[Music] It's Friday 17th of April and this is your capital economics weekly briefing. I'm David Wilde coming up the Gulf economies how much has their outlook been changed by what's been happening in the Middle East. But first, Neil Shearing is with me to run through another week in Global macro and market, Ty Neil. Hi, David's. There is a trickle of ships going through the Strait of Hormuz, Brent Crude holding under $100, stocks are well up, Trump is talking a deal with Iran. So maybe that risk is receiving. Either way, I thought this week we could give listeners something else to worry about. The IMF's been holding its spring meetings over the past week. They wrap up tomorrow that Saturday and in amongst the discussion has been all this talk about global imbalances. We've been going on about these imbalances for ages now it is a talking point at the IMF and around Washington. So first question really is why is talk of imbalances back? Well, it's partly because imbalances have increased. But I think before we get into that, let's just take a step back and think what do we mean by imbalances? This is partly about trade but it's not just about trade actually. When economists think about global imbalances, it's about the current account position. So it's trading goods but also trading services and investment income flows. Now, the key point here is that if one country runs a surplus, a current account surplus, then by definition, because the international balance of payments must balance someone else must run a deficit. And we're not seeking perfectly balanced trade in good services and investment flows. Rather, the problem becomes if those imbalances become particularly large, they can become destabilizing. So what we're seeking is not necessarily a perfectly balanced world that's never going to happen. It's perfectly fine for some countries to run services and others to run deficits. But when those become large and excessive, they can start to threaten global economic stability. Now, why is that? The reason is that, as I say, every surplus must have a deficit and the deficit country is essentially consuming more than it produces. If you run a current account deficit, you're consuming more than you produce. And you fund that by borrowing from overseas, by borrowing from the surplus country. So you're accumulating external liabilities in the process. So you're reliant on the surplus country, continue into purchase large amounts of assets and in the country essentially fund your excess consumption. Now, all of that's fine for a time. But if it's done to excess, then it can start to create vulnerabilities within the balance of payments and therefore the financial system and the economy more generally. This is the source of umpteen different emerging market crises over the years. It underpinned 2016, 2007, 2008, the financial crisis then. And there was a strong degree to which strong element to which imbalances within the eurozone were a feature of the eurozone crisis in 2012 and 2013. So we should absolutely be concerned when global trade imbalances and current account imbalances become large and excessive. The question though is half day once again become excessive and they're not quite as big as they were in 2016, 2007, but they are increasing and we can get into to why that might be. It might be useful also just to identify where, you know, we talk about imbalances. You mentioned previous imbalances among emerging markets. You talked about internal imbalances within the eurozone. When we talk about imbalances today, and there are lots of imbalances around, but when we're talking about one of the ones that we should be paying attention to, what are the ones that worry global policy makers? Well, if you take a step back, we're talking now about current account imbalances around imbalances within the within the the in-stational balance of payments effectively. If you wind a clock back to 2006, essentially what you had was a bunch of surplus countries, China, Japan, Germany and the oil producers run in large coming to account surpluses and the offset about being deficits in some emerging economies, but also the UK, Spain and most importantly the US. So back then, the US current account deficit was about 1.6 percent of global GDP. The biggest is ever been on record. Winder clock forward to today and the countries that we're looking at now, it are markedly different and the sale of the imbalances are different and suckly different too. So if you look at the US's deficit, it's about 1 percent of global GDP last year. So compare that to 1.6 percent of GDP in 2006. The US current account deficit is a share of global GDP's now much smaller. It's still running by far the largest current account deficit of any major economy. It's still the world's consumer of last resort, but its external deficit is smaller. That reflects to some extent the fact that the US energy deficit that was large in 2006 has disappeared because the US has become a small net energy exporter. So the composition of its current account and trade balances has shifted. Now on the surplus side, there's been a marked shift and this is where things start to get interesting. So if you look back in 2006, China's current account surplus, largest it was as a share of China's GDP was only equivalent at its peak to about 0.6.7 percent of global GDP. Last year, China's current account surplus was equivalent to 0.8 percent of global GDP. So relative to the size of the global economy, China's now running a larger surplus than