Is the World Economy heading for a sustainable recovery?

In a nutshell, the above question seems to be uppermost in the minds of everybody  and that  question is asked all the time. As always six economists will produce seven different theories, we think it would be good to ask some questions that may help in answering the above question.

At the outset, it is imperative that we underscore the fact that we do not claim to know the answer, though we continue to be extremely skeptical of the present recovery.  We have consistently held that the present economic momentum will taper off. The consequences will be disastrous if the government decides to step back. Now, World Bank (which is always late to the party) has said the same thing. therefore it may be important to look at the sum of different pieces that comprise the whole and then ask pertinent questions.

We have decided to pose two questions that we think are important at the present juncture. 

Question 1:

We all know that a sustainable economic recovery will mean a rise in the demand for the metals and as a natural corollary, the prices at a later date. The question that we need to ask is that should the rising metal prices be construed as rising demand?

Those who would look at the above question should keep in mind that a recent article offered the following  intersting statistics:

• Global Auto production accounts for about 25% of the aluminum usage, 25% of Zinc usage, 15% of Steel usage, and about 8-10% of copper usage.
• Auto Catalysts accounts for vehicles accounts for 40-50% of the Platinum and Palladium demand.
• Interestingly Global auto output is expected to rise by about 20% or about 71 million cars in 2010, more than 2008 production and only about 3% below the peak level of production seen in 2007 - the peak year of the bubble era. 

Considering the above, as well as the fact that the process of debt deleveraging is just starting (as is clear from the recent US credit growth statistics), collapse in capital spending all over USA, Europe and especially Japan, we should ask ourselves: are we going to see a sustained demand for Automobiles?

A more pertinent problem is in the form of inventory of all the base metals, which has reached the highest point since 2004 (in some cases since 2000). 

Question 2: 

Can China lead the world out of the morass that we find ourselves in after the recent economic meltdown?

The short answer is possible, but be weary of a straight forward answer. There are many more issues. The Chinese economy has been on a roll (or more like roller coaster to be less economic with the truth). China's economic recovery is built more on quicksand than solid healthy economic foundations. In short, it based on a few important factors: (a) Government spending, (b) Loan growth, and (c) asset market rise.

All three are (to say the least) aspects of the recovery that dont lend much confidence. Of the above three factors, the only factor that has a semblance of possible continuity for the time being is government spending. But how long? Nobody knows. If the tepid economic conditions were to continue, then it is likely that in the next year or China is likely to run into a capital account deficit and then their mercantalist policies are likely to reach a dead end.

The loan growth cannot continue as it has already reached dangerous proportions. Loan disbursements last year are at clearly unsustainable levels. A decline in new loans will invariablely mean that that the asset markets will collapse if there is no new money entering them. A long-time China observer recently pointed out that to maintain economic growth of 8% this year, banks in China will have to increase lending that is equivalent of 30% of its GDP (to place this in perspective: the current lending is about 25% of GDP). Is that possible? It is theoretically, but practically it will not just release the 'animal spirits' of the speculators, instead it will release large 'red' dragons all over that country.

The only way China can (in the long-term, not in the short-term) help the world considering all the present imbalances in the world economy is by increasing internal consumption. But, that is easier said than done. The first impediment to that is that wages are too low. China cannot increase them as that would destory the present economic model that enabled it to become the 'workshop of the world' (or is it sweat shop of the world?). Second impediment: China's current domestic consumption is about 37% (while in the case of USA it is about 71% and in the case of India it is about 65%). Ironically, domestic consumption in China has declined from nearly 50% to the present 37% in the past 25 years (when the reforms there started).

So, if a reader is convinced that they have a satisfactory answer to the above two questions, then we believe that they have deciphered the riddle to our two questions.