates. The problems are greatest in India and Vietnam. Other countries, including China, need to be gradual, not aggressive, in tightening. Indeed, we believe China will keep rates on hold for now.
Another challenge across Asia is controlling capital inflows. The big worry is that if flows come in unchecked this may sew the seeds of a future bubble in asset prices and the economy. Thus there may be some justification for temporary capital controls. And whilst some countries are allowing their currencies to appreciate, others in Asia may feel there is also some justification to intervene in currency markets to prevent exchange rates overshooting. But the key is to continue to develop and deepen capital and financial markets, although that takes time.
Perhaps the biggest challenge for Asia is not talked about enough: the need to invest and how to pay for that investment. Over the next decade Asia needs about US$8.3 trillion of infrastructure investment. Where will this money come from? China does not have a problem funding its infrastructure, but others might. Such investment is needed to realise potential, drive urbanisation and job creation. It was a hot topic at May's annual Asian Development Bank meeting in Uzbekistan and will likely be a key issue for some time.
Asia is not decoupled from economic developments in the rest of the world, being particularly vulnerable to the global trade cycle. Hence the increasing importance of China.
3. What does it mean for China?
Third, what does this mean for China? In coming months, there will be many key global meetings. Next week is the Summer Davos in Tianjin, at which Premier Wen Jiabao will speak. In October, the IMF meetings take place in Washington. Then there is November's G20 in South Korea. China's role is key. There are benefits for ensuring an international approach to financial issues. For instance, I believe there are many macro prudential lessons the West can learn from Asia. These are key for preventing another crisis, by restraining debt, leverage and credit growth.
But currencies may be a dominant issue at future international meetings. The French, who preside over the G20 next year, have already indicated they will address currency issues. The US, meanwhile, faces not just a weak recovery but greater domestic political problems, suggesting China's currency policy may soon return to centre stage.
One of the main developments this year has been the increased use of the CNY offshore. This is positive for Hong Kong, with the market there known as the CNH. It is also positive in its own right. But China is likely to face increased pressure for the CNY to appreciate. China's response is likely to be a gradual appreciation of the CNY and to argue that is best contribution to the global economy is to ensure continued strong growth at home. That may not silence the critics.
President Hu and Premier Wen have talked of a harmonious society. They have highlighted imbalances: urban-rural, coastal-inland, environmental, social and international. There is currently increased focus here on the growing domestic imbalances. And addressing these is likely to remain a central theme for policy.
China also faces diverging regional issues. Wage problems in the Pearl River Delta, the export focus of the Yangtze and Pearl River Deltas, and the stronger domestic driven growth in Western and Central China.
I am often asked if China is a bubble economy. My answer is no. But it is an economy prone to bubbles, especially in asset prices and real estate. China needs to see a switch from export-led and investment-driven growth to increased private consumption. There is some evidence this is happening, helped by rising wages and also by the increased growth in Western and Central China. But there is still much further to go. In China, both personal savings and corporate savings are too high. But one should not underestimate the potential for China's domestic market to grow. Indeed, one of the needs from this recovery is to see more of Asian growth, not just Chinese growth, driven by domestic demand.
The crisis was triggered by many factors: a failure to heed warning signs, excessive leverage and debt, a systemic failure in the financial system and an imbalanced global economy. China has to play a vital role in achieving future balance.
The near doubling in bank lending last year, the fact the authorities asked banks recently to stress test for a 60% fall in real estate prices, highlights some near-term risks. Don't ignore such risks, but don't lose sight of the very positive outlook.
The London Expo of 1851 took place at the end of Britain's Industrial Revolution. Now, this Expo takes place during China's Industrial Revolution. The world is also seeing the opening up of India.
Indeed, across the emerging world some key, positive trends are being seen, often with China at the centre, or playing a key role. Some of these trends are: increased investment in Africa; an infrastructure boom across the Middle East and Asia; the boom in global trade, with new-trade corridors being seen with rising Intra-Asian, Asia-African, Asia-Middle East and Asia-Latin America trade; flows of goods, of people, of commodities, of remittances and of ideas; rapid urbanisation; and increased use of technology, with innovations in nanotechnology and science. More countries are sharing in this growth. And more are looking towards China and the G20, not to the US and G7 for leadership.
At Standard Chartered we talk of the 7% Club. These are economies that grow at 7% or more for a sustained period. 7% means an economy doubles in size in a decade and quadruples in a generation. An economy that grows by 7% is twice the size of an economy that grows at 5% after just three decades. The last quarter century saw some rapidly developing economies in this group, many across Asia. China is in the group. India has just joined it. And since 2000, several African countries have joined. Brazil and Indonesia will be members, certainly. Perhaps even Russia!
But this puts strains on inflation and commodity and food prices. Strains on resources, particularly water. Strains on the environment and strains on climate change. It points also to the need for technological innovation. Hence the importance of this Shanghai Expo.
In 1798, when the French were developing the idea of trade fairs that spawned the London great Expo, a famous economic book was written by Thomas Malthus, "An Essay on the Principle of Population." Some of the issues he addressed may have solutions here at this Expo. His book led to econonomics being called the dismal science. But I am far from dismal about the outlook. Whilst the next year will see uncertainty and volatility, the longer-term, led by China, could be very positive. Enjoy the evening. Enjoy the Shanghai Expo.
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