'US consumers have resumed their role as the engine of the global economy'

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Plunging oil prices, a strengthening dollar and a robust domestic economy means the US consumer has resumed its role as the engine of the global economy, delegates at this week’s TPM conference in Long Beach heard.

IHS chief economist Nariman Behravesh said that four main divergent trends had made the global economy eerily reminiscent of the 1980s and 1990s, and argued that the net effect was a positive outlook for global trade and supply chains.

He said the huge plunge in oil prices had resulted in the US once more becoming the largest oil producer in the world.

Before the drop, the price of oil had “surprisingly held up at over $100 a barrel for three years”, resulting in a genuine slowdown in demand, which had been followed by the surge of shale oil production in the US and increases in Iraqi and Libyan production.

“In OPEC, the Saudis resigned from their job as the swing producer and the market is now in a structural oversupply situation. We think it is possible oil might go down to $30 per barrel, and a lot of buyers in other countries, especially China, will then use that as an opportunity to stockpile, which should lead prices to rise again.”

IHS forecasts an average price of $40 per barrel this year, rising to $60 next year.

“The US is now the swing producer, but it is driven by market forces and has no cartel behaviour,” Dr Behravesh continued, dismissing the argument that by letting oil prices fall, the Saudis would force shale producers into bankruptcy.

Oil price break-even levels

“What’s very unusual about shale is that the investment required is very low, especially compared with the billions an offshore drilling project needs. You can start a new shale drilling site with as little as $2m, and it can be turned on and off very quickly.

“The Saudis are deluding themselves if they think they can get the shale producers out – although perhaps some of the smaller, more costly, ones might close. But the medium break-even point for shale is $49 per barrel, and for some of the big ones is $30.”

However, the big winners are consumers in developed economies, where oil price declines effectively amount to a tax cut.

“Every 10¢ drop is a $10bn tax cut, and that is a big boost to consumer spending,” said Dr Behravesh. “The net effect is a $2trn transfer of wealth which will boost consumption globally, and add 0.5% to GDP growth.

“It is true that marginal shale drillers are being forced out, but the losers are the big oil producing nations so dependent on oil revenue. We are talking about their fiscal break-even levels: in Venezuela, it is $160 per barrel; for Iran, it is $110; and for Russia, $100.

“How much of this windfall will oil-importing countries spend, compared with the revenue the oil exporters have lost? Our analysis shows that oil importing economies save 20% of a windfall and spend 80%, whereas oil exporters save 40% and spend 60%.

“At the same time, the US economy is the most upbeat it’s been for a long time, with a solid 3% growth.

“But why should the US seem to be immune to the weakness shown in other economies? Mainly because it’s a fundamentally domestic economy – the consumer accounts for 70% of the economy; exports just 13%.”

Back in the shops

Dr Behravesh forecast that US shoppers would spend a whopping $12.5trn this year, “The American consumer is the engine of global growth.”

He said this was fuelled by several factors: declining oil prices, jobs growing at their fastest pace for two decades and the “admirable job” of reducing debt burdens by US households.

However, he did outline weaknesses in the US.

“Capital expenditure is down by 20-30% and exports are growing very weakly, which is partly as a result of a strong dollar. In fact, if it continues to rise they could contract.

He described Europe as “looking a little perkier”, and said that added grounds for optimism was the fact that while Greece and Ukraine dominated the headlines, “neither has done much to damage to Western Europe; actually, growth accelerated between 2013 and 2014 and is in the process of doing it again, despite the risks”.

Declining oil prices, increasing monetary stimulus from central banks and a weaker euro helping export demand all contributed to a 1.7% growth forecast for this year.

Horror stories

Far more perturbing he said, was China. “I’m worried about China. In the last seven years, debt-to-GDP has gone from 120% to 250%, and no country anywhere has ever seen that level of debt without something bad happening.

“In the case of the US, Thailand and Spain, it was a full-blown financial crisis. But in China, it is more probably going to be a long period of very slow growth – a lost decade like Japan experienced.

“One legacy will be all these apartment buildings where the lights will never be turned on, but most of this debt was used to finance massive industrial capacity – for example, China has 96 separate automotive companies.

“Last year, Chinese growth was 7.4%, the lowest since 1990, and this year it will be lucky to get to 6.5%, and I think China will not see 7% growth for many years.

“And for quite a while we have been talking about the Chinese consumer as the new engine for global growth: it’s not going to happen – in China the consumer represents 35% of GDP, whereas in India it is 60%.

“China cannot go on investing in infrastructure and industrial capacity, they need to transition the economy and it will take 10-15 years.”

Dr Behravesh said that out of the BRIC countries, only India looked optimistic, and he described Brazilian and Russian prospects  as  “horror stories”.

“Brazil is in deep trouble, it’s a commodity exporter, and those are down, and there has been no structural reform. Russia appears to be caught in a perfect storm of economic sanctions, ongoing capital flight and the oil price plunge, and we are looking at a 5% contraction this year and 1-2% contraction next year.”

He said two other factors could be have sustained impact on the development of the global economy – the fact that central banks were moving in opposite directions, with the US Fed likely to increase interest rates sometime between June and September, while central banks in Europe were moving in the opposite direction, with increased monetary stimulus and depressed interest rates.

“There are obviously downsides to these situations, but the net effect of these trends is very positive for global growth, which we think will accelerate from 2.7% last year to 3% this year,” he said.