Subject: David Hale: Will the Falling Stock Market Produce a US Recession?
From: "Mark Zoff" <[email-masked]>
To: "Mark Zoff" <[email-masked]>
Date: Fri, 12 Aug 2011 21:44:07 -0400

Dear Clients,

Please find attached our latest monthly report, “Will the Falling Stock Market Produce a US Recession?” Key conclusions to the report include:

• Minimal downside risk in cyclical sectors and easy monetary policy should ensure that the US economy will grow by 2% or more in the second half

• The US debt ceiling deal’s future effectiveness will be constrained by policymakers’ aversion to cutting Medicare and Social Security

• The European Central Bank has had to step in and stem the recent European financial crisis while the European Financial Stability Facility awaits ratification

•Japan’s V-shaped recovery is masking a looming battle over nuclear power’s role in the country that is pitting public opinion against business sentiment

• China’s economy continues to enjoy robust expansion, but some signs of moderating growth are appearing within the economy

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Additionally, David Hale was recently interviewed by the Australian Broadcasting Corporation on a variety of topics concerning the global economy. You can read a transcript of this interview by clicking on the following link: http://www.abc.net.au/news/2011-08-09/hale-hall-interview-economic-outlook/2831604/?site=newcastle

As always, we welcome any comments or feedback you may have.

Sincerely,

Mark Zoff

Director of Research

DAVID HALE GLOBAL ECONOMICS INC.

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Will the Falling Stock Market Produce a US Recession?

August 12, 2011 • Volume 08.12

By David Hale

KEY CONCLUSIONS

•        Minimal downside risk in cyclical sectors and easy monetary policy should en-sure that the US economy will grow by 2% or more in the second half

•        Turnarounds in US residential and non-residential construction appear to have started, which should provide a meaningful boost to the US economy

•        The US debt ceiling deal’s future effectiveness will be constrained by policy-makers’ aversion to cutting Medicare and Social Security

•        Federal Reserve monetary policy will remain accommodative for at least two more years, but rising rent prices will limit the scope of a possible QE3

•        The European Central Bank has had to step in and stem the recent European financial crisis while the European Financial Stability Facility awaits ratification

•        European growth is expected to slow in the second half of 2011, with much of the periphery mired in either middling growth or outright contraction

•        Japan’s V-shaped recovery is masking a looming battle over nuclear power’s role in the country that is pitting public opinion against business sentiment

•        China’s economy continues to enjoy robust expansion, but some signs of moderating growth are appearing within the economy

•        East Asia’s strong fiscal position means that it has the ability to enact robust fiscal stimulus in the event of a US downturn

•        Australia’s two-tier economy has seen the mining sector boom while the rest of the economy has lagged

•        Most Latin American economies’ growth will temper this year, with Brazil being particularly vulnerable to a slowdown

INDUSTRIAL NATIONS’ MALAISE HAS DRAGGED DOWN GLOBAL MARKETS

The recent turbulence in global financial markets appears to reflect three factors. First, there has been disappointing economic data in the US that is provoking fears of a double dip. Secondly, there has been a large rise in Spanish and Italian bond yields which suggests that financial contagion from the recent Greek debt restructuring is now gripping core European economies. Thirdly, there is a perception that policymakers have few tools available to combat any new economic downturn. Interest rates are at record lows in the US, Japan, and the United Kingdom. There is little room to pursue fiscal stimulus when most G-7 countries have such large public sector debt burdens. Indeed, S&P has just downgraded US government securities in part because of the country’s large fiscal deficits.

THE US ECONOMY HAS MOVED PAST THE FIRST HALF HEADWINDS

The US economy has clearly been sluggish, but there is little risk of recession. The economy confronted three headwinds which depressed both final demand and output during the first half of 2011—a large rise in oil prices, the Japanese earthquake and its impact on the global auto supply chain, and severe weather. The price of gasoline is nearly $0.30 lower than in May and could fall further. The Japanese auto industry is restoring output sooner than was expected three months ago.

The July employment data confirmed that the economy is still expanding at a moderate pace. There was a gain of 154,000 jobs in the private sector that was once again offset by a contraction of 39,000 jobs in the state and local government sector. The job gains were broad-based, including manufacturing, construction, retailing, health care, and business services. The private sector diffusion index rose to 58.6 from 55.4 in May. There was also an upward revision of 56,000 in previous estimates of employment growth during May and June.

Consumer demand improved during July. Total retail sales rose by 0.5%. Retail sales excluding autos and gasoline rose by 0.3%, and the June figure was also revised up to 0.5% from 0.2%. Auto sales rose from 11.5 million to 12.2 million in July. There were also solid gains in sales at electronics, clothing, and furniture stores. The uptick in June and July retail sales suggests that real consumer spending could rise by 2.0% or more during the third quarter. As in previous months, there was a major divergence between up-market and down-market retailers. The up-market stores have significantly outperformed because high income people have benefitted from the stock market rally since 2009, and are now more confident about their employment security than low income people. The unemployment rate for college graduates is 4.3% compared to 15.0% for high school dropouts and 9.3% for high school graduates.

Equity analysts are also optimistic about the back-to-school season. The National Retail Federation is projecting that back-to-school sales could increase slightly from last year’s levels. The restaurant industry is more positive as well. Its cur-rent situation index rallied 1.4% from its May level to 100.5. Fifty-one percent of restaurant operators reported year-on-year sales gains in June compared to only 39% in May. The major risk to consumer spending is the large equity market correction, which could dampen the confidence of the high income people who account for nearly half of retail spending. The University of Michigan consumer confidence index fell from 63.7 to 54.9 in early August. Confidence suffered from both the debt ceiling negotiations in Washington and the volatility of the stock market. Since 1986, there have been six comparable declines. Half of these de-clines were associated with recessions (1970, 2001, and 2007); half were not (1992, 2003, 2005). If equity prices rally, consumer confidence should improve. If equity prices remain depressed or fall further, household wealth losses could reduce consumer spending by 0.7%. There is concern that the household sector is still too leveraged to increase spending, but household debt has declined from 98% of GDP to 88%. There has also been a large decline in household debt servicing payments because of declining leverage and low interest rates.

