The $2.3tn global GDP write-off
- Global nominal GDP is likely to contract by about $2.3tn in 2015, a consequence of the USD strengthening.
- It will be the sixth time since 1980 that global nominal GDP contracts in dollar terms and the second biggest contraction since 2009.
- This change will have far reaching implications across markets, principally for commodity prices.
Honey, I shrunk the GDP
The world is going to be about $2.37tn smaller in 2015 than what we thought when we prepared our Year Ahead forecasts (Table 1). This is not insignificant, as it represents 3.2% of last year’s estimated global GDP. For perspective, that would be as if an economy of the size between Brazil’s and the UK’s would have just disappeared. In our calculation, we include the US, the Euro area, Japan, the UK, Australia, Canada and all the emerging markets we cover. Together they totaled $70.9tn last year, or 91% of the world output as measured by the International Monetary Fund.
The change is mostly attributed to the stronger USD. We barely changed our real growth forecasts from the time of the Year Ahead publication (Table 2). In fact, we expect global real growth to accelerate to 3.5% in 2015 from 3.3% in 2014. The number of goods and services produced will increase at a faster rate; it is just that most of them are going to be produced in countries where the currency has weakened against the USD, and will continue to weaken, according to our forecast.
Table 3 shows our Year Ahead and current FX forecasts and compares them with recent historical data, underpinning the strengthening of the USD in recent months and in our forecasts.
A drop in global nominal GDP in USD is quite unusual
Nominal global GDP will contract by $2.3tn versus 2014 (Table 1), which is quite unusual based on historical standards (Chart 1 and Chart 2).
According to our forecasts, the US is the only country and Emerging Asia the only region where nominal GDP in dollar terms will expand this year.
There are some downside risks for Asia, though. We do not expect a meaningful CNY devaluation, but our currency strategists see it as a major tail risk for the global economy.
Global nominal GDP has contracted in only five years since 1981, and in three of those years by less than 1%. It has taken major events such as the 1982 debt crisis (-2.3%) and the 2008/09 Great Recession (-4.6%) to bring nominal global GDP contractions of the size likely in 2015 (Chart 1).
In normal times, nominal global GDP expands significantly every year. Average nominal global GDP growth has been 6% since 1981. China’s accession to the World Trade Organization, faster EM growth rates and appreciation of their currencies against the USD have brought average growth up to 6.6% since 2002.
The USD strengthening has important implications for the global economy, the most direct of which is on commodity prices. Such a broad-based decline in commodity prices shows that there are common macroeconomic factors at play.
The recent oil price plunge has brought significant debate about whether it was sparked due to changes in supply or due to lackluster global demand. Although both sides of the story have merits, we are forecasting real global growth to accelerate this year (Table 2). In addition, most other commodity prices, including iron ore, copper and sugar, have dropped significantly in recent months.
According to Harvard professor Jeffrey Frankel, the common factor driving commodity prices down is monetary policy. More precisely, Frankel argues that the expectation of higher rates in the US is behind these moves. There are four linkages between higher rates and commodity prices. Higher rates: 1) increase the incentive to extract storable commodities, rather than to store them; 2) decrease the incentive to carry inventories; 3) encourage financial investors to move away from commodities into safer assets; and 4) strengthen the USD, which reduces the commodities’ USD prices, even if they do not fall when measured in foreign currencies.
The last link is already working, as the USD is getting stronger against currencies of countries and regions that are expanding monetary policy (Japan/Europe) and against the currencies of commodity exporters.
The same factor that is taking $2.3tn from global nominal GDP is involved in bringing commodity prices down. In fact, the correlation of nominal global GDP growth and the yearly change in oil and copper prices since 1981 is 29% and 59%, respectively. From 2000 on, these correlations increase to 67% and 65%. Chart 3 and Chart 4 shed some light on why this correlation might have increased over time.
Global real GDP growth has been quite similar since 2000 compared to the 1980-2013 period (Chart 3), so this may not be the explanation, although the different growth composition – with China’s surge – may have helped. One difference is that since 2000 real Fed Fund rates have been negative, compared high positive real rates in the 1980s and the 1990s (Chart 4).
A second implication is that the US economy will become more important again, a consequence of the stronger USD. In our numbers, the US share of the global economy hit a low of 23.5% in 2011 and has stayed near those levels since then. In the past, fluctuations in the USD brought in 10pp swings in this share (Chart 5). We now expect the US economy to increase its share to 27% of the global economy by 2016.
The stronger USD, the drop in global nominal GDP and the rebalancing of demand measured in USD will have other implications as well. These changes could affect industries such as luxury goods, as some EM consumers might retrace as their income, measured in USD, drops. Currencies weakening against the USD will also have implications across industries, as this will bring discussions about sourcing and pricing to the forefront, such as whether to pass through the effects of a weaker currency on local costs of imported goods to non-US consumers.
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So let's just hope that the tumbling US Macro Picture does not take the shine off the world's economy...