New storm clouds gather: Mid-year stocktake of world economy
This month's issue of EFIC’s newsletter, World Risk Developments, does a ‘mid-year stocktake’ of the world economy. The last, ‘end-of-year’ stocktake was in December 2009. Since then, the global recovery has continued, but new risks are emerging that could blunt future growth.
Recent developments
‘Global growth now looks as if it will proceed at around a 4% annual pace through the first half of 2010’, says EFIC's chief economist, Roger Donnelly. ‘GDP has now climbed above its previous pre-crisis peak in emerging markets, and has almost reached that peak in the US; only in the eurozone does it languish’.
Until recently, a wide range of financial markets had also been rallying strongly, though for a month now many markets have been retracing on nervousness about the eurozone debt crisis.
Outlook
According to Donnelly, ‘The correction raises the question: Can the recovery continue? Or will it falter – validating the market’s fear that the eurozone crisis will be a big global growth shock?’
He lists five reasons why at least a moderate slowdown is in prospect, and downside risks have risen.
- Business cycle dynamics. The recovery from last year's deep slump largely owes its impetus to two transient factors – stockbuilding and fiscal and monetary stimulus – whose influence is now fading. Meanwhile, private consumption and investment demand in many advanced economies remains subdued as households and businesses attempt to repay excess debt and struggle with spare production capacity. The result is likely to be some slowdown in coming quarters.
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- China slowdown. Concurrently, Beijing is moving to wind back the stimulus it administered to the Chinese economy last year. Most forecasters foresee a soft landing, with GDP growth decelerating from its current 12% pa pace to around 9-10% in coming quarters, as rising consumption spending and exports compensate for the slowdown in investment. But there is the risk of a sharper slowdown if this rebalancing doesn't proceed smoothly; or if the tightening of credit causes a sharp correction of property prices.
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- Eurozone crisis. While the preceding two factors could act as a drag on global growth, the eurozone crisis has potential to act as a brake. It is already causing funding problems for European banks with large holdings of troubled sovereign debt and forcing governments in the directly affected economies to undertake sharp fiscal retrenchments. If worse comes to worst, and bond market confidence isn’t restored, some governments may be forced to default on and restructure their debt, which would reverberate back to the banks holding that debt.
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- Disinflation/deflation. With core inflation in the US and eurozone currently running at 1% or less, and Japan in deflation, the G3 has become vulnerable to the harmful process of debt deflation, in which indebted households, firms and governments see their wages and prices fall, their nominal incomes and revenues shrink, their debt/income ratios rise, and their debts become unmanageable.
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- Global imbalances. All of these drags could be kept at bay if the surplus nations of the world – those with large financial and external current account surpluses, predominantly in Asia and OPEC, but also Germany – showed a greater preparedness to import more from the deficit countries – including those in the eurozone plus the US and UK – and thereby allowed the latter to ‘grow out of’ their financial difficulties. Unfortunately most surplus economies want just as much as the deficit countries to follow such an export-led growth strategy.
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Unresolved tensions
'If the US goes back to its pre-crisis role of ‘consumer and borrower of last resort’, the global recovery could be sustained in the short term’, Donnelly argues. ‘But there would be a price to pay: global imbalances would rise again, paving the way for future instability, either in the form of a protectionist US reaction against a rising tide of imports, or an eventual run on US assets and the greenback by investors concerned that ‘this can’t go on’.’
‘One way to secure more balanced and sustainable growth would be through some multilateral agreement resembling the Louvre and Plaza agreements of the 1980s, in which governments of the surplus and deficit blocs agree to change their policy mixes to encourage global rebalancing.’
‘This will be something to watch – and hope – for at forthcoming G20 meetings’, Donnelly concludes.