In last month’s commentary we discussed the revolutionary socio economic shifts we are currently experiencing. This month we consider the main global economic issues that are arising from these events:
1. The expansion of the global middle class
Total and per capita income is rising rapidly within emerging economies. For the first time ever the majority of the world’s population is likely to be made up of the middle class. The middle class typically drive consumption; underpin business capital expenditure and government services. The size of the global middle class is estimated to increase at approximately 180 million per year to around 3.2 billion by 2020 and 4.9 billion by 2030.
Total world growth should continue to lift, although the regions to benefit will be a function of where the growth is occurring and who trades with those areas. The bulk of this growth is coming from Asia, but little from developed economies. Indeed, consumption from Asia is expected to grow from $11 trillion of global consumption of $35 trillion in 2015 to 25 trillion of $51trillion by 2025.
2. The lack of real income growth in developed countries
While real income is growing rapidly in developing countries, it has either fallen or stagnated in the developed world. The ever expanding labour force in developing economies has limited any lift in real median incomes (the middle class) in the developed world.
While real incomes have been falling, capital expenditure across many developed economies has failed to lift. This has been the missing ingredient of economic growth in most developed countries.
The good news is that the United States is leading the developed world in adjusting to globalised labour and product markets. Importantly, US census data released in September shows real median income has lifted for the third year in four and has just eclipsed the levels it had been in 2000. Real mean incomes, have been growing for a while, but this has largely been demonstrative of the income and wealth gap growing. Europe’s’ strong employment growth has begun to modestly lift real median incomes. A continuation of this trend is key to European economic growth becoming more enduring.
Central banks have tried to spur growth by driving interest rates lower. Instead they’ve inadvertently lifted saving rates as income has fallen. Governments have had little ability to pursue fiscal reform that generates income growth.
3. Central Banks setting policies
In the current environment, a danger for developed world central banks is thinking that despite growth and employment, inflation needs to be higher. The three major central banks have a mandated target inflation rate of 2%.
All three of the major developed world central banks – the US Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of Japan (BOJ) – have been buying substantial volumes of long-dated government bonds to help spur business investment. But these asset purchase programs are now past their use by date, with central banks now recognising their shortcomings. Central bank net asset purchases in advanced economies are set to decline sharply in the coming 12 to18 months. The Fed announced in September that they will gradually reduce the reinvestment of bond maturities and coupons; thus unwinding QE. This likely makes it easier for the ECB to reduce the volume of their monthly bond purchases.
There are concerns in some quarters, of a material risk of sharply tightening financial conditions.
In our view, the expected moderate monetary tightening would only have minimal impact on global growth and inflation. We do not expect interest rates to increase anywhere but in the US, but we do expect longer-dated bond yields to rise as the quantitative easing (QE) policies of these banks are gradually unwound. The extent to which longer dated interest rates can lift will be limited by the pace of European QE reduction and the foreign exchange reserve accumulation in particular by China and related bond purchases.