Investment Adviser - The Global Economy into 2012
Whilst there was an essential commonality of policy response to the Great Financial Crisis (GFC) of 2008-09, there now appears to be a rather broad range of policy focus amongst the world’s leading economies. That is either because the various economic groupings are facing different challenges, or else are choosing to tackle a similar problem with alternative policies. Consequently, we expect to see differing growth trajectories across economies, but a shared inflation experience.
The hit to the global economy and financial system in the wake of the Lehman’s collapse saw output and trade levels plunge globally. Authorities the world over faced a common challenge and responded in a universal manner: ample liquidity was provided to make sure that the financial system didn’t seize up altogether; interest rates were slashed to a minimum to underpin demand; and governments adopted aggressive public spending programmes to fill the gap left by the slump in private sector demand.
A legacy of that 2008-09 policy response, however, was a significant ratcheting up in the level of public debt, and this has helped to shape the major challenge facing many economies today. For some countries, the efforts to cope with the GFC also resulted in upward inflationary pressures. In China bad debts were an inevitable consequence of the massive credit stimulus programme. Consequently, unlike the response to the GFC, the future policy stance of the various economies will differ according to their priorities. So, what are likely to be the key features of the global economy going into 2012?
Quite apart from it being an election year, the US appears to have opted to try to grow its way out of debt, at least for the time being – getting the level of unemployment down appears to be the present policy focus. Consequently, any signs of a meaningful economic slowdown are likely to elicit another round of Quantitative Easing (QE). So far, there seems to be little likelihood that the US will slip back into recession, barring a major financial blow-out in Europe.
After a sluggish first half of the year, the US economy rebounded more forcefully in Q3. Temporary negative factors, including high commodity prices and the supply-chain problems following the Japanese disaster, faded going into the second half of the year. Added to that, lower bond yields boosted mortgage refinancing activity and consumer demand. Moreover, there are good grounds for expecting further encouraging news. We have still to see the full impact of the recovery in auto sales, underlying durable goods orders are firm, inventory levels are low and there appear to be some stirrings in the housing market. Job creation, although not yet sufficient to make serious inroads into the high level of unemployment, seems to be picking up from a mid-year stall. The US economy looks likely to continue to expand in 2012, albeit at a sub-trend pace of around 2.5%.
For the world’s second largest economy, China, the stimulus measures to underpin the economy in 2008 succeeded in sustaining economic growth, but at the expense of rising inflation and the emergence of non-performing loans. The latter is not a policy priority – the main focus has been to rein in inflationary pressures without slowing the economy more than is necessary. For the present, inflation does appear to have peaked at over 6%, but it may not rapidly get back to target, which is below 4.0%. Many judge that China has passed the ‘Lewis turning point’ (the point when the labour supply turns from being freely abundant to being in short supply) and that wage inflation is likely to pick up more forcibly going forward.
With inflation likely to prove to be sticky, the authorities will be reluctant to ease policy prematurely. Recent signs of some relaxation seem likely to have been in response to particular stresses and strains in the system, rather than the prelude to a more general easing in policy. The authorities have moved to ease the plight of smaller companies, who have borne the brunt of the bank lending squeeze, through easier loans and some tax concessions.
The other area of specific targeting has been the proposal to investigate the possibility of allowing the issuance of municipal bonds. The thinking is that local authority spending levels have surged since 2008, whilst revenues have not. If the trial issuance of bonds is successful then that would put local authority financing on a more secure footing and go some way to relieving a specific fault line.
Until there is convincing evidence that the inflationary pressures have been contained, and brought back towards target, the authorities are unlikely to sanction a general easing in policy However, by offering specific targeted relief the authorities should be able to deliver 7% to 8% economic growth in 2012.
As for Japan, the authorities have had to face the singular challenge of responding to a massive natural disaster which has had far-reaching consequences. The Japanese economy was going through a second successive quarter of negative growth when the earthquake/tsunami struck and disrupted nuclear generation activity, which had been 30% of the total electricity generation in the country. Output growth slumped, in particular, in the auto, technology and export sectors. The first priority was to get industry moving again. So, although the economy is no better off than it was in March, the disaster has boosted growth rates as affected industries sought to restore output levels to pre-crisis levels. That phase of the recovery is now close to completion.
The next phase will involve the reconstruction initiative in the areas most affected by the disaster, to be financed through a third Supplementary Budget, and expected to total around ¥13 trillion. It will also involve the wholesale switch from nuclear to thermal electricity generation. There will be an associated boost to activity from both of these ventures, but the bottom line is that Japan will not be better off as a consequence. Nevertheless, the Japanese economy should see growth of between 2% and 3% in 2012.
The present problems in the Euro area represent the greatest risk to the global economic growth outlook. At best, growth in the region may more-or-less stagnate, whilst at worst it could slip back into recession, depending on the outcome of the present sovereign debt/banking crises. Back in 2008 even the normally strong core economies were in need of substantial levels of support, with Germany, in particular, a victim of the collapse in global trade. Now, the righteous response of the strong economies is that the financially irresponsible peripheral countries need to get their house in order. The present troubles are seen as the responsibility of specific parts of the ‘union’, and they must make the necessary adjustments. A combination of austerity measures, bank deleveraging and greater financial sector regulation could see the Euro area as a whole in danger of falling back into recession. That danger would be even greater if the European officials fail to establish a more resilient financial system, capable of absorbing periodic shocks.
The UK, too, could be vulnerable to a slide back into recession. The planned deficit reduction programme has already resulted in a pick up in unemployment numbers, and it is expected that those will rise further. The underlying problem is that the anticipation that private sector recruitment would offset the cuts in public sector jobs has just not materialised on the necessary scale. Certainly, the falls in inflation in early 2012 should provide some relief for household spending power, and the likelihood that three of the four largest economies in the world will be growing will help to offset the less optimistic outlook for the Euro area.
For the present, the UK economy is growing at an annual pace just above 1%. It was always suggested that growth would struggle whilst the excesses of the past were worked off. The danger is that at such a feeble pace of expansion the economy will be vulnerable to external shocks. For just that reason the NIESR have posited that the government should provide some positive policy initiative to offset the drag from the deficit reduction scheme. It suggests that an income tax cut would help, without damaging the deficit-fighting credentials. If the UK does look in danger of sliding back into recession, then expect some government response, in addition to much more QE from the Bank of England.
Slower growth limits inflation
Whilst the growth outlook may be dependent upon what economy is being looked at, the inflation outlook looks likely to be less variable. There have been some incidences of rising inflationary pressures this year, although these were more a function of the upward spurt in commodity prices due variously to QE2 in the US, the Arab Spring events hitting the oil price and strong emerging economy demand. However, the imposition of austerity measures in many countries and the tighter policies adopted in the emerging economies should see a slower pace of global growth in 2012. Consequently, next year is unlikely to be a year when we have to worry about inflation, one ray of good news in what looks otherwise to be a difficult year.
Douglas Roberts, Senior International Economist, Standard Life Investments