The non-residential construction sector is showing clear signs of a turnaround after a long decline. Non-residential investment rose 1.8% in June after a gain of 1.2% in May. These numbers were so robust that they will probably lead to an upward revision of 0.3% in estimates of second quarter real GDP growth. Housing starts also rose 14.6% in June to 629,000. The single family sector is still suffering from excess supply, but the multifamily sector is benefitting from falling vacancy rates for apartments. The National Multi Housing Council Market Tightness Index was at 82 in July from 81 one year ago and 16 in April 2009. The demand for apartments is benefitting from the fact that the homeownership rate has declined to 65.9% from 69.2% in 2004. There are signs that house prices are firming as well. The non-seasonally adjusted Case-Shiller Twenty City Home Price Index rose 1.0% in May, but is still 4.5% below its level one year ago. The Core-Logic home price index rallied 0.7% in June. CoreLogic differentiates between sales of distressed properties and homes from conventional sellers. In the past year, prices of distressed properties fell 6.8% compared to a decline of only 1.1% for other properties.

The outlier in this recent stream of more positive data is the continued pessimism of the small business sector. The National Federation of Independent Business reported that its confidence index fell 0.9 points in July to 89.9, the fifth monthly decline in a row. Last month 12% of the owners added jobs, but 14% reduced employment, leaving a net 2% of firms reducing jobs in July. Other small business indicators are not as negative. The National Small Business Association recently conducted a survey of its members. It found that 49% are now projecting higher revenues compared to 54% in December. It also found that 29% of its members are planning to increase employment compared to 25% in December and 24% one year ago. The ADP survey was more upbeat as well. It reported that small firms (fewer than fifty workers) added a monthly average of 69,400 jobs between March and July.

The other disappointing indicator was the June trade report. The trade deficit rose to $53.1 billion from $50.8 billion during May. Exports fell $4.1 billion, the biggest drop in two years. Lower oil prices shaved imports by $1.9 billion. The biggest declines in exports were to Mexico and OPEC. The Mexican decline probably reflected disruptions in auto output resulting from the Japanese earthquake. The June trade deficit was larger than the Commerce Department estimated in its late July GDP report, so it could offset the potential gains in GDP growth from higher construction spending. The export sector could rally during the third and fourth quarter because of the continued expansion in the global economy and the low value of the dollar.

REVISED DATA SHOWS 2008-09 RECESSION MUCH WORSE THAN THOUGHT

The Commerce Department has recently revised its GDP estimates for the past three years. The new data show that the 2008-09 recession was worse than first reported while the upturn has been more subdued. Commerce now estimates that real GDP contracted 5.1% during the downturn compared to 4.1% previously. The economy enjoyed a spurt to 3.3% growth during late 2009 and the first half of 2010, but then slackened to only a 2.4% annualized rate during the second half of 2010 and just a 0.4% annualized rate during the first quarter of 2011. As real GDP growth during the recovery has averaged only 2.5%, the level of real GDP during the second quarter was still 0.4% below its previous peak in late 2007. The earlier data had suggested the economy set a new peak during the first quarter of 2011.

US CONSUMER HAS BEEN FAR WEAKER DURING THIS CYCLE THAN IN PAST

The economy’s weakness during the recovery has been broad-based. The strongest sector has been exports. They are now 4.8% above their previous peak while imports are still slightly below the old peak. Consumer spending has increased 0.7% from its previous peak with a gain of 1.1% for durable goods, 1.3% for non-durable goods, and 0.2% for services. In the recoveries after previous severe recessions, consumption had by now increased 13.6%. Real residential in-vestment is still 38.1% below its previous peak compared to a gain of 25.5% after previous severe recessions. Real business fixed investment is also 12.1% below its previous peak compared to a gain of 9.7% during the recoveries after previous severe recessions. Equipment spending is only 1.8% below the previous peak, but non-residential structures are 34.2% below the old peak. State and local government spending is 5.2% below its previous peak, but the Obama stimulus program has pushed federal spending 14.8% above the old peak.

One of the most distinguishing features of the current recovery has been the spectacular performance of profits compared to labor compensation. Profits have increased 26.5% from the previous peak compared to 45.2% for the past recoveries from severe recessions. Labor income, by contrast, has increased only 3.1% compared to 33.1% for the recoveries from past severe downturns.

The resilience of corporate profits is one of the major arguments against the economy suddenly sliding into recession. Profits typically begin to weaken several quarters before firms start to slash employment and push the economy into re-cession. In the first quarter, profits per worker in the US corporate sector rose to $17,319 from $17,221 during the fourth quarter of 2010, which was an all-time high. As most firms reported good profit numbers during the second quarter while employment growth remained subdued, the odds are high that profits per worker rose to a new high during the second quarter.

INVESTOR CONCERN ABOUT A DOUBLE-DIP RECESSION IS MISPLACED

The large stock market decline during the past few weeks suggests that investors are now discounting the risk of recession. There is little doubt that the economy is weaker than most forecasters expected six months ago, but growth is still likely to average 1.5-2.0% during the third quarter and 2.5-3.0% during the fourth quarter. The economy’s most cyclical sectors—housing, durable goods consumption, and business investment—are still so far below their previous cyclical peaks that it would take a major shock to send them spiraling downwards. There will be no such shock from monetary policy in the US or anywhere else in the world. The stock market decline itself could evolve into a major shock if share prices fail to rally, but there have been major corrections in the past which did not depress the economy. The stock market fell 36% in 1987 and real GDP grew by 4.1% in 1988. The primary risk in the outlook continues to be US fiscal policy. There will be significant fiscal drag in the economy during the next eighteen months, but it is likely to dampen spending momentum, not drive the economy into recession.

S&P DOWNGRADE SHINES LIGHT ON US’ POLITICAL DYSFUNCTION

S&P shocked the financial markets in early August by downgrading the US government’s credit rating to AA+ from AAA. It clearly stated its concerns about the dysfunctional nature of the US political system. It said:

The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation pro-gram that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a 'AAA' rating and with 'AAA' rated sovereign peers… (“United States of America Long-Term Rating Lowered To 'AA+' On

Political Risks And Rising Debt Burden; Outlook Negative,” Nikola Swann, Standard and Poor’s, August 5, 2011)

There was great indignation in Washington over S&P’s action and some members of Congress will no doubt attempt to hold hearings on the subject this autumn. Europe was equally indignant when the agencies downgraded Portugal a few months ago. There is a great suspicion of the agencies because of their failure to adequately discount the risk in securitized mortgages before the recent financial crisis. The agencies have not all agreed on the US credit rating, but the fact that one of the big three announced a downgrade has still come as a psychological shock even after the great budgetary theater in Washington during the past few months. Most observers thought that S&P would wait until the new special congressional committee on fiscal policy had a chance to approve new spending cuts. They expected S&P to act if that committee ended up in gridlock.

