Currency Realignment Changes Leadership in the Global Business Cycle

I. Global Assessment and Outlook The slowing in global economic recovery in the second half of 2002 continued in the first two quarters this year, driven by the adverse economic effects of geopolitical factors related to the Iraqi conflict. Globally, the uncertainty that preceded the start of the war contributed to higher oil prices, falling stock prices, softening in businesses investment and moderation in consumer spending. The uneven effects of the conflict on economies and regions, combined with asymmetrical reaction of the financial and commodity markets, gave rise to unbalanced monetary policies. As a result, the fusion of geopolitical factors, especially the increase in energy prices, and the continuous fall of the dollar have resulted in a reversal of the global business cycle. Among the major economic blocs, the political and economic events have brought about a reallocation of growth from Europe and Asia to the United States. The strengthening of the world economy is now heavily dependent on the outcome of the immense amount of policy stimulus in the United States for a return to its potential growth path. The business cycle reversal reflects the world's dependence on the United States as the sole driver of global economic growth. A failure of the United States to lead could possibly drive the world economy into a new recession. Although the United States in particular and the world economy in general continue to face significant uncertainty, the balance of risks has recently improved. We rate the chance of a global double dip occurring this year as less than 10%. The United States has been the engine of growth in the global economy over the past several years. Historical analysis of worldwide economic fluctuations suggests that the United States generally leads other industrial economies in the global business cycle. In addition, the research indicates that the economic and financial performance of the United States economy has a very significant influence on growth in developing countries. The booms and busts of global economic activity have historically started in the United States and then spread to the rest of the world. The accompanying Chart 1 clearly indicates that our outlook for the world economy reflects the duration and depth of the previous upswings of the global cycle. Following a moderate upward trend this year, the global recovery is forecast to gain momentum during 2005-06. The US economy - 32 percent of world's GDP - will lead the recovery growing by 2.7 per cent this year, by 4.2 percent in 2004 and by 4.4 percent in 2005. The rest of the world - 56 countries listed in Table 1 with a combined output that counts for 62 percent of global GDP - will grow by 2.1 percent this year, by 3.1 percent in 2004 and by 3.5 percent in 2005. This lead-lag relationship between the United States and the rest of the world will result in a slowly accelerating overall global economic growth from 1.1 percent in 2001 - the trough of the global recession - to 3.8 percent in 2005, which is 0.6 percent above the 30-year average trend rate of 3.2 percent. The optimistic outlook for the United States is based on the following assessment with respect to the dynamics of the economy, technological trends, economic policies and the global energy outlook: * The final version of President Bush tax cuts has both short-term, so-called 'transitory', and long-term or permanent components. The combination and timing of the introduced tax cuts are expected to contribute to unequal growth in higher spending. Much of the growth in GDP will be felt in the third quarter of 2003 as withholding schedules are lowered and the child rebates take effect. Then, the permanent component of the tax cut will work its way for long-term reallocation of incomes for business investment and consumption expenditures to stimulate economic growth. * The Fed has clearly become very aggressive in its design of monetary policy, switching its 'bias' to ease and publicly recognizing the need to fight possible deflation risks. …