A key source of comfort during the financial turmoil of recent weeks has been the consensus that the world economy remains strong.
This is important, for it means that even if the financial contagion continues to spread, the world economy will prove resilient to the shock.
There can be no doubt that the world economy is in better health than it was during 1997-99. At that time, emerging markets with stretched fundamentals staggered from one crisis to another, starting with the Asian flu, then the Russian crisis, and then it spread to Latin America. Global growth slowed, but at the time, it was all an emerging market story. Despite the associated financial turbulence, the major economies managed to perform reasonably well.
This time, it's the other way around. The U.S. economy has clearly slowed. The housing market is in recession and is likely to remain so for a long time. GDP growth averaged 2.9 per cent in 2006, but averaged two per cent in the first half of this year (an inventory-led exaggerated dip in Q1 and a temporary rebound in Q2).
Importantly, consumer spending appears to be slowing, with latest retail sales growth at 3.3 per cent. And recent volatility in financial markets is creating a risk that confidence will be dampened further. Growth is likely to slip below the two-per-cent level during the second half of the year.
But growth in the rest of the world remains strong, right? Well, not in Japan. Growth averaged 2.5 per cent in 2006, and rose to 3.2 per cent in 2007Q1, but then fell dramatically to 0.5 per cent in the second quarter. Two sources of weakness were apparent in the data - the Japanese consumer remains weak (latest retail sales growth of -0.4 per cent) and exports to the U.S. have slowed.
But Europe is experiencing a renaissance, right? True, the European economy has seen a return to good growth, led by Germany. But, again, the most recent news is less than stellar. After averaging just over three-per-cent growth in 2006, European growth eased to 2.8 per cent in the first quarter and then to 1.6 per cent in the second quarter.
Again, consumers appear to be taking a breather - the latest retail sales figures show growth running at 2.2 per cent - and exports to the U.S. have slowed.
This time around, the major markets are moderating, while the emerging market economies remain strong. Brazil, Russia, India and especially China are all humming. China, in particular, is scrambling to slow its economy by tightening monetary policy.
Nevertheless, these economies are all reliant to some degree on the majors for final demand, either directly through exports or indirectly through strong prices for commodities.
Between them, the U.S., the EU and Japan make up 45 per cent of the world economy, a fact that keeps them in the driver's seat. Brazil, Russia, India and China together constitute about 27 per cent of the world economy, so it would take a significant acceleration in their growth to offset a moderation in the Big 3. This is not in the cards.
The bottom line? The world truly is in better shape than in the late 1990s, and should prove resilient to financial turbulence. Indeed, the more likely interpretation is that the turbulence we are seeing is a symptom of a generalized moderation in economic growth, not the cause.
Investors are recalibrating all risks in light of slower growth and seeking higher returns in exchange.
(Stephen Poloz is a senior vice-president and chief economist for Export Development Canada. He can be reached at spoloz@edc.ca)