The S&P action is unlikely to have a major impact on US federal government borrowing costs in the short term. The bond market has rallied because of investor concern about the economy. It also will be difficult for global investors to find an alternative to the US debt market. The US government debt market has tradable securities of $9.65 trillion. There are government debt markets in other triple-A countries with a value of over $7.35 trillion. As the US has the largest and most liquid debt market in the world, there will be no simple way to redeploy capital. There is also no market for securities issued by the European Union. The debt of Europe is issued by individual nation states. The largest European debt market is Italy.

In the past thirty years, five industrial nations have experienced downgrades and then regained triple-A ratings after a period of fiscal adjustments. They are: Australia, Canada, Denmark, Finland, and Sweden. The downgrades typically lasted for nine to eighteen years. S&P has said that the US will probably also need several years to regain triple-A status.

US DEBT CEILING DEAL DELAYS MAKING TOUGH DECISIONS FOR NOW

The White House and the Congress agreed on a new deficit reduction package in return for an agreement to increase the federal debt ceiling by $2.4 trillion in early August. The package calls for $917 billion of reductions in discretionary spending during the next ten years and the creation of a special bipartisan congressional committee to propose another $1.2-1.5 trillion of spending cuts or tax increases. If the committee cannot reach an agreement, there will automatically be $1.2 trillion of spending cuts split equally between defense and non-defense expenditures.

The budget package announced in early August should be regarded as a tentative compromise. There is no guarantee that future Congresses will agree to carry out the spending cuts outlined in the package.

The package puts a heavy emphasis on slashing non-defense discretionary spending to levels possibly as low as 2.0% of GDP in 2021. The fifty-year average of non-defense discretionary spending is 4.0% of GDP, and the projected 2021 level would be the lowest since the Eisenhower administration. The non-defense discretionary budget includes many critical public goods which will be difficult to slash. If we use the average level of spending for 2007-10, the largest items are education (16.3% of the total), transportation (15.3%), health research and training (11.9%), housing assistance (9.4%), law enforcement (7.6%), child care, nutrition assistance, income security for the blind, disabled, and aged (7.6%), and natural resources and pollution control (7.2%). Chairman of the House Transportation Committee John Mica (R-FL) has been talking about reducing transportation spending by 33%, but in view of the poor quality of American infrastructure it is difficult to see how Congress could approve such a large reduction. The US now ranks 19th in the quality of roads and 18th in the quality of its railways according to a recent survey by the World Economic Forum.

The American Society of Civil Engineers has just produced a report on the condition of US infrastructure. The report says that the US will need $220 billion per annum of spending for the next thirty years to maintain adequate roads, bridges, and other transit systems. It estimates that defective infrastructure cost businesses and households $130 billion in 2010, and that the cumulative cost will rise to nearly $3 trillion by 2040.

The simple reality of US fiscal policy is that it will be impossible to truly constrain spending without reforms of the major entitlement programs, including Social Security, Medicaid, and Medicare. They now account for 60% of federal spending, and their share is projected to grow steadily in the years to come. The CBO estimates that federal healthcare spending could grow from 5.6% of GDP to 15% or more during the next fifty to sixty years. The recent budget compromise avoided making any cuts in these programs in the initial round of cuts.

US fiscal policy is already poised to be quite restrictive in the year ahead. The Obama administration’s budget that was published in February suggests there will be fiscal drag equal to 3.9% of GDP in fiscal 2012. There will be tax in-creases of 2.2% of GDP and spending cuts of 1.7% of GDP. The spending cuts will include large reductions in aid to state and local governments. As many still have large fiscal deficits, they will have to make further cuts in spending and employment. In the first half of this year, they laid off over 150,000 workers. The Obama administration is aware of this fiscal tightening and would like to extend the payroll tax cuts for another year. There is no sign yet that the Republicans would agree to such an action.

House and Senate leaders have named the members of the special congressional panel which will have to produce a new deficit reduction package this autumn. The members are all party veterans who have a strong relationship with their party’s leadership. The most interesting choice was Senator Rob Portman (R-OH). He only won his seat last November, but has served in the House and was both OMB director and trade ambassador for the Bush administration. As a result of his previous experience and history of moderation on issues, he is the member who may have the greatest potential to achieve a compromise overcoming the strong partisan divisions over fiscal policy.

Some Democratic Senators, such as Charles Schumer (D-NY), are starting to look more favorably on Republican proposals to offer US multinational companies a tax break on profits which they repatriate. Under this plan, firms would pay only a 5.25% tax on profits they bring home rather than the standard 35% tax rate. The Bush administration offered such a break seven years ago, and firms repatriated $362 billion dollars. They used the money primarily for share repurchases, higher dividends, and debt repayment; not to bolster employment or investment. The Obama administration is reluctant to repeat this exercise because of perceptions that it would not be effective stimulus.

The argument for offering the tax break again is it would at least have some benign effects compared to doing nothing. It would probably increase government revenues by $30 billion or more. If firms did increase dividends and share repurchases, it might give a lift to equity prices after a large decline. It might also on the margin boost employment and investment.

The administration is also searching for ways to bolster the housing market. It is considering a plan to have Fannie Mae and Freddie Mac sell their foreclosed properties to investment groups in order to reduce the amount of excess housing on the market. These two agencies own 250,000 homes and have another 830,000 moving through foreclosure. Some Wall Street firms have expressed an interest in supporting this proposal.

COULD STALLED TRADE AGREEMENTS FINALLY BE SIGNED INTO LAW?

The final policy action which the administration and Congress is pursuing to stimulate the economy is liberalization of trade policy. The party leaders in the Senate announced last week that they would clear the way for approval of the Korea, Colombia, and Panama trade agreements. These agreements were initially completed by the Bush administration in 2007, but the Democrats deferred voting on them because of opposition from trade unions. There was a further delay this year because of partisan disagreements about the Trade Adjustment Assistance program for workers who lost their jobs because of trade. The Republicans wanted to kill the program while the Democrats wanted to preserve it. The Republicans have now agreed to extend the program, so it should be possible to enact the trade agreements during September. Korea and Colombia have signed trade agreements with many other countries, so US firms will need the trade agreements in order to have effective access to these markets.

