Is the world economy in good or bad shape?

Judged by the pace of growth the world economy seems to be sound. Despite soaring oil prices, the IMF's latest World Economy Outlook expects the global output to grow by 4.3% in 05 and 06 well above its underlying trend,. But risks are growing and Inflation is picking up. US current-account deficit is now above 6% of GDP totally out of order. With saving rates of US households negative, consumers look more and more at the limits. The world economy thus is both surprisingly buoyant and extremely unbalanced.
The outlook is more uncertain than since long. Some big sources of today's growth are unsustainable because nobody neither person nor institutions can in the long run spend more than what they earn Theoretically global balance must be restored through slower growth in US compared with the rest of the world. But no one is sure when this adjustment will take pace, nor how painful the ultimate adjustment might be, nor if such an adjustment will have to be at all.
Why? US foreign debt is more than 90% in its own currency and no owner of US$ is interested to cause losses of assets by selling US$ at lower rates. There is one old saying If you borrow small you are weak towards the borrower, if you borrow big you are strong. It's exactly what the US are.
Still many experts believe that a reaction to the big borrowing will come. Many people are worried that foreigners will blink first-because investors lose their appetite for American assets or because Asia's central banks stop buying dollars on such a huge scale. In the opinion of many experts this could send the dollar crashing. These are indeed risks. But they seem smaller than the possibility that America's consumers will blink first.
The factors supporting US spending especially soaring house prices are becoming more shaky. And in recent weeks these foundations have been jolted not only by hurricanes and sharply higher energy costs, but also by a subtle yet dangerous shift in America's macroeconomic mix towards higher inflation, higher interest rates, and looser fiscal policy.
According to latest surveys of consumers' expectations towards inflation, this will over the next five years jump above 3%. Still not excessive in comparison to earlier years, when inflation in US reached 10% and more. The Federal Reserve raised its interest rates to 3.75% with statements hinting to the fact that the Fed's governors are more worried about prices than growth and indicating further interest rises. Fears of higher inflation could become worse if the federal government goes on a spending binge. In the short term, government spending will boost the economy, but that effect could easily be outweighed by higher interest rates.
All these factors suggest that the growth in consumer spending will slow. Less clear is whether it will slow gradually or stall. By themselves, today's fuel prices will slow consumer spending, but will not send it tumbling. After all, Americans have shrugged off higher fuel costs for two years. But with petroleum stocks so slow fuel prices could well rise further.
An even bigger worry is a broader loss of consumer confidence. There are signs that American consumers are jittery. This could be dangerous. Not only could falling confidence prick the housing bubble, but flatter house prices would themselves reduce consumer spending. In Australia and Britain, for instance, consumer confidence fell and spending slowed when house prices stopped rising.
The impact of this on the world economy depends on whether foreign demand picks America's soaring external deficits have been financed by rising surpluses elsewhere. These surpluses sparked talk of a global saving glut. But the appearance of a glut has more to do with a lack of investment demand abroad than a rise in saving, but there is little possibility that the behavior behind these surpluses will change overnight.
In fact some big economies like China and Germany are becoming more not less dependent on exports. With its domestic economy going behind Germany's current account surplus is reaching nearly 4% of GDP this year. Germany needs to be able to grow economic reforms more than ever.
China's current account surplus, 4.2% of GDP in 2004, has soared this year further. Although China's leaders talk a lot about shifting their economy from exports towards domestic consumption, they need to do more to make that happen. And oil exporting countries, who as a group are now the biggest counter parts to America's external deficits, are keener to build up large surpluses than to boost investment at home. Still there are bright spots notably in Japan , the country still with the biggest current account surplus . After a decade of stagnation its economy shows very clear signs of recovery on the domestic front But Japans reviving domestic economy is an exception in a world that remains too dependent on American demand . The combination of slower consumer spending in America and few alternative sources of demand suggest that the world economy will slow . Given that it is growing above it's sustainable rate and badly out of balance that may be no bad thing . But as with all balancing acts the risk is that any adjustment when it comes goes too far .


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