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Delta Dissonance: Global Economic Roundup

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Each July, I meet with nearly 25 economists from almost as many countries for a week of shared research and intense debate about the state of the global economy. The meetings are strictly Chatham House rules, which means I cannot attribute what anyone says but can share what I learned. The group has been meeting for more than 80 years and is older than most international institutions.

This is the second year we met virtually instead of in person; many of my colleagues were forced back into lockdowns in response to variants. The only break the group took was during WWII. Our meetings this year were again scheduled around the clock to accommodate different time zones.

Global growth is expected to exceed 6% in 2021 after contracting 3.6% in 2020. Optimism is greatest for the U.S., which is riding a tailwind of vaccinations and fiscal stimulus. The divide between the developed and developing worlds is widening along with inequality within countries. Everything from an uneven distribution of vaccines and unstable political regimes to limits on fiscal policy is stunting recovery in developing economies.

Debt loads have risen the world over, which could limit the ability to counter the next downturn and the damage caused by variants. Wealthier countries are stepping in to help with debt restructuring and forgiveness. Even Argentina, which has deflated more times than I can remember, will receive at least a one-year waiver in dealing with its debt problems.

Inflation is heating up pretty much everywhere. Most expect the surge in inflation to be transitory, though confidence in those forecasts is waning. Reopening is much harder than shutting down. Bottlenecks are broad-based, curbing manufacturing activity and efforts to ramp up the service sector.

Stagflation has begun to take hold in some of the most mismanaged economies. Turkey stands out, with inflation expected to surge to a double-digit pace by year-end.

Central banks are beginning to acknowledge the risks of a more persistent inflation. “A substantial majority” of participants at the June meeting of the Federal Open Market Committee (FOMC) see inflation risks “tilted to the upside.” Central banks in many developing economies have already begun the painful process of raising rates.

The result could be a more compressed boom/bust cycle. That creates trouble for asset prices, which have benefitted from longer expansions and exceedingly low interest rates. Equity and home values are bubbling in much of the world.

The virus and its mutations remain the largest threat. The Delta variant, which ravaged India in May, now dominates all regions but Latin America where the Gamma variant is still spreading. Countries that escaped the first waves are getting hit. Our inability to extinguish the virus has meant that we are learning to live with the risks of COVID, which are dire for the unvaccinated.

Developed economies are not immune. Japan banned spectators from the Tokyo Olympics. The Delta variant is showing up in every state in the U.S. Florida is experiencing a surge in infections as temperatures jump and people move inside where air conditioning is the norm. One recent study suggests that vaccine-resistant variants could emerge from pockets of the unvaccinated.

Climate change and the extreme weather events it triggers are additional risks. A fifty-year drought in Taiwan has forced a rationing of water, which is critical to the island’s computer chip production. That has exacerbated bottlenecks and chip shortages. Taiwan accounts for more than 60% of the world’s computer chips and a larger share of the most sophisticated chips.

This edition of Economic Currents provides a roundup of the global outlook by region. The global recovery is gaining steam. The gains we are experiencing come with a price: higher inflation, just about everywhere. Central banks are expected to remain hesitant to preempt a rise in inflation, especially given the rise of COVID variants.

The convergence evident between the developing and the developed worlds before the crisis has been derailed. More coordinated efforts to stem the spread of the disease could help reverse those trends. Asset prices are vulnerable to a correction. We have not seen the likes of inflation like this in decades, before many financial market participants were born.

Global Roundup North America
The U.S.
The U.S. is expected to expand at a 6.6% pace in 2021 after contracting 3.5% in 2020. That is slower than we expected last month. The spread of the Delta variant, new lockdowns abroad and the shift in funds from stimulus toward infrastructure moved growth into 2022 and 2023. Our forecast assumes an infrastructure package, either on a bipartisan basis or via the annual budget process.

Fiscal stimulus was much stronger in the U.S. than elsewhere. Much of the spending was temporary and used to fill gaping holes that the pandemic revealed in our limited safety nets. The administration’s more ambitious spending and tax goals are expected to be curtailed by moderates in the president’s own party.

Consumers have amassed more than $2 trillion in excess savings. That will support a lot of spending even if it is not depleted. Stimulus checks enabled low- and middleincome households to save along with high-income households. That has temporarily boosted spending gains. The gap between the haves and have-nots will again widen as we move into 2022.

Spending is shifting from goods and homes to services, but not fast enough to alleviate bottlenecks. Home sales and construction started falling when consumers reacted to sky-high prices and a lack of supply. Builders have delayed projects in hopes that material costs will drop and labor shortages will ease.

Inflation and wages are moving up. The largest gains are occurring in areas most affected by the pandemic. Vehicle prices, car rentals, airfares and entry-level wages are surging.

