Divided After All These Years
By Dr. Gerard Lyons, Chief Economist, Standard Chartered Bank
So far, 2012 has provided further evidence of a divided and disconnected world economy that faces major policy dilemmas. Europe is imploding, the UK is contracting, the US is stagnating and, while Asia is cooling, it at least has the policy tools to be able to rebound.
The global economy has slowed significantly, from a healthy, policy-induced growth rate of 4.2% in 2010 to a much cooler 3.0% growth last year. This year, global growth may be only 2.6%. This masks considerable differences but, as we have seen in recent years, globalisation means no region of the world is completely immune to problems in the West.
The good news is that, helped by policy stimulus, emerging economies, led by China, may see some pick-up into 2013. The trouble is many economies in the West are running out of policy tools to be able to respond with if they are hit by another shock. Hence, it is easy to construct a ‘perfect storm’ scenario for 2013, in which a combination of problems comes together and things get worse.
The biggest shock would be if energy prices were forced higher following a Western-led attack on Iran. This is not inevitable, but the risk cannot be overlooked. It would come as a major blow to global growth as the recent easing in oil prices has helped many economies considerably.
For now, the biggest shocks are coming from Europe. This is the world’s weakest link, which is remarkable given how wealthy that region is and how strong some of its core economies are, especially Germany. It is staggering how Europe’s political leaders have let it get this bad.
Over the past year there has been a need for European politicians to act fast, comprehensively and ahead of events. Instead they have been slow, inadequate and, usually, have only acted after problems have emerged. To make matters worse, they are also focusing on the wrong problem – of excessive debt – when the real challenge facing Europe is the lack of growth.
At their recent summit – the 19th in a couple of years – European leaders finally made some progress, but it was not enough to end recession and to address deep-rooted issues at the heart of the euro. But their actions also led the European Central Bank (ECB) to cut interest rates to a record low of 0.75%. In the coming months, a return to unconventional policy may be needed, such as the ECB buying bonds and providing cheap long-term loans to banks.
If only the US was booming things might not be so bad. But it isn't. The US economy is as weak as Europe's, despite increased optimism about low energy prices because of shale gas and despite big firms being in great shape. Thus US interest rates are staying near record lows. No matter who wins the presidential election, some difficult decisions on tax and government spending need to be addressed, and the likelihood is the US faces only steady, and far from spectacular, growth.
Western economies may be only half-way through their painful adjustment. Gross government debt levels in advanced economies have risen from an already high average of 74% of GDP ahead of the crisis to 105% by the end of 2011. But one of the main reasons government borrowing is rising is because growth and demand is so weak, as people and firms continue to pay down their debt and deleverage.
A related worry is that, in trying to prevent a depression and financial melt-down, central banks have inflated their balance sheets across the globe, from China and Japan to Europe, the UK and the US. The aggregate assets of central banks now stand at a huge USD 18trn, or about 30% of global GDP. This is twice the ratio of a decade ago. In addition, policy interest rates are below inflation in many countries, discouraging savings and encouraging speculative activity.
Such loose monetary conditions indicate that central banks have become the shock absorbers for the world economy.
This is particularly challenging for the emerging economies, as it is they who have to cope with the fallout from low rates in West. Capital will flow towards their economies in search of higher yields and all this at a time when some of them now face homegrown problems. While the West is in a mild depression, emerging economies, having seen steady growth in recent years, are at a more advanced stage of the cycle which, in the past, may have led to trade or inflation problems. That is why no-one should be surprised if there are setbacks across the emerging world, after all the business cycle does exist. The trend is up, but there will be setbacks along the way. That is the reality. But it is important not to confuse cyclical setbacks being seen in a number of emerging countries with positive longer-term structural features.