was the case in 2006, 2007. Now how is that possible given that the consumer of last resort, the US, is running a smaller deficit. Well, the answer is that other country's services have started to fall as a share of global GDP. That's partly because the big surplus countries and the big oil producers are running smaller services because the US is now running is now sucking in less oil from them. But it's also because China's export machine is starting to eat the breakfast lunch and dinner of other exporters. So Japan's surplus is smaller than as a share of global GDP. Then was the case in the mid-2000s, the same as Germany as well. So within the surplus countries, we started to see a shift in the size of surpluses and in particular China started to compete further at the value chain and take an export share from other surplus countries such as their surpluses start to diminish. So these are the large and excessive imbalances that you described. A lot of focus then on China. Why? I mean, what is this matter? Where's the risks here? One risk is that if you're a deficit country that you suddenly, the funding for your deficit starts to dry up because you lose the confidence of foreign investors, then clearly the risk of that happening increases as your deficit rises as a share of global GDP. So the risk of this happening to the US and to other deficit countries like the UK is about as not as great as was the case back in the mid-2000s. So I think that's less of a concern now than was the case in and around the global financial crisis. There was going to kind of sudden stop affecting it in capital flows, creating painful contractions in in deficit countries and adjustments in in deficit countries. Instead, I think the interest is, as I say, in what's happening in the surplus countries and it really poses two challenges. So what we're seeing is the extreme competitive pressure now emanating from Chinese exporters. And there are two consequences of this. One is that they're starting to take export share from other surplus economies principally Germany. And that's contributing to a week of aggregate demand in Germany, a week of economic growth and compounding that the economic challenge is facing Europe's largest economy, but also some other surplus economies, be it Japan, for example. I think there's also a sense in which the geopolitical backdrop now is very different today than was the case back in the mid-2000s. Economics particularly under greater than post-grad economics taught at universities and colleges has nothing to say about economic resilience and geostrategic competition, etc, etc. It's all just about effectively allocating resources according to cost and prices and getting the most efficient outcome. But the emergence of China as a geostrategic kind of competitor, particularly to the US, but also to other countries, I think raises some really serious questions if you then have extreme competition coming from China, does eating into your manufacturing share, export share, such that it starts to erode your manufacturing base. So what we're seeing now is China emerging as a huge exporter, for example, of vehicles, electric vehicles, but also batteries, green technology, biotech. It's starting to move quite quickly up the value chain in two drones. We're seeing that very real life example of that playing out and some of the security challenges playing out from that in the goal for the moment. So there's a question over and above the narrow issue of macroeconomic imbalances around economic security and the challenges pose when what might become a geostrategic competitor starts to really erode your manufacturing base, eat into your manufacturing base because that can affect economic resilience and other say create all manner of questions around economic security and national security. So those are the two questions, I think, if you're a surplus country or two issues, if you're a surplus country, you're seeing much greater economic competition there from China, that's resulting in weaker growth. If you're kind of in the quote on quote Western
block, there's a whole bunch of economic national security questions around the fact that China is now starting to really eat into and compete with Western manufacturers, and much higher at the value chain in areas of advanced technology. And to be clear, the IMF, lots of other analysts see China's current account surplus, that the trade surplus that underpins that narrowing in the coming years. And I'm just working off our baseline scenario around the Middle East conflict, where oil gets flowing back through the strait of hormones and oil prices fall back. So on that basis, we don't think that's going to happen. We actually think that the current account balance that China's trade surplus is actually going to keep rising in the coming years. So does that explain why? Does that underpim why we expect that to keep happening? Fundamentally, what's happening here, and that the driver of China's current account surplus is extremely high domestic savings rates. So I think if you are expecting a forecast in China's surplus to fall, then you implicitly are assuming consumption as a show of GDP or rise in the savings as a show of GDP will fall too. The counter-part to which we'll be a fall in the savings as a show of GDP. Now, we just don't see the catalyst for that happening at the moment. If you look through the five-year plan, for example, that we've just had earlier this year, there's nothing really in there that suggests to us that