Wages in the leisure and hospitality sector soared nearly 90 cents an hour in the second quarter, the fastest quarterly pace on record. That boosted overall wage growth to a 6% pace in the second quarter, but inflation wiped out that and more.

Large firms are better positioned to absorb those shocks than small businesses. Profit margins widened for many during the pandemic, while they rapidly adopted existing technologies to boost productivity growth. Investment in new technologies accelerated at the fastest pace since the dot.com bubble, when companies made leapfrog investments to avoid Y2K problems. (Google it, if you are too young to remember Y2K.)

Still, a portion of wage gains is being passed along to consumers. Some of the inflation we are experiencing could linger.

The Federal Reserve has taken note. Public debate over when to take action has become heated. We expect the Fed to taper its asset purchases by year-end. Hawks will gain an upper hand among those who vote on policy in 2022. They will likely dissent as Chairman Jay Powell pushes back on rate hikes.

Our forecast assumes regional outbreaks will worsen but not trigger new lockdowns. They are likely to occur in rural areas, which have a smaller effect on overall GDP.

Canada Canada is expected to grow at a 6% pace in 2021 after contracting more than 5% in 2020. The country imposed some of the most stringent restrictions on congregating in the developed world. Vaccinations have picked up; the proportion of fully vaccinated could soon eclipse the U.S.

Consumers are emerging from lockdowns and the housing market is bubbling; home prices are up more than 30% in the hottest markets, the fastest pace since the 1980s. The rebound in commodity prices has provided a lift to Canada’s lumber and oil markets.

Canadian firms took over much of the U.S. lumber business when the industry consolidated in the wake of the subprime crisis of 2008-09. That put Canada on the winning side of the global surge in lumber prices and home building.

Inflation is accelerating. The Bank of Canada is expected to raise rates in 2022, more than six months ahead of the Fed. The focus will be on froth in the housing market, which has become a global concern.

Latin America Latin America is expected to rise at a 6.5% pace in 2021 after essentially flatlining in 2020. This will leave the region badly lagging its precrisis performance. Mobility has increased despite a resumption of infections and restrictions. People have no choice but to bear the risk of contagion to feed their families.

Poor access to vaccines and poorer quality vaccines exacerbated contagion. Chile, which rapidly vaccinated its population, is suffering from breakthrough infections associated with Chinese vaccines.

A bounceback in commodity prices and exports has helped Brazil, the region’s largest economy. Mexico is being helped by strong ties to the U.S., a pickup in remittances and a rebound in manufacturing. Supplychain constraints are slowing manufacturing gains.

Inflation is accelerating. The central banks in Brazil and Mexico have already begun to raise rates to combat inflation. Other central banks in the region will follow.

Political tensions are growing as reforms are being overturned. Prime Minister Jair Bolsonaro has a hard-core base as does former former President Luiz Inácio Lula da Silva; Lula’s convictions on corruption were recently overturned, which means he can run again. The political instability in the region is undermining investment and prospects for longer term growth.

Separately, the losses in educational attainment triggered by the crisis could become generational. The poor lacked the electricity and the electronics to stay online as schools closed. Without a way to catch up in economies still plagued by the rapid spread of infections, the blow to educational attainment could linger and further undermine the potential of the region to grow.

Europe The U.K. The U.K. is expected to rebound at a 7% pace in 2021 after contracting a heart-wrenching 9.9% in 2020; the losses were the worst in 300 years. The Delta variant is spreading despite a surge in vaccinations. The U.K. government is moving ahead to lift restrictions in the hope that vaccines will prevent the worst outcomes.

Inflation is picking up, both in response to a rise in commodity prices and Brexit, which has put a damper on trade. Brexit is exacerbating labor shortages.

 
"We have not seen the likes of inflation like this in decades, before many financial market participants were born."
Businesses have a lot of cash on their balance sheets, which should support a rebound in investment. The question is how much of that will remain in the U.K. The finance sector has held up better than expected in the wake of Brexit but the pandemic likely delayed the move by many banks out of London. Fiscal stimulus is waning and will become a drag on growth as we move into 2022.

The Eurozone
 
“China is already showing signs of slowing and is expected to continue to fall short of its 2030 plan.”
The eurozone is expected to rise 4.5% in 2021 after contracting nearly 7% in 2020. Vaccinations are picking up across the region and restrictions are being lifted, but unevenly as the Delta variant spreads.

Fiscal stimulus and the excess savings triggered by the crisis are helping but could soon dissipate. The excess savings is concentrated in wealthier households than in the U.S. That suggests a smaller share of the funds will be spent. Stimulus checks, which provide an extra boost to savings in lower income households in the U.S., were not issued in the Eurozone.

Manufacturing activity is beginning to slow in response to supply-chain bottlenecks and the shift to spending on services. Travel and tourism are expanding, much as they did during the summer months in 2020.

