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By HaleStewart December 31, 2013 12:35 pm
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2014 International Economic Predictions

As the end of the year is upon us, it only seems natural to make predictions about the upcoming year.  First, here is a link to my predictions from last year.  If I do say so myself, they were generally very accurate.  So, let’s start into 2014 predictions.

The US will finally experience consistent growth about 2.75%.  For the last few years, the standard prediction for the US economy has been that growth will finally accelerate to a self-sustaining level, which usually means annual growth of 3%+.  However, this growth has never materialized, largely because economists forgot the US was in the middle of a debt-deflation economic recovery.  This means that consumers were paying down debt incurred at the end of the previous expansion (usually as the result of a financial bubble).  However, consumers are now in better financial shape as shown by the following two charts:

The household financial services obligations ratio is near its lowest level in over 30 years, and  

Household net worth has surpassed its pre-recession peak, creating the “wealth effect” for consumers.

In addition, the Ryan-Murry budget prevents the standard budgetary drama we’ve seen unfold in Washington over the last few years (we will probably have to suffer through some type of debt-ceiling drama, however).  Also consider that recent ISM data has been very bullish.  The only potential speed bump is the negative impact of rising interest rates, especially on the housing market.  However, I believe this story will have two parts.  The first will be the market adjusting to the increase and the second will be a realization that – despite the increase – 3.5% on the 10-year Treasury bond is still an amazingly low rate of interest to pay.

Inflation will continue to be a global non-story.  Despite a large amount of hand-wringing about central banks printing vast sums of money, inflation has not emerged, largely for two reasons.  The first is a depressed aggregate demand situation.  The two largest economic regions in the world (the EU and the US) each have high rates of unemployment (12%+ and 7%, respectively) meaning there is no demand pull inflationary pressure.  And commodity prices are under control as well.  Consider this chart of the DBC ETF, which tracks overall commodity levels:

Prices are near three year lows.  While we will probably see isolated inflationary situations (Brazil and India) these are country specific situations.

There is nothing to indicate Chinese growth won’t continue in the 7%+ annual range for the duration of the year.  However, two structural problems will start to emerge.  The first is the long-term economic effects of pollution on the economy.  This year we learned a 7 year old child had lung cancer as a result of living in a major Chinese city.  Pictures from space show literally hundreds of square miles underneath a cloud of smog.  Airline pilots must now be qualified to land on instruments because the smog is regularly so heavy as to prevent visibility.  Yes, China has grown at incredibly strong rates for a very long time.  But the environmental cost will lead to higher rates of cancer, premature deaths and a host of other pollution related illnesses the country must now budget for.  And, this budgeting won’t be cheap.  Secondly, a debt problem is lurking underneath the county’s stellar growth.  The Financial Times has written about this story in depth (see this link).  The most important aspect of this story is China is issuing more and more debt, but getting less and less return for the investment.  At some point, this debt will come home to roost.

The EU will continue to muddle along.  The EU has a central problem: they’re a currency union without a central budgetary authority.  As a result, countries like Greece and Portugal are faced with long-term adjustments that would have been far faster if they had their own currency.  If Greece was still on the Drachma, their budgetary problems would have led to a collapse of their currency, allowing them to essentially inflate their way out of the problem.  Instead, the country must internally devalue which means a massive drop in unit labor costs.  This takes longer and is arguably far more painful.  At the same time, the EU has Germany, which continues to export its way to prosperity.  In between we have other countries that are meandering along at best (Italy, France and Spain).  Deflation continues to be a potential problem.  Unemployment is over 12%, retail sales growth is weak and consumer credit issuance is still negative.  While the Markit numbers have been solid over the last few months, we’re a long way from singing “happy days are here again.”  There are just too many problems lurking below the surface to hope for anything save sub-par, lackluster growth. 

Latin America will continue to surprise everyone with good growth.  The world will also continue to overlook this region of the world.  When the Fed announced their taper in May 2012, capital flew out of developing markets (such as Latin America), leading to a drop in the regions respective equity indexes.  Here’s a chart of the Latin American tracking ETF that shows the drop (graphically).

However, there is little in the economic numbers to warrant this capital flight.  Yes, Brazil is experiencing problems, but other countries are doing well.  Colombia just printed an annual GDP growth rate over 5% while both Chile and Peru are over 4%.  Mexico just surprised to the upside with their latest GDP print as well.  The “bad old days” are out; the countries have in general learned from their mistakes and will continue to make forward economic progress. 

So, there you have it.  My predictions for 2014.  Have a happy and safe new year.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer

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