stimulating consumption and raising consumption as a show of GDP will take precedence and priority over other economic policy priorities, particularly economic self-sufficiency. And certain there is an advance in key areas of technology. All of that will continue to evolve huge amounts of build out of the industrial base and the high savings rate and the continued large current account surplus. So in our view, there doesn't seem to be a kind of fundamental macroeconomic adjustment on the horizon in China that would lead to a reduction in the current account surplus. And pre-GFC, you were talking about the last time we had these massive, massive Chinese surplus, US deficits. At the time, the conversation was very much about the idea that China's imbalance was being fueled by this very undervalued REN-NB. Let's talk about FX adjustments now. To what extent are they an answer to resolving imbalances? They are an answer to some extent, I think. So if you look at the IFF's work, they suggest that the RIM-NB might be undervalued by 10-15% when they look at the real exchange rate. That looks about right to me. So I think there's some sense in which the RIM-NB might be a bit undervalued and a stronger RIM-NB would help. But this has to be underpinned, as I say, by a more fundamental economic adjustment in China and a shift in the economic growth model. And as we've discussed before, including on this podcast, I think that they're that expecting that as a kind of triumph of hope over experience. There doesn't seem to be much to suggest that that's on the horizon. I would say also that the IMF and others, it doesn't really work around global imbalances, but they've tended to come at this a bit through the lens of 2006, 2007 and previous balance of payments crises. There's not much debate, not much discussion around the, as I say, the kind of geostrategic implications of all of this and the national security, economic security challenges that flow from that. And in a sense, I think that that is the area where concerns I think will continue to build over the next couple of years, particularly in Europe. So if there's going to be an end to the, or some of some kind of resolution of some, these imbalances or narrowing of these imbalances might be a better way of putting it, then one way that this could plausibly happen is that if other countries start to push back more aggressively against exports from China because of some of these concerns around economic security and national security, we see an element of the happening in Europe right now, but not on a widespread basis. I mean, that's the key point, isn't it? The global environment is very different. Think about previous cases of imbalances, some got resolved. The plaza record, US beta trading planners came together in New York. They hammered out this agreement to let the dollar appreciate even actually pre GFC. I mean, it was marked at the time by very strong robust channels of communication, cooperation between the US and China. At least they were talking about imbalances and resolving them in, indeed, between the US and Europe. There was greater communication and cooperation than there is today. So a more dangerous world imbalances don't often resolve themselves quietly. They do, though, the GFC, as you say, being a case in point. So what could be the trigger for a painful resolution to what's happening at the moment? Well, you're right. When we've had a kind of coordinated reduction in imbalances in the past, it has typically been through multilateral action and been facilitator or enabled by the fact that the protagonists have all been allies. So back in the 80s, the plaza record, the big surplus countries were Germany and Japan and the major deficit country was the US. All essentially allies and they were able to hash out a deal. This time, the major deficit country remains the US, but the surplus country is China. And frankly, there will be Trump's visit in Xi next month. I'm sure, and though doubt there will be a big signing ceremony in the great hall of the people where China commits to buy a certain amount of US goods, and this is the greatest deal ever made, ever struck. Another feather in the cap of the great deal maker that is President Trump and it will make no difference whatsoever to the US current deficit position and these global imbalances, because they still won't tackle the root cause of the imbalances. For the reasons we've just discussed. So yes, it's possible to kind of sketch away forward, path forward, to reduce some of these imbalances and it would involve the US running a much smaller budget deficit, federal budget deficit, which in turn would reduce aggregate demand in the US and bring down the US deficit, but at the same time China, reflecting its domestic economy, getting savings down consumption up, that was sucking more imports from the rest of the world and helped to revive aggregate demand in the deficit country, the US, that is contracting its federal budget deficit. So that's the way that you bring about a narrowing in imbalances through coordinated action that gets the Chinese savings rate down and gets consumption up in China, but at the same time the US agrees to fiscal consolidation that reduces its own budget and therefore currently kind of deficit. That all requires a major policy shift in both the US and China. It requires some cooperation between these two economic superpowers that are increasingly economic and geopolitical rivals. I just can't see it happening. So brace yourselves