Each paragraph below focuses on the following economic players: the US, the UK, EU, Canada, Japan, Australia and China.
The U.S. is in the strongest economic position when compared to its developed world counterparts. 3Q GDP was over 3%. While 4Q projections are lower, they’re still higher than most other countries. The unemployment rate is below 5% which has translated into strong retail sales growth. Strong auto and housing sales point to continued consumer confidence. While business spending has been waning, a weak oil market is at least partially responsible. Recent anecdotal reports indicate mining investment should pick up in 1H17. Business confidence recently jumped in reaction to the election, as executives and business owners see lower taxes and less regulation. The overall economic position is very strong.
In contrast is the UK. While the immediate post-Brexit recession did not materialise, there is still plenty of time for the negative ramifications of Brexit to sink economic growth – a more than likely scenario given the complete mess that is Brexit. After the vote, Britain had to hire a large number of people to actually negotiate the deal; their trade staff was horribly scanty. And as of now, the country does not appear to be any closer to an opening negotiating position. The business lobby has proposed a two-stage withdrawal to prevent a toxic shock to the economy. Meanwhile, the EU has hardened their negotiating position to ensure the UK does not receive the same benefits for limited participation in the trade block. Overall, it appears the UK is in for along, painful slog.
The EU is a mixed bag. Economically, they’re actually in fairly decent shape. GDP growth, while low, has grown consistently for the last few years. Unemployment is still high, but jobs growth is occurring. Retail sales are rising, the trade balance is positive and the Markit indexes point to a continued growth. However, the region faces a potentially fatal year politically. The recent Italian referendum, which was called by the Prime Minister when he had strong approval rating, was another blow to the pro-EU establishment. And three elections next year in France, Germany and Switzerland could elect more anti-EU leaders. This could be especially devastating because not only are France and Germany two of the EUs founding members, they are also the two largest economies. If they eventually vote to leave the trading block, it’s doubtful it would survive.
Canada is looking brighter. The economy recently experienced a mild recession (two quarters of negative economic growth); including the recession, the economy has contracted in three of the last seven quarters. This was largely due to two events: the drop in oil prices, which lowered Canada’s mining investment, and a stagnation in exports that started in 2014 and which is largely attributable to weak US growth. But there are also signs of growth. The unemployment rate – which increased from 6.6% to 7.2% in 2015 – has declined to 6.8%. Although retail sales were weak in the 1H16, they’ve picked up over the last few months. Oil’s stabilisation will provide additional support as will an increase in US growth. Finally, the new administration has pledged to increase fiscal stimulus, which should also help get the economy back on track.
Japan continues to be in a very difficult position. On the positive side, GDP growth is up and unemployment is very low. The basic problem is the QE program continues to fall short, as explained in the BOJs latest policy assessment:
A. Transmission Mechanism of QQE
QQE has lowered real interest rates by raising inflation expectations and pushing down nominal interest rates. Although the natural rate of interest has followed a downward trend, real interest rates have been well below the natural rate of interest, leading to an improvement in financial conditions. As a result, economic activity and price developments improved, and Japan's economy is no longer in deflation, which is commonly defined as a sustained decline in prices.
B. Factors That Have Hampered Achieving the 2 Percent Price Stability Target
However, the price stability target of 2 percent has not been achieved. In terms of the mechanism described above, this is largely due to developments in inflation expectations. The following two factors have played a role in the development of inflation expectations. First, exogenous developments, including (1) the decline in crude oil prices, (2) the weakness in demand following the consumption tax hike in April 2014, and (3) the slowdown in emerging economies and volatile global financial markets, have lowered the observed inflation rate. And second, amid this decline in the observed inflation rate, inflation expectations -- after having been largely flat -- weakened, reflecting the fact that expectations formation in Japan is largely adaptive, that is, backward-looking.
Until Japan solves this problem, their economy will be mired in a weak growth environment.
The Australian economy remains a solid performer, as I noted earlier this month:
The economy is growing a bit below trend, but growth is not so weak as to cause serious concern. Underemployment is a problem; most job gains this year are from temporary positions. Weak growth is probably a primary cause of low wage growth and middling retail sales. Yet, consumers remain optimistic. Residential investment is moderate but business investment is weak as the economy is still rebalancing from the massive post-2000 raw materials boom. In other news, the Australian government downgraded growth forecasts.
Finally, there is China. Economically, it has defied expectations of a hard crash, soldiering on to solid growth numbers. But there is now the broader issue of trade policy and geopolitics. For the last few years, China was expanded its sphere of influence to militarily include most, it not all, of the South China Sea. And they are now the dominant economic country in Asia, not only due to the sheer size of their economy but also because of the creation of the Asian Development Bank, which will rival the World Bank and IMF. China’s Asian dominance will run headlong into Trump’s belligerence based foreign policy. We have no idea what will happen. However, the early signs point to two headstrong leaders who are preparing for conflict.
That’s it for me for this year. See you in 2017, which will probably be a bumpy ride.