FEDERAL RESERVE TO KEEP RATES LOW FOR AT LEAST TWO MORE YEARS

The Federal Reserve has responded to the recent turmoil in financial markets by announcing that it will hold interest rates close to zero until mid-2013. The Fed communiqué said, “that economic growth so far this year has been considerably slower than the FOMC had expected.” Three district presidents voted against the change because they wanted to retain the language of restraining interest rates “for an extended period.” This was the largest number of dissenting votes since 1992. There had been speculation that the Fed might re-turn to a policy of quantitative easing, but Federal Reserve Chairman Ben Bernanke has been reluctant to take such an action because the core inflation rate has increased to 1.6% from 0.6% when he introduced the policy nine months ago. The communiqué left the door open to such a policy saying, “The committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.” But the Fed will be reluctant to return to quantitative easing unless there are signs that the economy is sliding back into recession.

The core inflation rate is likely to remain above 1.0% because the declining vacancy rate for apartments is putting upward pressure on rents. Shelter costs account for 40% of the core CPI’s weighting. It would take a recession to drive core inflation back to last year’s levels. The next most important statement on monetary policy will come from Ben Bernanke’s speech at Jackson Hole on August 26th. He may use the speech to outline other alternatives for monetary policy if the economy remains weak.

The Federal Reserve will announce new capital rules for systemically important financial institutions (SIFIs) in September. The Fed will call for a 2.5% capital buffer over and above the 7.0% Tier 1 capital requirement for the largest banks. If banks pursue rapid growth, the capital buffer could be increased by an additional 1%. The Fed is still formulating criteria for selecting systemically important non-bank institutions. It says that it wants a short list rather than a long one. The Fed is dividing non-bank financial intermediaries into four groups:

1)       Hedge Funds, Private Equity Firms, and Asset Managers

2)       Insurance Companies

3)       Specialty Lenders

4)       Broker Dealers and Futures Commission Merchants

While the Fed wants a short list of non-bank intermediaries for its new capital rules, it wants a much longer list to report their detailed operating and financial data to the new Financial Research Office in the Treasury.

US banks have already significantly increased their capital without any new regulations. The equity/assets ratio has increased to just over 11% from 6% during the early 1980s. The ratio was about 10.2% before the financial crisis and dipped to 9.2% during the second quarter of 2008. Banks rebuilt their capital during 2009 and 2010 through a mixture of equity offerings and profit retention. The risk posed by the new attempts to increase bank capital is that it could depress lending and slow the economy.

GLOBAL TURMOIL WILL MEAN MORE DOVISH GLOBAL MONETARY POLICY

The recent turmoil in financial markets could have divergent consequences on the global economy. It increases the risks of a slowdown in the old industrial countries because of falling asset prices and potentially tighter credit conditions. It has produced a sharp decline in commodity prices which could lower inflation and lessen the pressure on many developing countries to pursue tighter monetary policies. China, Brazil, and India may now be able to shift to a neutral monetary policy despite the fact that inflation is still above their targets.

EUROPEAN LEADERS HAVE LIMITED WAYS TO RESPOND TO CRISIS

The eurozone finance ministers announced a new rescue program for Greece in late July which they hoped would stabilize their financial markets. At the insistence of Germany, the program included a plan to have private investors in Greek debt roll over their bonds into longer maturity instruments with a 21% reduction in the value of the principal. As Greek debt was selling at a 50% discount to face value, this proposal was accepted by many of the leading banks. But the fact that investors were going to suffer a potential loss on their Greek debt increased their risk aversion to the securities of other troubled European countries, such as Spain and Italy. There was a sharp rise in their bond yields and large decline in the equity prices of their banks. It appeared that financial contagion was moving from the periphery of Europe to the core. As Italy and Spain account for 28% of the euro area’s GDP, the European Central Bank (ECB) felt compelled to intervene. It announced over the weekend of August 6th that it would purchase Spanish and Italian bonds. Its action helped to calm investor concerns and produced an 80-90 basis point decline in bond yields.

At the summit which produced a new financial rescue package for Greece in late July, the eurozone finance ministers announced plans to expand the role of the European Financial Stability Facility (EFSF). It would now be empowered to buy government debt or help banks. The EFSF could not help Italy during the recent interest rate spike because the parliaments of the seventeen eurozone members have not yet ratified these policy changes. It will probably take them two or three months to complete this process. As a result there was no alternative to ECB intervention. During the past year the ECB has purchased about €74 billion of Greek, Irish, and Portuguese debt. These interventions had an initially benign effect on bond yields, but as the fiscal situation in each country deteriorated the ECB could not prevent yields from increasing.

The ECB agreed to intervene after the Italian government announced a variety of actions to tighten fiscal policy. Prime Minister Silvio Berlusconi announced that Italy would attempt to achieve a balanced budget by 2013 rather than 2014. He proposed a balanced budget amendment to the constitution. He promised to introduce new legislation to liberalize labor markets and promote privatization of state assets in order to bolster Italy’s mediocre growth rate.

Italy’s public debt has exceeded 100% of GDP since 1992, but its fiscal management has been respectable in recent years. In the ten years before the financial crisis, its primary surplus averaged close to 3% of GDP, or twice the eurozone average. These surpluses reduced the public debt from a peak of 122% of GDP in 1994 to 104% in 2007. As it did not pursue a stimulus package during the crisis, its public debt since 2007 has only increased by 17% of GDP compared to 89% for Ireland, 47% for Greece, 37% for the US, and 28% for Spain and Portugal. At the end of 2010, the maturity of its public debt was also 7.2 years compared to 4.7 years for the US.

European Commission President Jose Manuel Barroso increased anxiety in the European financial markets during early August by sending a letter which called upon governments to give their full backing to the European currency by accelerating their approval of the new role for the EFSF. His comments irritated the Germans because they had been reluctant to make the changes, and have so far opposed proposals to expand the size of the EFSF beyond its current resources of €440 billion. But there is now likely to be a major debate about the new role of the EFSF and its size because the ECB will want to turn over its intervention role to the EFSF. It will be embarrassing if the former governor of the Italian central bank, Mario Draghi, has to buy large volumes of Italian debt when he becomes head of the ECB in November.

