Recoupling in 2014 – Julius Baer’s Gattiker comments

The year ahead has all the ingredients to go down in financial history as the ‘year of recoupling’, according to Christian Gattiker, head Research and Chief Strategist at Julius Baer.

After years of exceptional stress and distortions in the world economy and financial markets, a lot has changed. This calls for a reassessment of growth prospects – in both the Old World and emerging markets – as well as asset prices and investment decisions.

Growth stampede and savings glut
In the first few years of this millennium, we experienced a world of exceptional growth and crises. China opening up to the world economy by joining the World Trade Organisation in 2001 reminded us of Napoleon Bonaparte’s quote “when China wakes, she will shake the world.” First of all, it created massive growth in China – and all its (commodity) suppliers – as well as a global ‘savings glut’ since many emerging markets were only growing by capital expenditure, not consumption.

The largest share of export revenues was ‘recycled’ in Western capital markets. This in turns spurred large increases of leverage in some of the mature economies. The US housing market is the poster child of these excesses. The bursting of bubbles (US credit crises first, euro crisis later) was as unpleasant as the years before were enjoyable.

Long cycles coming to an end
Just when economists and investors have become used to this type of imbalances and changes in growth patterns, the harbingers of a new era are on their way. In fact, the decoupling (a term coined a few years ago) seems to be increasingly turning into a recoupling. Looking at economic growth, differences between the largest emerging economies (the BRIC – Brazil, Russia, India and China) and the mature economies (USA, eurozone and Japan) are shrinking drastically.

What has changed? First of all, in the crisis-stricken Western economies, a lot of healing has taken place. The USA ‘rebooted’ its financial system in 2008/2009 and worked off the inflated financial debts of US consumers. Europe has enlarged its institutional options by introducing the fiscal compact, a banking union and a large firewall of around €2trn, backed by a more proactive central bank.

Secondly, the business model of many emerging markets is running into trouble: many policymakers there reacted by providing stimulus for their domestic economies, preferably by issuing more and more credit. This in turn resulted in unsustainable current account deficits (basically importing far more than they could afford).

More balanced, but watch out for currency crises
Given these changes, a lot of evidence speaks for a more balanced growth mix on this planet in 2014 and beyond. The differences in growth will no longer be as drastic as they used to be in the years past. This sounds like a benign growth outlook for 2014 – which is reflected in our growth expectations with the USA, Europe and Japan all growing by 1% to 2.5%, while the emerging world should grow ‘merely’ at mid-single-digit rates on average.

However, (economic) life does not proceed smoothly for too long. Some of the imbalances will indeed be corrected by a steady change in flows of goods and services. But a part of the adaptation to the new regime will be more abrupt and disruptive. In particular for those economies that have quite extreme current account imbalances, currency crises will remain on the cards in 2014. This will make it less of a quiet ride.

What happened to inflation fears?
Ever since the central banks of the USA, Europe and Japan embarked on major expansion of their monetary aggregates, investors have been concerned about the effects on the prices of goods and services. Although we know that inflation can arise surprisingly quickly after oversupply of money, we struggle to see major inflationary pressures in the coming year.

The reason is simply overcapacity: out of 21 major economies (mature and emerging) we do not see any one of them currently running at their potential growth rate. Inflation usually becomes an issue as soon as economies operate at full capacity and demand is still rising. The opposite is the case for 2014 – there is major slack in the glob-al economy, as emerging economies tended to overinvest in the past years, and the Western economies raised efficiency as a response. Hence, inflation does not seem to be a major topic.

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