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The Global Economic Outlook for 2008
- Faced with the risks presented by the fall in the value of the dollar, investment money shifts away from US-based credit products towards real assets and Asia; Decoupling of US economic stagnation and the rapid growth of newly industrialized countries -

December 26, 2007

Overview

In the early part of 2007, the developed nations, including the United States, enjoyed steady economic expansion, but from the summer onwards they began to suffer from the turmoil in the financial markets triggered by the subprime mortgage crisis in the United States and the outlook became increasingly uncertain. At about the same time, the prices of real assets such as crude oil and gold and of shares from newly industrialized countries, particularly in Asia, began to rise rapidly, and the decline in the value of the dollar accelerated. This indicates that the investment money which until recently has been channeled into US-based financial assets such as securitization products has begun to shift towards real assets and newly industrialized countries. The subprime crisis and the rise of the commodity markets that rocked the world economy and markets in 2007 were caused in part by huge inflows and outflows of investment money, and the movement of money in this way has become a major determining factor in the trend of the real economies of countries and regions.

With huge volumes of global money, including oil money and Asian foreign exchange reserves, moving out of financial products such as US mortgage bonds and into real assets such as crude oil and investment in newly industrialized countries, centering on Asia, the United States, which is experiencing an outflow of risk money, is likely to see continued economic stagnation, while the natural resource-producing countries and newly industrialized countries, which are seeing an inflow of risk money, are likely to enjoy continued rapid growth. However, these flows of funds present a number of inherent problems, including (i) the self-propagation of global money, (ii) growing inflationary pressures around the world, (iii) the growth of the asset bubble in Asia, and (iv) the acceleration of the worldwide shift away from the dollar, and the future may bring a variety of negative effects.

Given this situation, let us consider separately the three key factors that will determine the trend of the global economy in 2008.

(1) The trend of the US economy and of adjustments in the US housing market
If the inventory ratio for new housing (inventory/sales) is to fall to what is considered the appropriate level of "just over 4 months", then the sharp reduction in investment in housing will have to continue at least until the second half of 2008. Until this time, it is likely that the reduction in investment in housing will continue to exert downward pressure on the US economy.
In conjunction with the substantial rise in the inventory ratio for resale housing, the price of housing has also begun to fall. As the inventory ratio for resale housing is unlikely to fall before mid-2008, it is likely that the price of housing will also continue to fall at least until that time. The ratio of investment in housing to GDP and the ratio of housing assets to disposable income among US households suggest that the price of housing is still at a fairly high level and that the fall will continue for some time.
This fall in the price of housing will exert downward pressure on consumer spending via the reverse asset effect. The increased interest burden due to the review of interest rates on subprime loans will also exert downward pressure on consumer spending.

(2) The trend and impact of the rise in the price of crude oil
One reason for the rise in the price of crude oil is the rise in demand for crude oil due the rapid growth of newly industrialized countries. It is though that the upward pressure on the average price of crude oil in 2008 will be of the order of 10% or more, and given the inflow of investment funds, it is possible that the average price for the year will reach $90.
The rise in the price of crude oil will have a negative impact on the developed nations by diverting income towards the oil-producing countries. At the same time, the rapid economic growth of the oil-producing countries will have a positive impact on oil-consuming countries by boosting their exports to the oil-producing countries. Taking these two factors together, a rise of $10 dollars in the price of crude oil is expected to depress the economic growth rate by 0.3% in the United States, where dependence on exports is low, but by only 0.1% in the Euro Zone, where a high proportion of export shipments go to oil-producing countries.
Countries that are successful in attracting oil money, which will be increasingly abundant thanks to the rise in the price of crude oil, can also expect to see benefits such as a fall in long-term interest rates and a rise in share prices, etc.

(3) The likelihood that "decoupling" will continue
In recent years, the United States' contribution to the global economy has decreased significantly, and today the main pulling power is generated by newly industrialized countries, especially the BRICs. Since 2005, the dependence of the global economy on the United States has fallen sharply, with other countries continuing to enjoy rapid economic growth in spite of the slowdown in the United States. The ratio of the exports of each region going to each destination is also changing; the ratio of exports going to the United States has fallen sharply, while the ratio going to the newly industrialized countries, especially China, has seen a substantial rise. This suggests that exports to destinations outside the home region are concentrated in China, but China's exports to newly industrialized countries have risen sharply and the coupling between its economy and those of the developed nations is weakening. The exports and growth of the newly industrialized countries have begun to shed their dependence on the United States, and the chances that the newly industrialized countries will maintain their high growth rates even if the United States experiences an economic slowdown are higher than they have been in the past.

By country/region, the economic outlook is as follows:

United States: Owing to the adjustment in the housing market and the accompanying stagnation of consumer spending, the sense of economic stagnation in the United States is likely to continue into mid-2008. However, against a backdrop of rapid growth in the newly industrialized countries and the continued weakness of the dollar, the strength of exports is underpinning the economy, and recession will be avoided. From the second half of 2008 onwards, as the pressure for adjustment in the housing market diminishes, the economy should begin to pick up, but with little hope of strong growth in consumer spending, it is likely that growth will remain below the latent growth rate.
Europe: In the Euro Zone, owing to the slowing of export growth due to the deceleration of the US economy and the strength of the euro, among other factors, a slowing of the rate of economic expansion is likely to be unavoidable. However, against the backdrop of a recovery in employment and continued strength of exports to central and eastern Europe and to Russia, the economy remains on a firm footing and from the second half of 2008 the pace of growth is set to see a gradual rise. In the United Kingdom, against a backdrop of a resurgence of credit uncertainty and falling house prices, the economy is likely to see an increasingly clear deceleration, centering on consumer spending.
However, given that income and employment conditions are still good, it is likely that a severe economic slump will be avoided.
Asia: Although the deceleration of the US economy and the rise in the price of crude oil will exert downward pressure, Asia is likely to see stable economic growth. In China, although a slowing of export growth is unavoidable, the government has announced a number of initiatives such as raising the minimum wage and economic growth of more than 10% is likely to be maintained, led by consumer spending. India too is likely to maintain a high growth rate, against a backdrop of continued strength of exports in the IT services sector and a rise in direct inward investment.

There are a number of risks in this scenario, notably, (i) the risk that the depreciation of the dollar will accelerate and that this will bring a rise in commodity prices and a worldwide rise in long-term interest rates, (ii) the risk of economic recession in the United States as a result of falling employment and a prolonged period of credit uncertainty, and (iii) the risk of rising inflation due to the rise in the prices of food and energy, and vigilance will be required.

For more information on the content of this report, please contact Takeshi Makita, the Japan Research Institute, Limited.

Tel: 03-3288-4244
E-mail:makita.takeshi@jri.co.jp

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