The AFR today has an article where three leading American economists provide their forecasts on the world economy for the short to mid term. After much sacrificing of beasts, reading of entrails and casting of bones, our modern day diviners (selected so that neither of them quite agree with each other) have predicted three outcomes rephrased and annonated somewhat by me:

– a hard landing. In order to slow down its overheated economy, China will re-value its yuan upwards with one of the consequences being that it will buy less US treasury bonds. (currently, much of the US dollars that’s flowing into the Chinese economy is piped back into the US by the Chinese government purchasing US treasury bonds which the US government then uses to finance its spending habits. Why do the Chinese do this? So that the yuan can remain pegged to the dollar) Anyway, once this river of finance slows, there’ll be less credit floating around in the US and hence more competition for finance. The result is that interest rates will rise and all those bubbles (housing, assets, investment) in the US will deflate. And seeing as much of what happens in the US affects the rest of the world, the same will happen in Australia. The predicted timeframe is by the end of this year, so if you’re thinking of buying a house, wait till mid next year.

– a soft(ish) landing. The US government will realise it cant keep operating such a huge deficit and start increasing taxes in order to fund it. This will result in a slowing of the economy and growth in the US but as the US has a flexible economy, it should be able to wear the slowing without any massive corrections in its markets. (Flexible in the sense that it has a diversified economy with very little aritificial barriers for money to swoosh around so even though some portions will suffer, others will adjust and the overall result wont be too bad). The slowing US economy will probably result in less money flowing into China (as the Americans buy less of everything) and that may then slow the Chinese economy in a good way. Too bad for the rest of the world though, especially those moribund European economies. Australia will likely go the same way as its best buddy (hopefully).

– continual growth. There is no current account deficit in the US, markets are just investing in the US because currently it gives the best returns. So its best to think of the current account deficit as a capital account surplus. Eventually as China, the Asian and the some of the Europeans markets start generating good returns, capital investment will shift to them and the US capital account surplus will decrease. This will all happen in an orderly fashion. In other words, everything will just work out hunky doo if people would only stop intervening with the market (and stop scaring the Chinese with silly talk of overheating economies, asset bubbles and the social effects of too many rich people in a once communist state)

They all pretty much agree however that the biggest risk is that China and Asian banks which currently hold a lot of US dollars ($2 trillion) decide to get rid of some of those dollars.

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