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The outlook for the global economy
in 2012 is clear, but it is not pretty. It includes
recession in Europe, anemic growth, at best, in the
United States (US), and a sharp slowdown in China
and most emerging market economies.
Asian economies are exposed to
China. Latin America is exposed to lower commodity
prices, as both China and the advanced economies
slow. Central and Eastern Europe are exposed to the
eurozone.
Turmoil in the Middle East is
causing serious economic risks, both there and
elsewhere, as geopolitical risk remains high, and,
thus, high oil prices will constrain global growth.
At this point, a eurozone recession
is certain. While its depth and length cannot be
predicted, a continued credit crunch, sovereign debt
problems, lack of competitiveness, and fiscal
austerity imply a serious downturn.
The US, which has been growing at a
snail’s pace since 2010, faces considerable downside
risks from the eurozone crisis. It must also contend
with significant fiscal drag and ongoing
deleveraging in the household sector, amid weak job
creation, stagnant incomes, and persistent downward
pressure on real estate and financial wealth, rising
inequality, and political gridlock.
Elsewhere, among major advanced
economies, the United Kingdom (UK) is double
dipping, as frontloaded fiscal consolidation and
eurozone exposure undermine growth. In Japan, the
post-earthquake recovery will fizzle out as weak
governments fail to implement structural reforms.
Meanwhile, flaws in China’s growth
model are becoming obvious. Falling property prices
are starting a chain reaction that will have a
negative effect on developers, investment, and
government revenue.
The construction boom is starting to
stall, just as net exports have become a drag on
growth, owing to weakening demand from the US and
especially the eurozone. Having sought to cool the
property market by reining in runaway prices,
Chinese leaders will be hard pressed to restart
growth.
They are not alone. On the policy
side, the US, Europe, and Japan have been postponing
the serious economic, fiscal, and financial reforms
that are needed to restore sustainable and balanced
growth.
Private and public sector
deleveraging in advanced economies has barely begun,
with balance sheets of households, banks, financial
institutions, and local and central governments
still strained. Only the high-grade corporate sector
has improved.
But, with so many persistent tail
risks and global uncertainties weighing on final
demand and with excess capacity remaining high,
owing to past overinvestment in real estate in many
countries and China’s surge in manufacturing
investment in recent years, these companies’ capital
spending and hiring have remained muted.
Rising inequality, owing partly to
job slashing corporate restructuring, is reducing
aggregate demand further, because households, poorer
individuals, and labour-income earners have a higher
marginal propensity to spend than corporations,
richer households, and capital-income earners.
Moreover, as inequality fuels popular protest around
the world, social and political instability could
pose an additional risk to economic performance.
At the same time, key current
account imbalances remain large. Orderly adjustment
requires lower domestic demand in overspending
countries with large current account deficits and
lower trade surpluses in over-saving countries via
nominal and real currency appreciation.
To maintain growth, overspending
countries need nominal and real depreciation to
improve trade balances, while surplus countries need
to boost domestic demand, especially consumption.
But, this adjustment of relative prices via currency
movements is stalled, because surplus countries are
resisting exchange rate appreciation in favour of
imposing recessionary deflation on deficit
countries.
The ensuing currency battles are
being fought on several fronts: foreign exchange
intervention, quantitative easing, and capital
controls on inflows. With global growth weakening
further in 2012, those battles could escalate into
trade wars.
Policymakers are running out of
options. Currency devaluation is a zero-sum game,
because not all countries can depreciate and improve
net exports at the same time.
Monetary policy will be eased as
inflation becomes a nonissue in advanced economies
and a lesser issue in emerging markets. But,
monetary policy is increasingly ineffective in
advanced economies, where the problems stem from
insolvency and creditworthiness, rather than
liquidity.
Meanwhile, fiscal policy is
constrained by the rise of deficits and debts.
Backstopping and bailing out financial institutions
is politically unpopular, while near-insolvent
governments do not have the money to do so.
Politically, the promise of the G-20
has given way to the reality of the G-0. Weak
governments find it increasingly difficult to
implement international policy coordination, as the
worldviews, goals, and interests of advanced
economies and emerging markets come into conflict.
As a result, dealing with stock
imbalances, including the large debts of households,
financial institutions, and governments by papering
over solvency problems with financing and liquidity
may eventually give way to painful and possibly
disorderly restructurings. Likewise, addressing weak
competitiveness and current account imbalances
requires currency adjustments that may eventually
lead some members to exit the eurozone.
Restoring robust growth is difficult
enough without the ever-present spectre of
deleveraging and a severe shortage of policy
ammunition. But, that is the challenge that a
fragile and unbalanced global economy faces in 2012.
It will require fastening seatbelts,
as this is going to be a bumpy year. |
