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Economist’s warning: the past can’t help this time

One of the US’ most renowned economists, Martin Feldstein, Professor of Economics at Harvard University, warns the recovery may be here but it looks very different to past recoveries. He spoke to Amanda White about his outlook for developed and emerging markets.

While still not wanting to rule it out, renowned economist, Martin Feldstein, is less worried now than six months ago about a double-dip recession. However it is not as if all the pessimism has been exorcised.

“The most accepted modelled forecast for the US is well-known – growth at 3 plus per cent and the recession is behind us. I hope that is true,” Feldstein says. “But I also want to emphasise some of the cautions to bear in mind.”

He says, even if there is solid growth there are serious risks.

“I’m offering caution because the economic upturn will be very different in nature from other business cycles.”

In the past economic upturns have been generated by the Federal Reserve’s tightening and easing, but this has not been generated by Fed tightening, he says.

“Fiscal incentives are the driver not monetary policy.”

Feldstein has had a long history as a political adviser. He served as President Reagan’s chief economic adviser and part of the Washington-based financial advisory body the Group of Thirty since 2003 – he is also on President Obama’s Economic Recovery Advisory Board.

He says investors should be aware that “it’s not clear that what has happened in the past will work this time”.

While the US has had growth of 3.2 per cent in the first quarter of this year, he says it has been “very strange growth”, dominated by consumer spending but without an increase in real income driving the spending.

“About 80 per cent of the growth has been driven by consumer spending – but there has been no real increase in income driving that. All of the increase has come from a reduction in the savings rate, if that hadn’t gone down then growth rate would be more like 1 per cent.”

With this in mind he says equity markets are not doing anything unexpected. But it is not that simple.

“The markets seem to be doing nothing unexpected if you believe 3 per cent growth going forward. But there is an extra risk that long-term rates will rise in part because of large fiscal deficits, so if you have slower growth and higher real long-term rates then the market is overvalued.”

Institutional investors globally have been turning their attention to emerging markets equities, and while Feldstein does see some opportunities, he also warns investors heed some caution.

For example, while he is bullish on China per se, he is not positive about the Chinese equity market.

“I wouldn’t invest in the Chinese listed market, partly because the government is a senior partner in most large companies. For the Chinese household investors most of the money is bottled in China, when that’s relaxed then don’t know what will happen to valuations.”

However Feldstein, currently serves on the board of directors of the National Committee on United States-China Relations still believes, the growth of 9 to 10 per cent in the next year or so, makes China an attractive opportunity.

He also sees some traits as analogous with India which has a forecast growth rate of 8 per cent.

“I’m very bullish on India, less sensitive to foreign trade,” he says.

“India is the most decoupled but it is still coupled in two ways. When investors sell the emerging markets index, then India is sold without distinction, and the large companies of India still depend on access to credit markets.”

Feldstein is an advocate of social security reform, and believes US policy makers will readdress this in the future.

“I am a fan of a pension system that has pay-as-you-go, with investment. In the next year or two I’m confident that will happen in the US. There is support among senior policy makers and there is money in the President’s budget for that.”

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