in other words. So let me ask you on a practical basis. If you're a capital economics client, you're a PM, you're managing a global supply chain, you're trying to hammer out a 5, 10 year strategy for your business. What are you meant to do with this information? How are you meant to respond? Well I think the first thing to say is that we are not back in 2006, 2007 territory where imbalances have built to such an extent that they've posed an immediate threat to the global financial system. Because as I say, the nature of these imbalances is slightly different in a particular deficit to smaller and the accumulation of like external liabilities don't appear to be reflected in a kind of build up of domestic financial fundribilities. So I do think I would look at the situation with regards to global imbalances at the moment and conclude from that that this is 2006, 2007 playing out again and we're on the cusp of a major economic and financial crisis as these global imbalances start to crystallize it and ultimately resolve themselves. However, I think what it will do is keep particularly the US and China, which deny the major protagonist that this, it will keep bringing them into kind of periodic conflict over trade and related issues because these imbalances are not going to be resolved by, for example, China agrees by more US soybeans. That is not how you resolve them. So the danger here I think is that the world assumes and the US political establishment assumes and the Trump administration assumes that a deal struck next month will help to resolve these imbalances. We get to the end of this year and we get into 2027 and actually we find that China's current account surplus remains extremely large. The US current account deficit remains extremely large. There has been no resolution to these imbalances and therefore we get a kind of renewed tension and strains in the US-China relationship, renewed trade wars, renewed tariff threats. And so this is not going away. This issue is not going away. We'll get periodic shocks, I think, running through to global financial system and markets. That was Neil Shearing talking about global imbalances, including the potential risks for Europe. We've actually got a related drop in coming up this Thursday the 23rd. Drop ins are our short form online briefings and I will pop a registration link to this one in the show notes. Along with a couple of our recent reports on global imbalances for you to dig deeper. Another drop into flag for next week focuses on the macro risks emerging from developments in private credit markets. That's happening on Tuesday at 10am New York 3 o'clock London. Now as always you can find details of all of our upcoming drop in sessions on
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[email protected] whether that's to get started on that subscription or to send feedback on this show positive or otherwise. Now this podcast is being recorded Friday morning London time and reports are suggesting that a deal to resolve the conflict with Iran could be agreed soon. If that does happen it would be a clear positive for the global economy not least for the Gulf economies which have been dragged into the conflict as Iran has sought to broaden it and raise the cost for the US and its regional partners. So to get a sense of how much the Gulf economies have been hurt and what this could all mean for their longer term ambitions I caught up with Jeopardy Chief Emerging Markets economist Jason Tovey. I started by asking him what we know so far about the economic damage to the Gulf states. Yeah I mean I think it's so to say that there has been a significant impact across the six GCC economies and of course different sectors as well. So I think if we start with the hydrocarbon sectors the oil and gas. There's been Iranian attacks on energy infrastructure alongside the closure of the stroke of one weeks and that's forced many Gulf economies to shut down their oil wells or shut down in Qatar's KCLNG facilities. Now I had the OPEC monthly oil market report earlier this week and that showed for the first time just how extensive the hit to oil and gas production in these economies has been. So in the likes of Q8 and the UAE, we saw falls in oil production of 40 to 50% in March. We did have figures from Saudi which fed a bit better thanks to its ability to divert its exports via the east to west pipeline to the mid-sea but even their output still fell by around 20% or so. And then there's Qatar which has potentially halted energy production completely. Now even if the war ends soon it will take time for those energy sectors to fully recover. When it comes to shutting down wells you can't simply turn the taps back on and get the oil flowing again that it takes time to to do that. And we also know that there has been some damage to energy infrastructure in the region that could take some weeks or months or in Qatar's case we know it will take years to repair. Qatar energy is saying that around 17% of its NNG production has been knocked out for the next three to five years. So that's energy sectors. There is also growing down to the evidence of the hit to non-hydrocarbon sectors. We had the PMIs which fell across the boards in the Gulf in some cases touching their lows during the pandemic. We've had some trade figures from some of the Asian economies as well as Brazil and they show a sharp decline in their exports to the Gulf. And of course we know travel and tourism sectors are suffering pretty badly as well. Flights are down by 50% in