Outlook: America gives the world's leaders plenty to worry about

Growth to bank on; Absent Chancellor
Click to follow
The Independent Online

It's one of those things about Davos, but it's hard to recall a year when the World Economic Forum annual meeting has dared to declare the economic outlook essentially fine. Year in, year out, the world economy is invariably said to be at some kind of defining moment, a crucial watershed which could plunge us back into the dark ages of economic calamity at any moment.

In truth, there's probably less to be concerned about right now than in ages. Yet come rain, shine or snow, the Davos agenda can always be relied on to dwell on the possibility of a crisis. Even when there is none in sight, they are imagined just beyond the horizon. The issues change but the script remains the same.

So it is that though the economic environment is plainly much better than it was a year ago - when the stock market was in meltdown, large parts of the world were in recession and America was about to go to war in Iraq - the one thing the elite of business, finance and economic analysis gathered here in this Swiss alpine resort can agree on is that there is still plenty to worry about.

Last year it was the geo-political consequences of war. This time it is America's burgeoning twin deficits in trade and in the public finances.

Not everyone is quite as gloomy as Stephen Roach, Morgan Stanley's notoriously pessimistic chief economist, who has long thought the US economy is heading for hell in a handcart. His views seem only to have been strengthened by the recovery, and he predicts that sooner or later there will have to be a sharp adjustment in real interest rates to address the inflationary consequences of a weak dollar and a soaring budget deficit, with serious consequences for demand.

Yet nearly everyone appears to worry about the outlook to some degree. Even ultra-bulls of the US economy such as Jacob Frenkel, chairman of Merrill Lynch International, doubt the sustainability of growth built on historically low interest rates, huge budget deficits and a plunging dollar.

For how much longer will the Chinese and Japanese governments be prepared to continue financing American profligacy? Last year, Japan spent 20 trillion yen supporting the competitiveness of its exports through currency intervention. Much of this went into US Treasury bonds, helping keep US interest rates low despite the plunging dollar. The Chinese government is involved in a similar programme. In essence, what China and Japan are doing is lending America the money to keep buying their exports. Can that be sustainable? Well, possibly not, but things generally don't end as badly for developed economies as worriers think they might, and there is little reason to suppose they will do this time either. The recovery is now well entrenched and in some sectors all the elements are there for a return to near boom conditions. That message is clear enough from US business leaders.

Nor is there any sign of Chinese and Japanese appetite for dollar assets diminishing. Indeed, representatives of both countries here at the World Economic Forum confirm that currency intervention will continue as long as the dollar keeps falling.

It is never possible to say anything with absolute certainty about Chinese intentions, which remain inscrutable, but unless China is deliberately misleading the market, the dollar peg will remain in place for some while yet.

The most likely eventual reform is flotation against a basket of international currencies, with the rate maintained within a defined band. That might not seem so very different from the present system and in any case won't happen for at least nine months. Japan is equally determined to spend as much as it takes in currency intervention, regardless of the inevitable paper losses, to maintain its export-led recovery.

In summary, the unsustainable looks like being sustained for quite a bit longer yet. So why are business leaders still looking for reasons to be pessimistic? One possible explanation is that despite the upturn, conditions remain for most industries intensely competitive. That's not going to change. Globalisation has made intense levels of competition a permanent feature of the business landscape, even in recovery mode. For many chief executives here, the present return to more normal levels of growth doesn't feel so very different from the downturn of the past four years. Even the biggest and most entrenched of companies must innovate as never before to defend their market positions.

The outlook for the global economy looks better than it has in years, but you can understand why so many business leaders remain in a state of such high anxiety. Economic recovery used to bring relief and pause for breath. For many businesses that may no longer be the case. There's no rest for the wicked, even up here in the snow capped mountains of central Switzerland.

Growth to bank on

According to a report by Mercer Oliver Wyman being circulated here, the total market capitalisation of the financial services sector is set to triple over the next 10 years. Forecasts like this are necessarily only guesswork or, as in this case, a somewhat crude extrapolation from past trends, yet there may be reasons for believing Mercer broadly correct.

Surprising but true, the global market value of the financial services sector has already recovered sufficiently to exceed its previous peak in early 2000. That's in sharp contrast to the rest of the stock market - the non-financial bits - which are still 30 per cent below peak levels.

In past downturns, financials have tended to perform worse than others. The key difference this time around is that there was no banking crisis, and even bombed out insurers largely managed to survive with solvency intact. Yet still financials trade on a discount to the rest of the market of about 35 per cent. Investors remain wary of the volatility of the financial sector, which is still viewed as potentially much more risky than other corporates. The industry also continues to suffer from a general lack of transparency, and the belief that it is more vulnerable than others to the threat of increased competition from new entrants. Too often, the accounts seem impenetrable and many investors have come to share Warren Buffett's view that the industry is shot through with "financial weapons of mass destruction" that few even inside these organisations fully understand.

But though the discount may prove hard to eradicate, there's little doubt financial services as a whole will remain a growth industry long into the future. In part that's because of the inventiveness of wholesale capital markets, whose size and complexity continues to grow almost exponentially. Deregulation and liberalisation in previously closed markets compounds the process. But it is also because as populations grow richer, they spend more of their money on financial services. Fifty years ago, financial services accounted for less than 3 per cent of GDP in developed Europe and America. Today, that number is approaching 10 per cent.

Buy financial stocks with a high exposure to Asia, seems to be about the sum of it.

Absent Chancellor

No sign of Gordon Brown at Davos, despite a long standing promise that this year he would attend. Perhaps it was the vague possibility his next door neighbour, Tony Blair, might fly in which put him off. Or maybe he's just too busy worrying about the public finances and organising his own mini-Davos, to be held in London next week, to find the time. Alternatively it might be the salutary lesson of the last Tory government that put him off. In the dying months of the old regime, nearly half the Cabinet turned up, only to row constantly about the euro. The sight of all those ministers hob nobbing with the world's business elite against the backdrop of snow capped mountains looked too much like decadence, and although Davos can hardly be blamed for the Tory wipeout at the polls, it cannot have helped.

Yet whatever the reasons, his no show was a missed opportunity to air Britain's reforming agenda in Europe. Few can boast as robust an economy as Britain, and it is surely part of the Chancellor's job to ensure it remains that way by selling its attributes to the rest of the world.

jeremy.warner@independent.co.uk

Comments