Getting to Tomorrow
by Byron Wien, The Blackstone Group LP
Getting to Tomorrow March 2014 We started off the year with a scare from the emerging markets. The Argentine peso was devalued by more than 20%, but other currencies in the developing world had declined sharply as well. Equities in these countries fell also, with many markets down 10% or more. In the developed world equities declined about 5%, but in Japan fell twice that. At the beginning of the year I feared a sell-off and when people asked me why, I fumbled for a credible answer. My thinking was that sentiment was much too optimistic. Everyone had made money in the stock market in 2013, although few had done as well as the Standard & Poor’s 500. People were generally positive about the outlook for 2014 and there was a background of complacency. When these conditions prevail, something always comes along to shake confidence. It is just hard to see what it is going to be in advance.
I continue to be constructive on equities and expect the economy in the United States to expand by more than the 1.9% real growth rate reported for 2013. What worries me overall is the nature of the policy responses I see across the world. Almost every leader seems to be pursuing a policy program likely to produce favorable results in the short term, but possibly creating more serious problems later on. There is a widespread unwillingness to make the hard choices. No leader appears to be willing to take the political risk that may be involved in dealing with the fundamental problems facing his or her country. Perhaps for many it is extraordinarily difficult to implement programs targeted to long-term goals. While the immediate conditions may not be favorable for the financial markets, the current policies may have less positive long-term implications.
Let’s start with Japan. Shinzo Abe’s first two arrows – fiscal stimulus and monetary expansion – are clearly working. The deflationary recession has ended and the economy is growing. The third arrow – dismantling regulation and producing sustainable growth – is proving harder to achieve. In the meantime the aging population grows larger and the work force is reaching a peak. This could be countered by implementing a liberal immigration policy, but the country has no appetite for that. At some point the stimulative programs will have to be scaled back and the question is: will the economy have developed enough natural momentum by that time to continue to grow? Concern about that may be the principal factor behind the recent sell-off.
In China, the Third Plenum in November outlined a plan by the new leaders, Xi and Li, to reduce corruption and rebalance the economy. Growth had been moving along at a 7+% real rate but that was largely a result of the generous credit provided by the banking and shadow banking system. The government’s objective is to reduce spending on investment-sensitive projects like infrastructure and state-owned enterprises from 45% of GDP to 35% and increase the consumer component from 35% to 45%. The latter balance existed before leadership in the 1990s decided to invest in state-owned businesses that would produce goods for export, thereby increasing foreign exchange reserves. The government also made investments in infrastructure that would make China more competitive globally and pave the way for growth. The problem with trying to become more of a consumer economy is that growth is likely to slow down as investment is reduced. Some economists focusing on China think it might even drop to a level of 4%. This would create both political and social problems since fewer higher-paying industrial jobs would be created and the migration from the countryside to the city would slow. The question is whether the new leaders have the will to push through this rebalancing, which is clearly in China’s long-term interest but is likely to create some short-term unrest.
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