aggregate in Q8. They're completely halted still. And then in Dubai we have some hotel occupancy figures and they show that hotel occupancies come the amount 20% compared to typical levels of 70 to 80%. So yeah overall a very significant hit we've seen so far to both energy and non-energy sectors across the Gulf. We've been talking to clients through this conflict. We've modeled these scenarios haven't we based on the duration of the conflict, the extent of the damage, the baseline scenario is the one we're assuming is the one that's going to come through. But we also have an adverse scenario where the war goes on for months. The damage is more extensive. The hit to the global economy is greater. But it sounds like even under our baseline scenario, global economy I think we described it as negative but manageable. But for these countries I mean what you're describing there it does sound pretty economically disastrous. Yeah absolutely. So I mean if we start with at baseline scenario like you say and I'm sure regular readers of our analysis will probably know that envisages them into hostilities by the end of this month. We've limited further damage to energy infrastructure and the normalization of traffic through the straight. Now we're also approaching at that time. So in extra days are going to be quite critical and the latest times are low that we are moving in the direction of such an outcome. There's a cease-firing place between the US and Iran. We also now have one between Israel and Lebanon and that was apparently key to moving along the talks that started in Islamabad on Saturday. It's also worth noting that we've made the point that the US blockade of the straight as cutoff free Iran was being a key financial lifeline up until now in terms of its ability to export its oil and in turn generate foreign comments. That may have shifted the calculus moving the Iranian regime. But I say next few days are going to be pretty critical but at least all of the noises we're getting suggest at least some kind of framework deal to end the war could be achieved in the coming days followed then by more comprehensive and technical agreement. Like we say though even in that scenario there's been a significant hit to energy production in the Gulf economies. For whites, in most of these places energy sectors accounts are somewhere between 30 to 50% of GDP. So if you can imagine really roughsies in already some very significant hits even if energy production starts to recover will take time like I say. So there will be a significant drag on GDP growth from energy sectors in these economies and then at the same time that there will be lists at least even if it's 10-3 blow to non-hydrocarbon sectors. The overall result is that even in our baseline scenario you're looking at falls in GDP of in this year across the Gulf of somewhere between 5 to 10%. So yeah a very substantial hit for being nothing we've seen outside perhaps the pandemic and going back further outside of times when the Gulf economy is saying the 1980s were really cutting down energy productions tried to prop up prices. I want to talk about what happens after this year for these economies but before I look we just talk a bit about Dubai. Lots of frankly mean coverage in the British press about what's happened in Dubai about influences in Dubai people living their tax free, cowering from missiles. But the fact is that Dubai was positioning itself as a major global services hub with all that you've just said talks specifically about what this conflict has meant for Dubai's economy and where you see that going. Yeah so I mean Dubai's probably the one part of the region I've had the most questions about. Lots of two spies and really it's suffered extensively from Iranian attacks that's really punctured that sort of perceived safety and stability to upon which Dubai has really built its economy over the past few decades. I mentioned earlier tourism obviously suffering very heavily and more generally Dubai because very heavily on people going out and spending so it's major sectors and things like retail restaurants hotels recreation with missiles and drones flying overhead over the past few weeks people understand that we have not been confident enough to go out and do that. Now my view on how Dubai sits coming out of this is that I suspect those commonly residing in Dubai will view this as a blip. The Emirate after all still has significant advantages some of which you mentioned like low tax and low crime is a clean and safe environment decent schools so on and so forth. If though I think for those residing in Dubai already I said they will see this as a blip. I doubt there's going to be a huge extra so long as the the war is over very soon. I think the key channels comes from those firms or workers that were considering setting up or moving to Dubai. I think that I say the the war has really punctured that's perceived stability and I think for those that it will be a big question mark now going forward of if we move to Dubai is there going to be a risk of renewed conflict down the line that we could get caught up in and even if that slows the flow of firms and workers to the Emirate that could be enough to really damage its or medium to long term prospects and in particular it could undermine Dubai's property sector. So wait for what it's worth to buy as property market has been for a big boom over the past five to six years property prices up by or they're nearly doubled over that time. So if we saw the confidence of weaker demand alongside this through a significant amount of supply coming on streaming to Dubai's property market over the next couple of years that could see some of that froth the way it's seeing in Dubai's property market come off and then that poses or see some challenges for Dubai's government in extremities. So these are the firms big umbrella firms essentially that have a web of companies involved in various sectors in Dubai.