Inflation is moving up but not as rapidly as in other parts of the world. Gains are expected to be transitory; the European Central Bank is expected to remain patient.

Supply-chain problems are widespread and slowing the recovery in the manufacturing sector. That has added to goods inflation, although hopes are high that bottlenecks will abate as we move into the second half of the year.

Inequality within the region is expected to intensify, despite efforts to provide stimulus for poorer countries. Germany and France are expected to regain losses to the crisis faster than Portugal, Italy, Greece and Spain.

Central Europe Central Europe is expected to grow at a 4.6% pace in 2021 after contracting 4% in 2020. Manufacturing activity has rebounded but is not doing as well as it might because of supply-chain problems. Vaccinations are lagging the rest of Europe even as infections due to the Delta variant are increasing.

Inflation is picking up more rapidly in Hungary and Poland than in the Czech Republic, Slovakia and Slovenia. A combination of both fiscal and monetary policy stimulus helped support the region throughout the crisis.

President Viktor Orbán of Hungary is a destabilizing force in the region and Europe more broadly. He is both admired and emulated by his peers. He is a nationalist whose open racism and concentration of power is accelerating the backlash to immigrants and women. His corruption is well-documented. His consolidation of power during the height of the pandemic was so egregious that the European Union pushed back. Opposition parties are attempting to unite and defeat Orbán in the next election.

Russia Russia is forecast to grow 3.3% in 2021 after contracting 3% in 2020. Rising oil prices have provided a bit of a tailwind but the spread of the Delta variant will no doubt undermine recovery. Despite developing and exporting Russian-made vaccines, vaccination rates are low, in part because of a lack of trust in the government.

Backlash to President Vladimir Putin has intensified, along with his crackdown on civil unrest. President Alexander Lukashenko of Belarus has close ties to Putin and is also cracking down on the surge in civil unrest. The hijacking of a plane crossing the country’s air space to arrest an opposition journalist is among the most egregious of his recent moves.

Separately, Russia remains a military threat to Ukraine. Putin continues to stoke violence and misinformation across Europe and in the U.S. Hacking attacks are accelerating, which is further disrupting supply chains and the broader recovery from the crisis.

Turkey Turkey is expected to grow at a 7% pace in 2021 after squeaking out a small gain in 2020. Gains are expected to be driven by a dramatic easing of credit and accumulation of debt. Tourism is picking up, mostly from Russia, after collapsing in the first half of 2020. Vaccinations are picking up but not fast enough to stem the spread of the Delta variant.

Inflation is expected to hit a double-digit rate by yearend. Stagflation is the baseline. The country could suffer a more prolonged slowdown if the central bank is not allowed to continue to raise rates. It would not be the first time the independence of the country’s central bank has been undermined by President Recep Tayyip Erdoğan.

Asia Japan Japan is expected to grow at a 2.5% pace in 2021 after contracting nearly 5% in 2020. The spread of the Delta variant, low vaccination rates and limiting attendance at the Tokyo Olympics have pushed risks to the downside.

Consumer spending is expected to pick up after stagnating. Business investment remains suppressed. Exports are expected to slow after surging earlier in the crisis, notably to China.

Stagnant profits and lack of investment could collide with upward pressure on wages and prompt a wave of business failures. Smaller businesses were closing ahead of the crisis instead of paying more to find young workers, who are scarce in the aging country.

China China is forecast to grow at an official rate of just above 8.5%, after slowing to 2.5% in 2020. The manufacturingled recovery is losing steam along with consumer spending. The Delta variant is prompting regional lockdowns. Vaccines are being rolled out but trust in the government on vaccines is justifiably low. China has a history of releasing ineffective vaccines.

China is already showing signs of slowing and is expected to continue to fall short of its 2030 plan. The aging of its labor force into retirement and backtracking on market reforms are undermining its potential growth.

President Xi Jinping is attempting to counter weaker growth by shoring up his legitimacy. Hong Kong is rapidly being absorbed into the mainland. Taiwan is his next major target. Xi considers Taiwan a part of China. That would ensure China’s chokehold on the global supply chain. A hot war can not be ruled out.

China has had skirmishes with India and continues to expand its military presence in the South China Sea. Countries bordering China are looking to the U.S. and the rest of the world to threaten sanctions. Regional experts say the U.S. would have to threaten to oust China from the World Trade Organization (WTO), an unlikely move given the spillover effects for the global supply chain, to stem Xi’s ambitions for Taiwan.

South Korea
 
“The central banks in Brazil and Mexico have already begun to raise rates to combat inflation.”
South Korea is expected to grow at close to a 4% pace in 2021 after flatlining in 2020. Aggressive masking, testing and tracing enabled Koreans to stem the contagion at the onset of the pandemic. A slow rollout of vaccines and the spread of the Delta variant are hitting the country along with the rest of Asia. South Korea is hoping to get 70% of its population vaccinated in the second half of the year.

