The global outlook for 2014

If we were to cast our minds back 20 years to this time of the year in 1993, we would have found that the world economy was in the doldrums. The US economy was plagued by a large budget deficit and seemingly struggling to emerge from the recession that had followed the Savings and Loans Crisis; Japan’s Bubble Economy had burst and left behind it “mountains” of debt; the European ERM Crisis was upon us; and many feared that the emerging markets were in the midst of an unsustainable bubble.

Over the next few years, though, economic growth picked up, US tax revenues soared and the economy entered a period of “Goldilocks growth” that we believe owed very little to the central banks and everything to the advent of the personal computer and the Internet revolution. The Golden Age that was the mid-1990s was hugely positive for financial markets and it was due, in our view, to the surge in productivity, value added and supply-side-led growth that proved both profitable and socially “inclusive”.

Unfortunately, the PC revolution had run its course by the late 1990s and, with no obvious replacement, this led to a slowdown in productivity growth and “real” wealth creation (what economists call value added) that the authorities implicitly attempted to conceal first through the use of a corporate sector-based credit boom in the late 1990s, a household sector-based credit and mortgage boom in the mid-2000s and, more latterly, a public sector credit boom. These successive credit booms have not generated real wealth (hence the volatile but essentially flat trend in financial markets) and they have not been socially inclusive; all that they have succeeded in doing is creating periods of artificial growth in aggregate demand, while leaving the supply side of the economies not just unchanged but compromised.

Described at its most basic level, the total sustainable output of any economy can be defined by the level of employment multiplied by the average level of productivity. Long term employment will be determined by education, entrepreneurship and other “real world factors”, while the level of productivity is a function of past capital expenditure, innovation and business efficiency. In practice, these factors will be affected by a mixture of social factors, politics and even luck, but what will have only a relatively small impact on these real factors is the level of nominal money or credit within the economy.