EARLY QUESTIONS FOR 2011   A very happy New Year to everyone and best wishes to you all.   There are plenty of issues to discuss as we start 2011. I thought I would start the year off by offering my perspective on some of them.   HOW SUSTAINABLE IS GROWTH?   As we turn the year, my relatively cheerful view of 2011 global GDP growth has become more popular with many becoming less pessimistic about the US. Consensus global GDP forecasts are now comfortably above 4 pct. My own view remains that 5 pct growth is possible in both 2011 and in 2012.   Below the surface, though, many still have considerable doubts about the sustainability of this momentum. As it relates to the “growth economies”, many people are increasingly concerned that Chinese inflation risks and persistent bubble-like threats make it difficult for China to sustain domestic led growth. I shall discuss this more below, but, as we begin January, the prospects for the Chinese CPI seem to be one of the most important near term issues.   Amongst the developed world, while many have revised their forecasts for the US, a large number of market participants still worry about how sustainable the US expansion is, and whether it can withstand any attempts to tighten fiscal policy down the road (as well as higher interest rates when they eventually appear). Many will be watching the UK, where fiscal tightening will start soon.  What happens in the UK may be quite relevant beyond the UK borders.   While more market participants seem to acknowledge Germany’s current strength, many doubt the sustainability of the country’s exporting success (making them therefore vulnerable to a fresh external shock) And, Germany is also susceptible to vulnerability through the financial system and further troubles in European Monetary Union (EMU)   At the core of my continued global optimism remains the rise of China, other BRIC economies and other “growth” economies.  Specifically, my view is that their consumers will provide new opportunities for western exporting companies and countries. I suspect the “surprise” will be how well some countries exports continue to do, including the US.   THE US. HOW STRONG?   The US ended 2010 on quite an upbeat note, with many positive data releases during December, and the trend in weekly job claims especially pleasing for the optimists. As we enter the New Year, the first payroll report is likely to be highly important.  If it shows signs of job improvement, it could not only result in the remaining pessimists changing their stance, but also in improving the mood of politicians and the general public. Based on the strong decline in jobless claims, it seems to be coming.   Even before the payrolls, however, given the rise in the Chicago manufacturing ISM release to its strongest level in 20 years, the nationwide ISM is likely to also be given close attention.   It seems to me that the US is poised to deliver a few quarters of above trend growth and declining unemployment.  The early releases in the next few days should hopefully confirm this view.    There are many risks to this improved outlook, including an unnecessarily too sharp tightening of financial conditions.  To me, this would represent perhaps the most important risk factor, at least for the balance of the year. In this context, it will be interesting to see if US monetary policymakers remain so “friendly” even if the data improves as I expect. I suspect they will, at least for now. They can’t afford to do otherwise unless inflation expectations start to rise sharply.   EUROPE AND TROUBLES IN THE EURO AREA   From what I can tell from by holiday reading, there is widespread expectation that EMU is going to face considerable further challenges in the New Year with Portugal widely cited by many as being in the immediate firing line. With this, there are deeply entrenched beliefs that European GDP growth will struggle, at best, and remains very vulnerable to contagion. This is despite the upbeat news from Europe’s largest economy, Germany, and the buoyant mood of its policymakers.   One of the things I have taught myself over the years is to be wary of what might be termed a lazy consensus. It is usually not a good place to be either as a forecaster or an investor.  The consensus view about the EMU is clearly pessimistic, and I am not sure this is right. This time last year, it was certainly right. And it might be so again.  The risks of further trouble in the Euro Area are clear to see.  That’s why they are discussed so much in the media. It is conceivable, however, that the region might get through without fresh investor strikes. I suspect that Europe’s policymakers will have enjoyed their period of calm over the holidays and, eager to see it preserved when markets re-open, I can imagine they are prepared for market tests. In any case, if the rest of the world’s environment improves, especially the US and China, then I suspect, investors’ fears might easily turn to more of a search for return and some of the wider bond spreads in Europe would then start to seem attractive.   It is quite interesting to note that, rather than any country leaving EMU, 2011 starts off with a new member having joined.  