As a result of the recent rescue package for Greece, the EFSF now has commitments on as much as €160 billion of its resources. It is possible that both Ireland and Portugal could borrow an additional €35 billion, which would lower the EFSF’s surplus lending capacity to €210 billion. Such a sum would be inadequate if it be-comes necessary for the EFSF to intervene on a large scale in the Spanish and Italian debt markets. The odds are therefore high that the eurozone finance ministers will expand the EFSF later this year.

EUROPEAN CORE AND PERIPHERY GROWTH BIFURCATION CONTINUES

European economists are now revising down their growth estimates for the third and fourth quarters because of weakness in purchasing agent surveys. Since April the composite PMI has fallen by nearly seven points. Only once in its thirteen-year history—late 2008—has the composite PMI experienced a steeper decline. As a result of this downturn it is now estimated that the annualized third quarter growth rate may be only 0.4% compared to over 3.0% during the first quarter. French growth was zero during the second quarter, while Greek growth fell 6.9% year on year. This slowdown has lessened the odds that the ECB will hike interest rates when    Mario Draghi takes over in November.

Sweden and Germany continue to be the European growth leaders. They will have growth rates this year of 4.6% and over 3.0%. Poland is next at 4.4% followed by Austria at 3.0%, Norway at 2.5%, Belgium at 2.4%, and Switzerland at 2.2%. France and Holland will grow by 1.9%. The laggards are the countries on the periphery. Greece will contract by 4.9% and Portugal by 2.1%. Italy will grow by 0.8% and Spain by 0.7%. Ireland will grow just 0.3%. There is unlikely to be positive growth in Greece and Portugal until 2013. Fiscal contraction is one of the factors constraining growth in the periphery. There are still large fiscal deficits in the peripheral countries, including Greece (7.5% of GDP), Ireland (10%), Portugal (5.9%), and Spain (6.0%).

THE CASE FOR AND AGAINST A FRENCH CREDIT RATING DOWNGRADE

France is the leading European country where there could now be a debate about its credit rating. Its public debt will soon be 87.6% of GDP and the government is attempting to reduce the fiscal deficit to 5.7% of GDP this year. Among triple-A rated countries, only France and Austria have failed to run either a balanced budget or budget surplus during the past thirty-five years. France should be able to achieve its deficit targets in 2011 because tax receipts are increasing and spending is under control. The risk is that there could be pressure to increase spending during the run-up to the presidential and parliamentary elections next year. France will also face a long-term challenge with the rising cost of healthcare and pensions. France recently raised its retirement age, but the EU Commission is still projecting that spending on the elderly could rise by 2.7% of GDP by 2035.

The rating agencies have said that they have no plans to downgrade France’s rating. They believe that the Sarkozy government has the political ability to reduce the deficit. They also take comfort from the fact that France’s public debt is twice tax revenues whereas the US debt is three-and-a-half times tax revenue. The tax share of GDP in France is much higher than in the US. The moment of risk for France will probably come after next year’s presidential and parliamentary elections. The agencies will want to see evidence that the new government will be able to control spending. Some of the Socialist candidates are promising fiscal austerity, but it is not yet clear who their nominee will be.

There was a sharp decline in the share price of French banks this week because of concern about their exposure to debt in peripheral countries and reliance on wholesale funding. The French banks should not have any funding problems be-cause they have access to lending from the ECB.

In mid-July, the European Banking Association conducted a stress test of ninety-one systematically important banks. Eight banks failed the test because their core capital was less than 5% of risk-weighted assets. Five were Spanish banks, two were Greek, and one was Austrian. They will need to raise €2.5 billion of capital by the end of the year. An additional sixteen banks that had Tier 1 capital equal to only 5-6% of risk-weighted assets will need to raise new capital in 2012.

There has recently been a decline in European bank stocks because of concern about their exposure to sovereign debt. The authorities always regarded sovereign debt as a riskless asset, but recent events in the peripheral countries have now made investors more apprehensive. In May 2011 eurozone banks had made loans to eurozone governments of €1,156 billion and held securities issued by them of €1,442.7 billion. Their total capital and reserves were equal to €2,118.8 billion. The heavy exposure of the banks to sovereign debt risk has created a tremendous moral hazard problem for the eurozone. It cannot allow governments to default without jeopardizing the solvency of the banks. It has to choose between propping up the governments with fiscal transfers or rescuing the banks with capital injections to compensate for losses on sovereign risk. The decision so far has been to protect the banks by preventing sovereign defaults.

The ECB’s role as a funding source is now a critical factor for investor confidence in European banks. According to the recently published European bank stress test, the ninety banks covered will have €5.4 trillion of liabilities maturing in the next twenty-four months; an amount equal to 45% of EU GDP. In France, Italy, and Germany, the largest two banks, alone, will need to rollover sums equal to 6%, 9%, and 17% of GDP, respectively. This compares to just 1.6% of GDP for the largest two banks in the US. It will be essential for investors to believe that Europe has an effective lender of last resort in order to execute these debt rollovers. The ECB currently has €418 billion of loans to European banks. Greek, Irish, Portuguese, and Spanish banks accounted for two-thirds of the total.

The critical factor in maintaining European financial stability during the next few years will be the willingness of Germany to play a supportive role in the EFSF and other rescue programs. The German people are not happy about the cost of propping up Greece, Ireland, and Portugal. The Bundesbank under Axel Weber and his successor, Jens Weidmann, has opposed the ECB buying the debt of peripheral countries. Some German academics have recently published articles suggesting that Greece should leave the monetary union and reestablish the drachma. But however controversial the rescue programs may be, German policy elites remain very supportive of the monetary union. As Germany sends 41% of its exports to the other European countries, they do not want to see a return to the currency instability which existed before the monetary union. The next major test of German support for the monetary union will probably come if France loses its triple-A credit rating. In such a scenario, the EFSF will become even more de-pendent upon Germany’s credit rating and financial resources than it is already. The Germans may then become concerned that the cost of supporting the EFSF could compromise their own credit rating. There is also great opposition in the Netherlands to the rescue programs, and polls show a majority of the people would like to restore the guilder, but the government can still muster a multiparty coalition to support pro-EMU legislation.

