When the G-7 countries meet this spring, one issue they will discuss is the desynchronization of the global economy. The US economy is again the G-7 growth locomotive. It grew at a 3.0% annual rate during the fourth quarter and is likely to expand by 2.5-3.0% during 2012. Europe is experiencing a recession. Japan’s earthquake reconstruction should produce a growth rate in the 1.5-2.0% range. As a result of the US upturn, Canada should also have a growth rate of 2.5% or more. The emerging market economies have also desynchronized. As a result of central bank efforts to fight inflation, the growth rates of Brazil, India, and China have slowed from the robust levels which prevailed in 2010. The African economy, by contrast, has gained new momentum from the rising commodity prices which forced many other countries to tighten monetary policy last year.

There are five factors driving the improvement in the US economy.

First, some of the economy’s most cyclical sectors, such as housing and commercial real estate construction, are just starting to recover. They lost two million jobs during the recession and could create several hundred thousand jobs if their recovery is sustained.

Secondly, the Federal Reserve is pursuing a highly accommodative monetary policy. It has pledged to keep short-term lending rates close to zero until 2014. It is redeploying its portfolio of Treasury securities from short maturity instruments to long-term bonds.

Thirdly, the corporate sector has enjoyed a dramatic recovery in profits since 2009. The profit share of GDP is at a sixty-year high and corporations have $2.2 trillion of excess cash on their balance sheets. The robust growth of profits has encouraged business spending on new equipment, but the ratio of investment to cash flow is still only 87%, so there is ample potential for further growth. The ratio of capital spending to cash flow before the 2008 recession was 130%.

Fourthly, the household sector has been deleveraging. It has reduced its debt by over one trillion dollars. The low level of interest rates, coupled with this deleveraging, has reduced household interest payments by $270 billion from the 2007 peak. The household debt servicing ratio has fallen to 5.8% from over 9.0% five years ago. The decline in interest payments has freed up more income for consumption.

Finally, there has been a major recovery in the banking sector. During 2007 and 2008, US banks lost over one trillion dollars. They are now earning just under 1% on their assets and have boosted equity-to-asset ratio above 11% from just over 9% three years ago. Their profits in 2011 were $119.5 billion compared to a previous peak of $145.2 billion in 2006. The recovery in bank profitability has led to a relaxation of lending standards for households and business.

The weakest sector of the US economy continues to be state and local governments. They have lost nearly 650,000 jobs since 2008. They received a great deal of federal assistance during 2009, 2010, and early 2011, but these funds have now largely run out. As they will continue to run a fiscal deficit of $49 billion this year, they will continue to trim spending.

The major short-term risk in the US economy is rising gasoline prices. They have increased over $0.60 per gallon since the December price trough, and imposed a de facto $60 billion tax increase on the household sector. If they continue to rise, they could dampen the recovery occurring in consumer spending, as happened during the second quarter of 2011.

The intermediate-term risk in the outlook is federal fiscal policy. The income tax cuts and payroll tax cuts enacted during the past two years are scheduled to expire at the end of 2012. Unless Congress acts, there could be tax hikes early next year equal to 3-4% of GDP which could drive the economy’s growth rate back to zero. It will be unclear how Congress will resolve this problem until after the November elections.

The most positive new factor in the US economy is rapidly growing energy output resulting from new fracking technology. Natural gas production has increased from just over 18 trillion cubic feet in 2005 to 23 trillion and could rise to over 26 trillion by 2035. US oil output has increased by one million barrels per day (mb/d) during the past three years and has the potential to increase much further as a result of shale oil development. As a result of growing oil sands output in Canada, a potential liberalization of Mexico’s oil investment policies, and rising US output, Citibank estimates that total North American oil production could rise from 15.4 mb/d in 2011 to 26.6 million mb/d in 2020. The coming gains in oil production could increase US GDP by nearly 3% and employment by 3.6 million jobs. There will also be a decline in the US current account by anywhere from 1.2% to 2.4% of GDP. The deficit is currently 3% of GDP.

President Obama had planned to significantly boost investment in alternative energies, such as solar power, but they are suffering from competition with low-cost natural gas and a surge of Chinese imports. The US recently tried to protect the domestic solar power sector by imposing tariffs on Chinese imports. China has spent billions of dollars trying to become the dominant global supplier of solar power technology.

The coming changes in North American energy output will have profound geopolitical consequences. The US will no longer need to import oil from the Middle East. The price of oil could decline despite steadily growing demand from China. There will also be great potential to increase production of shale oil in China, Argentina, South Africa, and Australia.

