Saturday, 1 May 2010

Long term Macro views - as per Angus Maddison

To begin with, I highly recommend reading Angus Maddison's book Contours of the World Economy, 1-2030 AD, Essays in Macro-Economic History.

In most of my previous posts, I have been focusing on the risks of a double dip recession and the outstanding structural issues faced by most of the developed countries.

In all that doom and gloom Marc Faber's style, there are some bright spots of development in the world and in this post I will try to highlight the incredible tectonic shift we have been witnessing in the World Economy.

I will focus on this post on looking at historical trends and I will try to highlight what to expect in the coming decades in relation to Macro Economic growth in the World.

Let's start first by reviewing the evolution of the share of World GDP from 1-2003 AD (percent of world total) as per Angus Maddison's book (page 381):

According to Angus Maddison, the share of the World GDP for Western Europe has dropped between 1973 to 2003 from 22.8 % to 16.5 %.
Between 1870 and 1913, Western Europe'share of Global GDP was around 30.5 % during the industrial revolution, although it was only 20.5% in 1820.

For the USA the peak share of World GDP was 1950 at 27.3 %. Since then their share of World GDP has dropped to 22.1 % in 1973 and to 20.6 % in 2003.

The interesting part is relating to the share of World GDP for China, the peak was around 1820 at 32.9% according to Angus Maddison. It dropped to 17.9% in 1870 which is explained by the industrial revolution experienced by Western Europe at the same time. In 1950 and 1973, China's share of World GDP was 4.6 %. In 2003, China's share of World GDP came back close to 1870's level at around 15.1 % of World GDP.

This it where it is becoming interesting, according to Angus Maddison's projection for 2030(page 340 in his book), you can expect the following:
Western Europe share of GDP will drop to 13% in 2030 from 19.2% in 2003.
Asia (including Japan) shares of World GDP will power ahead from 40.5 % in 2003 to 53.3% in 2030.
In 1820 Asia's share was 59.4 % with a low point of 18.6 % in 1950.

Asia will therefore become the largest driving force in world trade. China will again become the world's biggest economy by 2018 according to Angus Maddison, with USA at number two and India at number three!

Western European countries faces the following massive headwinds:
Ageing population for a start.
Very high debt to GDP ratios which will weight very severly on maximum GDP growth attainable. Given current budget deficits, private growth will be hindered by higher taxation and larger weight of the public sector on the GDP.

When the average debt to GDP in percentage will be around 100% in 2014 in Europe, Emerging markets average debt to GDP will be in the region of 35 % in 2014.

This graph comes from the following interesting research document published by Deutsche Bank which can be obtained using the link provided below:

The authors of this very good research document conclude with the following statement:

"Should consolidation fail, policymakers in DMs and some EMs may be tempted to look for other ways to fix the fiscal damage. Either they could tolerate a substantial acceleration in CPI inflation to inflate public debt and/or they risk severe adjustments in the real effective exchange rate. Such adverse scenarios should not be
disregarded. The assumption that major macro issues cannot go wrong in the DM world (including EMU) has to be scrapped in the aftermath of the global crisis while this time EM, not DM, economies are the ones in the lead to keep public indebtedness sustainable.
Welcome to a new world!"

Emerging markets Debt is therefore the new investment grade and Western Europe Debt looks more and more like the new High Yield (or junk already for some countries...).
While most of western developed countries are busy trying to debase their currencies to generate inflation, Asian currencies will continue to outperform due to the very good situation of their economy, enjoying both trade balance surpluses and manageable debt to GDP levels.

In relation to Commodities and Gold in particular, I expect them to continue to rise in the near future. As I mentioned previously in this blog, this is the reason why so many hedge fund managers are heavily exposed to Gold (Paulson, Moore, Soros, etc). This is part of their macro strategy following the ongoing rebalancing of the World Economy we are experiencing. They are simply betting that our politicians will try to inflate their way out of the debt problem we are facing.

In terms of macro investments, Asian currencies will rise against the Euro, USD and GBP. Fixed Income Emerging Markets funds will do very well in this new environment given their lower probability of defaults depending on the country they are exposed to (South Korea, Singapore, Taiwan, Maylasia, Indonesia are attractive).

According to the Deutsche Bank research, we are in a new world, I will conclude this post, that it is more a return to the mean, as Angus Maddison is clearly illustrating in his research. Asian countries are returning to the level of world GDP shares they had 200 years ago and before.

Like Mark Twain said "History doesn't repeat itself, but it does rhyme."

Same apply to Macro Economy, it doesn't repeat itself but it eventually does rhyme.

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