EUROPEAN DEBT FEARS HAVE PROPELLED THE SWISS FRANC IN AUGUST

The concerns about financial contagion in Spain and Italy have led to strong demand for the Swiss franc, which has appreciated by 17% against the European currency since June as of August 9th. The Swiss National Bank last week announced that it will attempt to drive interest rates close to zero in order to discourage demand for the franc. Switzerland has long been a haven for investors seeking safety because it has a current account surplus equal to 13.2% of GDP, modest government debt of 53% of GDP, and a triple-A credit rating. There is likely to be upward pressure on the Swiss franc as long as investors have concerns about European Union debt. The Swiss National Bank had suggested it might even consider pegging the franc to the euro, but such a policy would require large-scale intervention that could ultimately produce big losses if the peg broke.

THE UK’S ECONOMY CONTINUES TO SHOW BROAD-BASED WEAKNESS

The UK economy grew by only 0.2% during the second quarter. Consumer spending has been weak because inflation has exceeded income growth. It is projected to have fallen by 1.1% year on year during the second quarter after contracting 0.6% during the first quarter. It could fall another 1% during the second half of the year. The manufacturing purchasing manager index fell to 49.1 in July from 51.4 in June. The index for output fell to a two-year low as a result of falling orders. It appears that output has stalled because firms have completed inventory restocking. The Bank of England has just issued a report examining the weakness in the economy and how it should help to lower inflation. It confirms that there is no prospect of an interest rate hike for many months to come.

JAPAN FACES TOUGH DECISIONS ON NUCLEAR POWER IN NEAR FUTURE

The Japanese Ministry of Finance recently intervened in the currency markets to stem the appreciation of the yen. The Bank of Japan acted at the same time to ease monetary policy by increasing its asset purchase program to ¥50 trillion from ¥40 trillion. Japanese officials are concerned that further appreciation of the yen against a backdrop of slowing global growth could weaken the economy. New Vice Minister for International Affairs Takehiko Nakao is more in favor of intervention than his predecessor.

The economy is now experiencing a V-shaped recovery from the March earth-quake. Real GDP could grow by over 6% during the third and fourth quarters. The government is still formulating a policy for how to finance reconstruction. The key governmental body coordinating reconstruction activity has called for a ¥10 trillion increase in corporate and personal income taxes (2% of GDP) to pay for the effort. The total ten-year cost of the outlays is estimated to be ¥23 trillion.

The Democratic Party of Japan (DPJ) has so far been reluctant to endorse any tax increases. Prime Minister Naoto Kan appeared to endorse tax hikes during last year’s election and suffered a major defeat, so his party is reluctant to embrace the idea. It also is not clear when Mr. Kan will resign and who will replace him. One leading candidate, Finance Minister Yoshihiko Noda, is a fiscal conservative and might accept tax hikes. If there are no tax changes, the ratio of public debt to GDP could rise from 225% of GDP to 268% in 2015.

There is growing concern that Japan’s problems with power supplies and the strong yen could encourage firms to move more output offshore. A recent survey of 140 firms by Nikkei found that 40% of the country’s major corporations could shift some operations overseas during the next three years.  Among manufacturers with some foreign production, the ratio of overseas output to domestic production has increased from 18% in 1990 to 31% in 1997, where it has plateaued during recent years. During the past two decades, overseas investment by multi-national manufacturing firms has increased from 15% of domestic investment to nearly 60%, so the trend towards foreign diversification is well-established.

There is concern about power supplies because of growing public opposition to nuclear energy. Shortly after the earthquakes, polls showed that 42% of the public wanted to maintain the current levels of nuclear power while 32% wanted to reduce it and 12% wanted to abolish it. In the most recent polls, only 22% of the public wants to maintain current nuclear energy production while 77% want to reduce or abolish it. If Japan does abandon nuclear power, there will be an in-creased need for fossil fuels which could boost power costs by 20% and penalize corporate profits by ¥2 trillion.

CHINESE EFFORTS HAVE SLOWED CREDIT GROWTH, BUT NOT MUCH ELSE

China reported a 9.5% year-on-year growth rate during the second quarter com-pared to 9.7% during the first quarter. Capital formation accounted for 53% of growth during the first half compared to 59% during the first half of 2010. There was a modest slowdown in some of the July data. Industrial production grew 14.0% year on year compared to 15.1% in June. Real retail sales rose 10.3% year on year compared to 11.7% in May and 12.4% in March. Fixed asset in-vestment rose 24.4% compared to 25.9% in May. The CPI inflation rate rose to 6.5% year on year during July as a result of higher pork prices. It had been expected that the PBOC would respond to the higher CPI with another interest rate hike, but as a result of the turmoil in global financial markets it will probably leave policy unchanged. Most Chinese analysts believe that inflation has peaked, but it will decline slowly because global food supplies are still tight.

Monetary policy has slowed the growth of money and credit. Growth in loans dipped to 16.4% in July from nearly 20% at the end of last year. The growth of M2 has slipped to 14.7% year-on-year from 15.9% in June and just under 20% at the end of last year. July was the first time since the end of 2008 that M2 growth fell below 15%. The major casualty of this reduced lending has been small- and medium-sized enterprises. The banks always cut them off first, and they are then forced to turn to an informal lending market where interest rates can be as high as 60%. The share of real estate lending in total new bank loans also dropped from 23% during the first quarter to 15% during the second quarter. The government has been trying to reduce real estate lending because of concern about rising property prices.

China’s trade surplus rose to $31.5 billion in July from $22.3 billion in June. Export growth accelerated to 20.4% in July from 17.9% in June while imports rose 20.9%. Export growth to the US slowed to a 9.5% year-on-year rate from 29.9% in March while exports to other regions were more resilient. As a result of the resilience of China’s trade account, the People’s Bank of China (PBOC) has allowed the renminbi to rally 0.7% against the US dollar.

There has recently been an outburst of comments from central bank advisers and former members of the Monetary Policy Council calling upon China to allow faster revaluation of the renminbi. These calls were reinforced by the decision of S&P to downgrade the US’ credit rating. China has over $2 trillion invested in dollar securities. China condemned the US government after the downgrade, but will not be able to avoid buying Treasury securities unless it is prepared to allow much faster appreciation of the exchange rate.