The G-8 countries will be relieved that the US economy is regaining momentum at a time when Europe is confronting recession and China is showing signs of slowing down. It will help to offset the fiscal drag which is now prevalent in other G-7 countries and help to sustain the growth rate of the global economy in the 3-4% range. The G-8 should try to lessen the risk of renewed US weakness during 2013 by encouraging the Obama administration to begin exploring alternatives to the large tax hikes now scheduled to occur at year end. The US is having no problems funding its budget deficits, and significant fiscal drag in the US economy would limit the world economy’s growth potential next year. The US needs a plan to reduce its deficit gradually rather than abruptly. There have been deep partisan divisions in Washington over how to reduce the deficit, but both parties should be able to achieve a compromise aimed at avoiding recession during 2013.

The writer is an editor of “What’s Next?: Unconventional Wisdom on the Future of the World Economy”, which can be found online at whatsnextbook.com, as well as Chairman of David Hale Global Economics.

Broadcast: 27/04/2012

Reporter: Emma Alberici

David Hale is an economic adviser to banks world-wide, and joins Lateline to discuss the apparent failure of austerity measures to save Europe.

Interview and Transcript: http://www.abc.net.au/lateline/content/2012/s3490890.htm

Published October 2011

What’s Next? by David Hale

http://www.g8.utoronto.ca/newsdesk/cannes/index.html

http://video.cnbc.com/gallery/?video=2033211358

…But David Hale, an economist based in Chicago and veteran China watcher, said he saw “nothing new in this and (it) will continue so long as China remains an authoritarian country.”

http://www.swissinfo.ch/eng/news/international/Escaped_China_activist_in_US_protection-rights_group.html?cid=32575552

KIM LANDERS: The British economy is officially back in recession and economists say there’s a long way to go before the economy is back on the front foot.

The news has added to growing anxiety about the entire Western European region.

Finance reporter David Taylor has more.

DAVID TAYLOR: If you exclude two World Wars, it’s the worst four years for the British economy in a century.

British consumers are being squeezed by rising prices and a freeze on wages.

VOX POP: Everything is just going up and wages aren’t going up. I’ve been on the freeze now for four years so now I’m struggling.

VOX POP 2: Not really confident, no I don’t think things are going to change. Not for, I would say, two or three years.

DAVID TAYLOR: That lack of confidence is filtering through to the rest of the economy. The manufacturing sector is contracting by 0.1 per cent. Construction too is down 3 per cent.

David Hall runs a plastic pipes business for the construction industry.

He’s simply learning to adapt to the new economic environment.

DAVID HALL: We are in the environment that we’re in. I don’t think is, we can’t sit holding our hands, holding our head in our hands worrying about being low growth because that is the way it is going to be. That is the new norm.

DAVID TAYLOR: The services sector is a major part of the British economy, and it is showing some life, but only just.

Without the services sector, the recession would be far deeper than it is.

David Hale is an international economist based in Chicago.

DAVID HALE: Well, I don’t think this is going to be a severe recession. I think it will be a technical recession.

DAVID TAYLOR: Even still, economists are warning the recession still has some way to go.

Stephen Walters from JP Morgan.

STEPHEN WALTERS: It’s pretty much across the board not just the quite small construction sector but more broadly in the part of the economy that represents about three-quarters of their GDP that was also very soft.

DAVID TAYLOR: Well given that, is the recession likely to get even worse from here?

STEPHEN WALTERS: Well, it is going to get longer. I don’t think it will get much worse.

DAVID TAYLOR: Is there a difference?

STEPHEN WALTERS: Well, I think there is a difference because we do actually have quite shallow downturn. My colleagues in the UK expect GDP to contract again in the second quarter. Now that will make it three straight so that is a longer downturn but far less severe than what we saw during the global financial crisis when the UK economy was in a severe recession then and GDP contracted for more than a year and at a much faster pace. So, look I am not trying to gild the lily here, it is not a great outlook at all.

DAVID TAYLOR: It’s put the British prime minister, David Cameron, under enormous political pressure.

But he insists the answer to Britain’s economic problems is not to repeat the mistakes of the past.

DAVID CAMERON: This is a tough and difficult situation that the economy is in but the one thing we mustn’t do is to abandon public spending and deficit reduction plans because the solution to a debt crisis cannot be more debt.

DAVID TAYLOR: Meanwhile over in the United States, the economic recovery remains fragile.

The US Federal Reserve chairman, Ben Bernanke, is doing his best to instil some confidence in the economy.

BEN BERNANKE: We’ll continue to assess, you know, looking at the economic outlook, looking at the risks whether or not unemployment is making sufficient progress towards its longer run normal level and whether inflation is remaining close to target and if appropriate and depending also on an assessment of the costs and risks of additional policy actions, we remain entirely prepared to take additional balancing actions if necessary to achieve our objectives.

So those tools remain very much on the table and we will not hesitate to use them should the economy require that additional support.

DAVID TAYLOR: The Australian share market opened this morning after being closed yesterday for the Anzac Day public holiday.

It appears investors may be focusing on Australia’s closer economic ties with the Asian region.

At midday in the east the benchmark share index was up around half a per cent.

KIM LANDERS: David Taylor reporting.