A year ago the prospect was for gradual global economic recovery. The US economy was showing signs of recovery and with China's ongoing boom this seemed likely to stimulate activity in Euroland and Japan. Except for Singapore, south-east Asia was growing again. Interest rates were low everywhere, with cash rates zero in Japan and only 1 per cent in the USA. The Bush administration had pushed serious fiscal stimulus into the US economy and most other countries were running stimulatory budget deficits.
The prospect was for gradual recovery; recovery that was likely to gather force as the year progressed. Inflation was no threat to recovery - indeed US Fed chief Alan Greenspan had warned that the threat of deflation was larger than the threat of inflation, and said that US interest rates would stay low for the foreseeable future.
Markets were expecting a better year. Commodities and equities were expected to rise gradually. Bond yields were low and not expected to rise until economic recovery was more firmly established. The US dollar was widely perceived as too high - with large and growing fiscal and current account deficits - and indeed the fall of the US dollar had begun.
Wise forecasters must never ignore the X-factor. This is the unexpected shock that derails the smooth path usually predicted. In 2003, there was not one but two X-factors, and they were doozies. The first was SARS, whose apparently sudden emergence spooked people worldwide. It was winter, a major influenza pandemic had been predicted "sometime soon" by some medical experts and, above all, the authorities in China seemed not to be taking the situation seriously. Asian equities plummeted and there was a discernable check to confidence.
At the same time the long stand-off with Iraq seemed to be heading for action - most likely an invasion under UN auspices. In the event, the UN Security Council failed to support the hard-line position of the US and the UK. Unexpectedly for many, the US led "coalition of the willing" decided to act unilaterally, and went to war. While the X-factors were in play, fear and uncertainty provided a check to confidence and put the forecast gradual recovery at risk.
The war itself was over far more quickly than almost anyone expected. SARS also was fairly soon seen to be under control. Equities rallied, especially in Asia, and confidence was boosted. Despite the dreadful economic results in the June quarter (when confidence was at its lowest in most countries) the second half of the year saw economic momentum restored. Indeed, in the US the September quarter was one of the strongest on record. China, it emerged, had suffered very little damage from SARS, and the countries of south-east Asia, far harder hit by SARS, began to improve.
Reform finally delivered some dividend in Japan, and by year-end even the economies of Euroland were performing better. A rush of IPOs in the second half of the year, with sharply rising share prices generally, had boosted confidence in many countries.
Australia suffered one quarter of economic setback but generally sailed through the difficult period with considerable ease. Its cash rates were "below neutral", but at 4.75 per cent were high by international standards. Inflation is under control but credit growth and domestic demand have both been growing far too rapidly (with a related housing "bubble" and speculative excess) and toward year-end cash rates were raised by 50 basis points, with more rate rises expected in early 2004. The budget is in modest surplus but the current account deficit is too large. The Australian dollar has risen sharply, to be around US0.75 at year end.
New Zealand tells a similar story to that of Australia, although with domestic growth even faster and a currency rising even more strongly, presenting its monetary authorities with a similar but even sharper dilemma than that faced by the Australian central bank.
My interpretation of 2003 is that the gradual global recovery expected at the beginning of the year was temporarily put on hold by the X-factors in the first half, and then bounced back stronger than expected in the second half. No automaticity here of course - the second half was probably always set to be stronger than predicted, and the rapid resolution of the threat from SARS and the imagined threat from Saddam's Weapons of Mass Destruction both boosted confidence above levels assumed by the forecasters at the start of the year.
Looking ahead to 2004, the best guess is a continuation of the strong recovery now clearly underway. Economic activity should everywhere be stronger than it has been for some time. The US may grow more slowly than in the second half of 2003 (which was clearly unsustainable) but other major regions should grow more quickly. China is the great unknown. Its economy has been growing at almost double-digit rates and there seems no good reason why this will not continue in 2004. India, too, is a potentially powerful economy that should also grow rapidly in 2004.
Inflation seems no great threat - indeed the US Fed still discusses the threat of deflation but one suspects with less than total enthusiasm. Other perceived risks concern the US fiscal and current account "imbalances." (An economic "imbalance" is the economist's attempt to allow for X-factors).