China could help to lower inflation and promote domestic consumption by allowing faster appreciation of the exchange rate, but the recent turmoil in financial markets could make it more cautious. After three years of appreciation, China re-pegged its exchange rate in July 2008 because of the global financial crisis and concern about a downturn of exports. The forward market is currently discounting only a 1.5% gain in the renminbi during the year ahead.

There has been speculation about how China would respond if the recent turmoil in financial markets led to a new downturn in the US and Europe. China responded to the global financial crisis of 2008 and 2009 with a large infrastructure spending program and a 30% increase in bank lending. In 2008 China experienced both an export slump and downturn in the property sector because of credit policies designed to curtail real estate inflation. The situation is quite different today.

Despite the recent attempts to cool property inflation, the year-on-year growth rate of home sales was still 18% in July. Housing starts increased by 34% because of the government’s new push to construct social housing. The export share of GDP has also declined from 39% in 2006 to 29% recently.

There are financial constraints as well. The credit share of GDP has increased by nearly 30% during the past three years. Local governments borrowed over 5 trillion RMB during 2009 and 2010 to finance infrastructure investment. Their total debt is now 10.7 trillion RMB.  There is concern about the quality of these loans, so banks have cut back on lending to local governments. If China does need new policies to stimulate growth, there is likely to be more focus on social housing, as well as energy saving- and environment-related projects. The government could also take steps to promote the goal in the new five-year plan of boosting consumption. As the odds of recession in the US and Europe are low, it is doubtful that China will make any radical policy changes.

EAST ASIA IS VULNERABLE TO A US DIP, BUT HAS POLICY OPTIONS

The new concern in the East Asian economies is how a US recession would affect their exports. In April the year-on-year growth of Asian exports was 19%. Korea and Taiwan have performed very well because of their exposure to high value-added information and communications products. Singapore and the Philippines suffered from a slowdown in their electronics sector. The table shows the exposure of the East Asian countries to the US export market.

Until recently, the East Asian countries were enjoying such robust growth that the major concern of policy makers was inflation. There were interest rate hikes everywhere except for Hong Kong, which cannot tighten monetary policy because of its currency board link to the US dollar. The largest interest rate hikes were in India (375 basis points), China (125 basis points), Korea (125 basis points), and Malaysia (100 basis points). As a result of the slowdown now occurring, there is unlikely to be any new monetary tightening. At the current time, economists are shaving their Asian growth forecasts by about 0.3% for 2011 and 2012 because of concern about a slowdown in the US and Europe. Larger adjustments are not being made because domestic consumption is still robust. Consumption in the first quarter grew 8.0% in India, 7.6% in Hong Kong, 6.7% in Malaysia, 5.0% in Singapore, 5.0% in Taiwan, 4.9% in the Philippines, and 4.5% in Indonesia.

Consumption is about 50-60% of GDP in most Asian countries except for Singapore and China, where it is approximately 36%. The Philippines is the highest at 72% followed by Hong Kong at just over 60%, and Japan, Taiwan, India, Indonesia, and India at just under 60%.

The East Asian countries could also pursue more stimulative fiscal policies if necessary because they have modest fiscal deficits. Korea has a small fiscal surplus, and China has a deficit of just 1.6% of GDP. The other deficits are the Philippines (-3.3%), Malaysia (-5.1%), Thailand (-2.6%), and Indonesia (-1.5%). Only India has a large deficit at 8.0% of GDP.

COMMONWEALTH NATIONS FACE DISTINCT CHALLENEGES TO GROWTH

The Indian Reserve Bank surprised the markets by announcing a 50 basis point rate hike in late July. The Reserve Bank acted because Indian inflation is above 9.0% and the manufacturing non-food inflation rate has risen to 7.3% year on year from falling prices two years ago. Purchasing agent surveys have been falling and industrial production growth could slow to 1-2% by the fourth quarter. The service sector has been more resilient, but it has many export-oriented companies that are concerned about the US economy. Indian growth could slow to 7.5% during 2011 and 2012.

The Canadian economy continues to outperform the US economy. The private sector created 94,500 jobs in July while the government shed 71,500 jobs, about half of which were in the education sector. Growth declined during the second quarter because of disruptions in the auto industry, but it is now recovering. There had been speculation earlier this year that the Bank of Canada might hike interest rates in October, but as a consequence of the slowdown in the US economy it is unlikely that the central bank will act. Canada still sends 75% of its exports to the US. Inflation rose during the second quarter because of gasoline prices, but it is now declining. The recent decline in commodity prices has weakened the Canadian dollar after a large rally during the second quarter. Canada has a far better fiscal position than the US and a very strong banking system, but it will always be vulnerable to developments in the US economy.

Australia continues to have a dual economy. The resource sector is booming and boosting capital investment while domestic consumption is sluggish. Retail sales fell 0.1% in June and are only 1.4% higher than their level one year ago. Building approvals fell 3.5% in June, and are 15.5% below their levels one year ago. House prices fell 0.9% during the second quarter, and are 2.0% below their level one year ago. Job growth was flat during July and the unemployment rate rose to 5.1% from 4.9%. As a result of the disruptions which resulted from Queensland’s floods earlier this year, the Reserve Bank has shaved its growth forecast for 2011 to 3.25% from 4.25% while retaining its forecast of 2012 growth at 3.75%. The inflation rate was 0.9% during the second quarter and is up 3.6% year on year. The rise in the inflation rate would ordinarily set the stage for Reserve Bank tightening, but the growing concerns about the global economy and weak domestic demand will probably force monetary policy to remain on hold through the end of the year. The volatility in global markets has increased investor aversion to risk and caused a decline in the Australian dollar. It could rally when markets stabilize if investors continue to be positive on the growth outlook for China.

IS BRAZIL SIGNALING A LATIN AMERICAN SLOWDOWN OR AN OUTLIER?

Latin America enjoyed a 5.8% growth rate during the first quarter led by robust gains in Chile, Peru, and Argentina, but the region’s growth rate for 2011 is likely to be 4.8% compared to 6.0% in 2010. There is great concern about how a slowdown in the global economy could affect the region’s exports because it depends heavily upon commodities. Only Mexico has a low ratio at 20.9% because of its large manufacturing exports to the US.

