03:05 AM | March 26, 2014 | Clay Boswell in Houston
Compared to one year ago, there are more reasons to be optimistic about the economic outlook in the developed nations, particularly the United States, says Nariman Behravesh, chief economist at IHS. However, the outlook for the developing nations, notably China, has gotten worse. “China is an accident waiting to happen,” he says.
Behravesh spoke Wednesday at the 2014 IHS World Petrochemical Conference in Houston.
Two headwinds drag on the US economy, says Behravesh, but they are slackening. One is the continued deleveraging of the private sector. However, he notes, debt has been reduced almost to pre-crisis levels. Another is the federal government’s austerity measures. IHS estimates that they reduced growth by 1.5% last year. However, he adds, they worked, and the ratio of federal debt to gross domestic product has stabilized.
The US economy is simultaneously boosted by two strong tailwinds, Behravesh says. One is unconventional oil and gas, which he estimates generated 2 million jobs over the last five years, with another 2 million to come over the next five years. It has given the economy economic stimulus and a competitive advantage, he says, and it has also reversed growth in the trade deficit.
The second tailwind has been the Federal Reserve Bank’s policy of holding down interest rates, or quantitative easing. “It has worked, and very well,” says Behravesh. He does not expect interest rates to begin rising until early 2015 at the soonest.
“So the environment for growth is very good,” he says.
Europe is doing better, if not as well as the US, says Behravesh. The Eurozone economy is no longer shrinking, having grown 1.1% last year, a development he attributes to the European Central Bank’s monetary policy. The ECB has been “very effective” in addressing the sovereign risk crisis, he says.
However, he adds, the ECB has been “more stingy” than the Fed, and the benefits of its monetary policy have been accordingly weaker. Also, Europe is much more exposed to the Russian market, and its energy policies have been very costly.
By contrast, the situation in the emerging economies is worrisome, Behravesh says. Growth has slowed since 2010. During the boom years of the 2000s, these economies did not do enough to make growth sustainable, he says, and now the forces that drove their success have eased. Credit is no longer so cheap, globalization has leveled off, and the commodity supercycle has wound down. To improve their competitiveness and productivity, the emerging economies will require structural reforms.
China is the real issue, Behravesh says. In the past year, he has become “quite a bit more pessimistic.”
China’s fundamental problem stems from three related risks, Behravesh says. First is the explosion in debt, which grew from 120% of GDP to 220% of GDP during 2008-2013. “No country has had that kind of increase in debt without a financial crisis or much weaker growth,” he points out.
Second is the elusiveness of the debt: almost half of it is out of the government’s reach, in the so-called shadow banking system. The accounting systems are opaque, and there is no way to estimate the level of bad holdings, Behravesh says.
Finally, a great deal of the debt funded unproductive activities. Allocated according to political, not financial, considerations, it has been invested in speculative real estate, unused infrastructure, and excess capacity, he says.
“The government is left with two unpalatable choices,” Behravesh continues. One, which he calls “tough love,” is to live with the lower growth. The other, he says, is “to kick the can down the road, which I think is what’s going to happen.” In this scenario, the government would favor continued growth over a lasting solution and issue additional stimulus.
“The problem with that is, … if you don’t do anything about the debt problem, it gets worse,” Behravesh says. “Our best estimate is in the next year or two there will be no hard landing for China, but as you go further out, three to five years, the risk of that hard landing increases.”