but Crucy, a lot of them are involved in the property sector. And it was those companies that were at the heart of Dubai's crisis in 2009. Now, the crime of comfort at all of this is those companies, while they had significant debts in 2009 and even not leading up to the pandemic. Since over the past five to six years, since we've had this booming of property market, they've used the proceeds from that to pay down their debts. So those debts have come down quite significantly. And so we think, so long as the war does end soon, we think it's unlikely that regard to see significant strains among those firms, at least at an aggregate level. And even if there were some firms that struggle coming out of this, it's worth noting that, what do you, IE's banking sector as a whole, the figures that we get, so that it was in pretty decent health coming into the war. So it had significant capital buffers, and the number of forming loans were also pretty low. So for now, we think a debt crisis in Dubai should be avoided. What about the rest of the region in terms of the future? As you say, as you were saying, 2026, basically looking like a writer for a pretty nasty year for these economies, can we project into the future and just talk about how these economies are going to fare? How much of what happened here is just permanently broken? How much these economies can come back to where they were before? Yeah, so I think clearly the war will have some long-lasting ramifications, and that's for sure. I mean, if we split the game sort of between the hydrocarbon and non-hydrocarbon, there's links between the two that will come onto. But at a very least, I think the Gulf countries now that Iran has shown its ability to disrupt the straight. I suspect the Gulf countries will try to find ways to curb their reliance on it. And so, we've seen with Saudi, for example, that it has been able to duck quickly diver a lot of its crude exports via its pipeline to the Betsy. And I suspect other countries will look at alternative routes as well. So that's one angle, which things might change coming out of the war. And then we also have to think about how the energy shock and other countries around the world react to the energy shock. And I suspect that they will look to try to reduce their dependence on oil and gas, and in particular, their exposure to supplies from the Middle East. I mean, we've seen many ocean economies of the Philippines, for example, have been very concerned about its exposure and dependence on supplies from the Middle East. So we might see many parts of the world try to look for alternatives, or at least diversity, fire-dey supply of these products. And then there's also a chance that this, the war, accelerates the timeline towards peak oil demands. It's very speculative at this point that in looking further out, that could ultimately lead to lower energy prices than would otherwise have prevailed. And then that's where it poses a challenge for the Gulf. That would weigh on incomes. And ultimately put added pressure on these economies to diversify. That gives me to the point, actually, that the war has made those diversification efforts even more challenging than they already were. They've already mentioned about stability and security being undermined. It's worth noting the Gulf countries are often put that forward as a part of their pitch to phones and workers, tourists, and so on. Even once the war ends, we need to see what happens to the regime in Iran. If we continue to see a hard line regime there, then the perceived threat of conflict will continue to linger. And then it's worth noting the Gulf countries also put key sectors like tourism, AI related infrastructure at the heart of their diversification plans. Those are two sectors that may come out of this, which significance cars. Or at the very least, say, higher scale or other firms that related in the AI infrastructure world will be more reluctant to school facilities in the Gulf, give them that set of conflict and potentially in the future damage to that infrastructure. So I think overall the war, yes, is having a significant near term in fact, which may unwind over the coming years, but the war also undermines the Gulf economies efforts to diversify their economies further out. And that could pose a challenge both economically for the least countries, but also to the security going forward in the region. Jason Tovey there on the near to longer term outlook for the Gulf economies. He's got a new report out of what we know so far. I'll add a link to that in the show notes. And for a specific demographic of listener, I've note that Rory Stewart mentioned our Gulf economy forecast on this week's episode of the rest is politics. And if you're not in that demographic, that reference may mean nothing to you. Don't worry, you've heard it all from Jason. On next week's show, we will be previewing the April meetings of the Fed, the ECB and the Bank of England, but there will be plenty else going on the side. So don't miss it. Until then, goodbye.
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