Latin America performed well during the global financial crisis of 2008-09 because it had small fiscal and current account deficits, allowing room for policy stimulus. Fiscal deficits are modestly larger today than in 2008, but not excessive. They are 1.8% of GDP in Mexico, 2.4% in Brazil, 0.5% in Peru, 1.1% in Uruguay, 3.5% in Colombia, and 1.5% in Venezuela.

Brazil is the Latin American country showing the greatest signs of a slowdown. Industrial production fell 1.6% in June and purchasing manager surveys in July showed a deterioration of business confidence with reduced plans to hire. The Brazilian central bank has increased interest rates by 375 basis points during the past eighteen months, and the real has appreciated by 40% against the US dollar since 2009, so capital spending has been slowing down. Consumption has been resilient because of gains in employment and wages.

The government has announced a special policy package to help companies suffering from the strong real. In October, manufacturers in four labor-intensive sectors—clothing, footwear, furniture, and software—will see the payroll tax of 20% abolished. They will instead pay a 1.5% or 2.5% turnover tax. There will also be new tax rebates for exporters and faster utilization of investment tax credits. The total package is worth about 25 billion reals. In late July, Brazil also announced new taxes on futures and options in order to discourage investor demand for the real. The Brazilian finance minister said last year that there was a “currency war” because of the falling US dollar and stable renminbi. These policy actions are Brazil’s attempts to manage the consequences of the currency war.

STRIKES CONSTRAIN SOUTH AFRICA’S NEAR-TERM GROWTH PROSPECTS

South Africa’s economy has been suffering from strike activity and declining business confidence. The manufacturer’s purchasing agent index fell 9.7 points to 44.2 in July, and is now at a two-year low. Workers in the metals and engineering sectors went on strike during mid-July. They demanded wage hikes of 13% compared to offers of 4-7% from the companies. The unemployment rate rose to 25.7% during the second quarter from 25.3% one year ago. The government has long talked about creating more jobs, but it cannot get the trade unions to cooperate by restraining wage demands. Consumption has been resilient, but in-vestment has suffered from a lack of business confidence. Private sector in-vestment is 4.5% below its long-term trend and manufacturing investment is 8.0% below its trend. The Reserve Bank is concerned about inflation because of the wage demands, but with growth likely to be only 3.5% during 2011 and in-creasing concerns about the global economy, it is unlikely to raise interest rates this year.

The large rise in the gold price during recent weeks will give a boost to the South African mining industry, but the role of gold in the economy is far smaller today than it was in 1980. South Africa now produces only about 192 tonnes of gold compared to 1,000 tonnes in 1970 when it accounted for two-thirds of global production. This is the lowest level of output since before World War One and has reduced the mining share of GDP to 5.5%, or half its level in 1980. South Africa’s mining industry now relies more upon exports of platinum, coal, and iron ore.

GOLD PRICE HAS BEEN BUOYED BY MORE THAN JUST SAFE-HAVEN APPEAL

The price of gold has rallied sharply during recent weeks because of investor concern about the safety of financial assets. The gold price has also benefitted from increased central bank purchases. Korea announced in early August that it has recently purchased 25.0 tonnes of gold and increased its reserves to 39.4 tonnes. IMF data for June shows that other developing countries are also buying gold. Thailand recently bought gold for the second time this year and boosted its reserves from 19 tonnes to 127 tonnes. Russia bought another 5.85 tonnes and boosted its reserves to 836.7 tonnes. The fact that central banks are buying gold despite the large price gains of the past year indicates a clear desire to diversify their reserve assets. As a result of the US credit rating downgrade and concerns about the future of the euro, this desire is unlikely to abate any time soon. The great question is when will the People’s Bank of China buy more gold? China has the world’s sixth largest gold reserves at 1,054 tonnes, but it is worth only $48 billion compared to foreign exchange reserves of $3.2 trillion. Many Chinese officials have suggested the central bank should buy more gold. China will not publicize its purchases until long after they are completed, so we will probably not know what they are doing now until 2013 or 2014.

INDUSTRIAL NATIONS’ MONETARY TIGHTENING PLANS NOW ON HOLD

The Federal Reserve’s decision to hold US interest rates steady for two more years will give a downward bias to the dollar, but it will not be the only central bank to leave interest rates unchanged during the rest of 2011. The recent instability in global financial markets is going to make central banks cautious every-where. It had been expected that Europe, Canada, and Australia would raise interest rates by the fourth quarter. Those rate hikes will now be deferred until 2012. Inflation is still a problem in emerging market countries such as India, Brazil, and China, but if commodity prices remain subdued their inflation rates will decline and lessen pressure for more monetary tightening.

FOREIGN DIRECT INVESTMENT SHOULD REACH 2007 LEVELS BY 2013

The United Nations has just published a new survey of global trends in foreign direct investment. FDI flows increased 4.9% in 2010 to $1.24 trillion, but are still 37% below their 2007 peak. UNCTAD projects that FDI will rise to $1.4-$1.6 trillion in 2011, $1.7 trillion in 2012, and $1.9 trillion in 2013, which is equivalent to the peak that was achieved in 2007. Developing countries are becoming more important as both recipients and sources of FDI. For the first time, they absorbed more than half of global FDI flows in 2010 while accounting for 29% of outflows. FDI flows to the US rose 40% last year, but they fell sharply in Europe and Japan. Inflows to Asia rose 24% to $300 billion, but the gains were very diverse by region. Inflows to ASEAN doubled; inflows to China rose 11% to $106 billion; in-flows to South Asia fell 25%; and inflows to West Asia fell 12%. Latin American and Caribbean inflows rose by 13% with large gains for Brazil. Inflows to Africa fell 9% to $55 billion.

The largest developing country FDI capital exporters in 2010 were Hong Kong and China. They had outflows of $76 billion and $68 billion. Korea and Singapore each had capital outflows of greater than $19 billion. Malaysia had capital outflows of $13.3 billion. Among Latin America countries, Mexico had capital outflows of $14.3 billion followed by Brazil with $11.5 billion. Chile had capital outflows of $8.7 billion and Colombia had $6.5 billion. West Asia had $13 billion of capital outflows led by $3.9 billion from Saudi Arabia and $2 billion from the United Arab Emirates. Russia had capital outflows of $51.7 billion and Kazakhstan had outflows of $7.8 billion. The basic message from the new UN data is that emerging markets are becoming as important a factor in global capital flows as they are now in trade.

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©2011 David Hale Global Economics, Inc.

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