Exports picked up with the global demand for goods. Manufacturing has begun to slow in response to bottlenecks and the pivot from goods to services.

Inflation is increasing but the central bank is expected to remain patient. Inflation remains more contained than in other countries, largely due to the fact that the region was better at containing outbreaks and stayed fully open longer than other countries.

Peripheral Asia India is expected to grow by 9.5% in 2021 after contracting 7% in 2020. It has achieved an extremely high level of immunity in the most painful way with widespread infections. Infections and fatalities are likely understated.

Prime Minister Narendra Modi’s government is coming off of a large win in May. His nationalist policies continue to fall short on reforms. India is attracting investment as an alternative to China.

Those gains in investments will enhance an aggressive infrastructure package and are expected to spur the recovery. The world is in need of a growth engine now that China’s long term prospects are waning.

The Delta variant is now wreaking havoc on the Philippines, Indonesia, Malaysia, Thailand and more recently Vietnam. Singapore and Hong Kong are the only places in peripheral Asia which have achieved high vaccination rates. Most of Asia was able to escape earlier outbreaks due to heavy masking and an adherence to restrictions, sometimes aggressively enforced.

Australia and New Zealand Australia and New Zealand weathered COVID much better than other developed economies, with modest contractions in 2020. Gains in 2021 are more muted than their counterparts around the world, but the two countries need very little in terms of growth to lower unemployment.

New Zealand is suffering more from closures and loss of tourism than Australia. Australians have redirected the ample funds they typically spend on travel and tourism to domestic destinations, which has helped mitigate the loss in tourism, mostly from China.

The countries have been slower to gain access to vaccines. Both entered lockdowns quickly to contain even small outbreaks. The border rules are draconian for democracies and closer to those of authoritarian regimes. Some fear protectionist policies and harsher border restrictions will linger, which could undermine the potential of the two countries to grow longer term.

Inflation is picking up as are wages. Central banks in both countries are about to raise rates. New Zealand’s central bank has been trying to use its regulatory system to unsuccessfully stem a bubble in the housing market. Institutional investors are flipping properties to rent.

Middle East and North Africa Wealthy, oil-rich nations that have achieved a higher level of vaccination are expected to perform much better than less wealthy and less oil-dependent countries. Saudi Arabia, Kuwait and the UAE fall into the first category. They will need a year to catch up after sustaining deep losses when oil prices plummeted as a result of the pandemic and lockdowns.

Iran is an outlier, with sanctions limiting oil revenues. COVID cases have soared again, prompting a new round of restrictions.

Tourism is a big industry across the region and has been badly battered. It is hard to imagine that reversing anytime soon given the surge in the contagion poorer countries are suffering.

Sub-Saharan Africa The continent’s recent history of fighting epidemics and a cessation in travel helped stem contagion last year. Those early successes are quickly evaporating. Infections due to variants are surging and vaccines remain in short supply. Treatment of the disease is not as good as elsewhere, which could elevate fatalities. Data on infections grossly understate the severity of the spread.

The region is one of the least vaccinated in the world. Poorer countries rely on the developed world for vaccines donated through the COVAX program.

Nigeria, the continent’s largest economy, is benefitting from the rebound in oil prices and exports. Rising infections are curbing those gains. Conflicts and violence have escalated across the continent.

South Africa is the second largest economy and has been hit hardest by a resurgence in infections. Lack of electricity and rampant corruption remain the biggest constraints on business activity. Violence and clashes with police have intensified in response to rising poverty.

Legacy Effects Historically, pandemics have led to labor shortages, inflation, an erosion in public trust, escalating violence and, in worst-case scenarios, the fall of nations. Sound familiar? Demonstrations and violence in Cuba and South Africa are recent examples.

Correlation does not imply causality. Much has changed since the plagues of the past. We have science, which has helped limit fatalities. The labor shortages we are seeing may be due to sequencing rather than a permanent blow to labor supply. Consumers are spending. Businesses are ramping up faster than workers are able or feel safe enough to return to work.

Fiscal and monetary stimulus helped blunt the economic consequences, which should help to short-circuit civil unrest. This may be true for developed countries more than developing economies, although fuses are clearly shorter than they were prior to the pandemic.

The pandemic accelerated the adoption of existing technologies, which should curb the effect rising wages have on prices this time around. Again, developed economies were much better positioned to benefit from those shifts.

Bottom Line The global economy is improving unevenly. Vaccines are the best tool we have to level the playing field between the developed and developing worlds. Debt restructuring and forgiveness are others. Let’s put those tools to work.

Sharing time with my international colleagues reminded me why. The humanity that binds us is stronger than the borders and time zones that separate us.

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