Estonia has become the 17th member.  Needless to say, this hasn’t garnered much media attention.     CHINA AND ITS CHALLENGES   December seemed like a fraught month for Chinese policymakers, with the continued buoyant level of monetary growth and CPI inflation pushing above 5 pct – worrying even those of us who are more optimistic and giving great hope to the China bubble blowers out there.  The next Chinese CPI is surely a highly important statistic to watch, as will be the smoke signals emanating from Beijing regarding policy.   What was especially interesting and encouraging to observe as December drew to a close was the acceleration in the rise of the RMB. It really does seem as though the domestic policy priority now meets squarely with the desires of many overseas Governments, and I believe there will be more RMB strength in 2011 than what is currently priced into the forwards.   As far as Chinese GDP growth is concerned, I think there should be two important distinctions made going forward. First, it seems quite clear to me that growth over the first part of this decade is highly unlikely to match that of the past 5 years, i.e., very likely to be closer to 8 pct than 10pct. Indeed, this seems like a raised policy priority. Second, I am not sure this is bad news for China-related markets, as many will claim. If softer growth is part of the consequence of global and domestic Chinese rebalancing, then it is actually good news. It will be more sustainable. In this regard, I shall be continuing to watch the relative performance of retail sales versus industrial production as my guide to the sustainability of Chinese growth.   BRIC, BRICs AND GROWTH ECONOMIES   During the holiday, the BRIC concept received a lot of attention and, indeed, I wrote a Viewpoint about it myself. This followed news that China had confirmed an earlier Russian statement that South Africa will be invited to the BRIC national leaders summit in 2011.   I have given the whole topic further thought since my December 28th piece, and it has left me thinking even more that the crucial distinction investors have to make now going forward is:   What is a “growth economy” from the emerging world and what is not?  And, how important will these economies be for world growth? We will be writing a lot more on this topic, so I shall be brief here.   South Africa is a very important emerging economy for many reasons, especially as it is amongst the wealthier nations in Africa and it has good trading ties to most of the BRIC countries historically. It is, however, quite small in global terms, around $ 350 billion, a bit more than ½ pct of global GDP, and its population is not that large by big emerging market country standards. Unless South Africa’s real GDP growth accelerates dramatically (and by that, I mean by at least Chinese-style standards), it will be virtually impossible for it to have the same global impact as any of the BRIC countries.   James Wrisdale has been developing a neat programme that allows an easy walk through 2050 with the ability to observe individual country contributions to global growth over the whole period, and by decade, that any country can make based on Goldman Sachs assumptions through to 2050. Only those countries that are already more than 1 pct of global GDP are likely to be materially important. The four BRIC economies could deliver around 51 pct of the global growth over the next 40 years. South Africa’s contribution would not change that statistic very much if it were added. The other four “growth economies” that we are highlighting from the N11 group -- Indonesia, Mexico, South Korea and Turkey – could contribute collectively close to 10 pct. Combined with the BRICs, these 8 countries could deliver just over 60 pct of the world’s growth.  And, in the next decade from 2010-2019, these economies could deliver over 50 pct of the world’s growth.    The BRIC economies remain crucial to the world economy, as more and more of us will experience.   THE REMARKABLE STRENGTH OF THE YEN   Another issue for the days ahead will be, yet again, the remarkable strength of the Yen. While 2010 was generally good for my overall views, it was horrible with respect to my views on the Yen. It ended the year confounding me even more, as even with a rather dramatic rise in US 2-year note yields, any weakness of the Yen was brief and dramatically reversed in the past week or so. I cannot quite imagine what the latest fad is to warrant Yen strength, although I know many will suggest either the strength of the RMB and other Asian currencies, and perhaps the attraction of the Nikkei as alternatives. Neither explanation makes sense to me, and I can’t imagine the Japanese MOF sitting idly by and watching the Yen break beyond Y80 against the Dollar, especially when the markets are re-rating the US.   Interesting days and weeks ahead for many topics including many I haven’t raised.  I can’t finish without saying how nice the English Premier League table looks as we start 2011.   Once again, Happy New Year.   Jim O’Neill Chairman, Goldman Sachs Asset Management