Two big bank economists expect the world economy to continue growing in 2011, which will maintain the foundation for today’s high commodity prices.
Neither think that an economic downturn is likely, but they are cautiously watching for early warning signs of a recurrence of the problems that hit the world economy in 2008.
“We are in a synchronized expansion,” the Bank of Nova Scotia’s Carlos Gomes said during the Canadian Wheat Board’s GrainWorld conference last month. “We see growth everywhere.”
Added Paul Ferley, assistant chief economist at the Royal Bank of Canada: “Our bottom line assessment in terms of the global economic outlook is sustained, though gradual, growth.”
He said the bank isn’t worried that the world will slip back into recession.
“We’re not buying into the double-dip playing out.”
Ferley and Gomes’ views are positive for the commodity price outlook because prices are driven by commodity demand, which is caused by economic growth.
When the world’s financial system seized up in 2008, trade collapsed and economic activity slumped. Commodity prices crashed as demand died.
However, the world’s economy has been growing since mid-2009, allowing commodity demand to resume.
Customers are restocking depleted inventories, which will encourage world economic growth and trade.
Gomes said the world’s financial system has recovered.
The two key “stress and fear” indicators that he watches closely, the Chicago Board Options Exchange Market Volatility Index (VIX) and the TED spread, which is the difference between the interest rates on interbank loans and short-term U.S. gove r n m e nt debt, are showing few problems.
Since each is a form of early warning indicator, world financial prospects still look bright because the TED spread and VIX are low.
“As of right now, conditions remain fairly healthy,” said Gomes.
Ferley was more cautious, noting the danger of unexpected factors to disrupt world economic growth.
He said geopolitical shocks, such as drastic changes in the Middle East, could drive oil prices higher and undermine the U.S. economy and global growth.
“There is a lot of potential for that sort of geopolitical risk to play out,” said Ferley.
“Will it disrupt the flow of oil? The closer oil looks like it’s moving to $200 (per barrel) versus $100, the more concerned I get. You get $200 oil, you’re talking a major hit to the U.S. economy.”
Out-of-control growth and inflation in emerging economies could also cause commodity prices to surge, including oil.
China’s government is trying to slow growth and limit inflation, but it is unclear if its measures will work.
There is a danger that Asian governments could respond to rising prices by acting more aggressively to restrain inflation, which could cause a slump in growth and provoke a fall in commodity prices.
“If this modest tightening that we’re talking about doesn’t do the trick, growth remains too strong, particularly within Asia . . . it could set up a bit of a cycle where we get a bump-up in commodity prices and then that quickly getting reversed as policy has to tighten much more aggressively than what we’re assuming at the moment,” said Ferley.
If the boom-bust phenomenon occurs, as happened in 2007-08, the Canadian dollar could surge to $1.10, “but then, if you get a collapse in commodity prices … the (loonie) will sink with it.”
Ferley said the Royal Bank of Canada thinks the loonie will likely stay near one-to-one parity if world growth is moderate and the Asia-Pacific region doesn’t lose control of inflation.