Financial Times
Published: September 23, 2011
A downgrade in Italy’s credit rating; more bad business survey data from Europe; a search for capital to shore up French banks; and alarming signs that investors have lost faith in the ability of the world’s most important central bank to come to the rescue – all this week darkened the mood once again.
Disaster threatens. Echoes of the 2008 financial and economic crisis cannot be ignored, but are amplified this time by greater policy impotence. Governments must aim to maintain budgetary credibility without eliminating necessary growth. Central banks have less leeway to generate growth and barely understand the new tools they are using.
Certainly, the promise made by the Group of 20 leading economies that 2011 would herald a new “strong, stable and balanced” global economy is dead. The game is now to achieve the less ambitious goal of preventing the crisis spiralling out of control.
Policymakers still cling to the possibility of creating a virtuous circle of improved growth; reduced sovereign debt concerns; stronger banks; a brightening investment climate for companies; and a shift in the growth locomotive to Chinese consumers and other creditors. But their grip is weakening and the danger of recession looms.
The outcome is not set in stone. Imminent decisions by policymakers, companies and households will determine whether the economy will descend into downturn or emerge with a few cuts and bruises. In the weeks ahead, savvy investors will be seeking signposts indicating the global economy’s likely direction of travel. The following five areas are a good place to start.
Third-quarter growth
Growth in advanced economies slowed to a crawl in the second quarter, raising legitimate fears of a descent into recession, Chris Giles reports. A bounce-back in the third quarter would allay fears considerably.
Grounds for optimism rest on peculiarities in the May-June data and a fall in oil prices since the spring.
IMF estimates suggest second-quarter output was hit by temporary supply chain disruptions after the Japanese earthquake and tsunami in March; the restarting of car production lines worldwide, along with lower oil prices, could boost third-quarter growth.
Japan would clearly be the most significant beneficiary, but special factors also depressed German and UK second-quarter growth. Germany’s shutdown of its nuclear reactors following the meltdown at Japan’s Fukushima plant helped push second-quarter growth down to 0.1 per cent; some economists are pencilling in a jump to 0.5 per cent in the third. Britain enjoyed an additional day’s holiday for the royal wedding, reducing the number of days worked in the second.
A positive surprise on growth figures would muffle the relentless drumbeat of gloomy data and should encourage some consumers and companies to spend. But policymakers cannot bank on even a temporary return to better numbers. The third quarter coincided with financial market turbulence, further eurozone debt turmoil and unrelated confidence-damping events, such as Britain’s riots.
A bounce-back in the third quarter is therefore necessary for a benign outcome – but it is far from sufficient, and not guaranteed.
Eurozone debt crisis
Greece triggered the eurozone debt crisis, and Greece will largely determine what happens next, Ralph Atkins reports. Athens is being pressed hard by the Troika (the International Monetary Fund, European Commission and European Central Bank) to put its emergency rescue programme back on track or face a halt to bail-out payments. But it is unclear whether George Papandreou, Greek prime minister, can deliver. The risk is of a default that delivers a Lehman Brothers-scale shock to the global economy.
Italy is already feeling contagion effects. Silvio Berlusconi, prime minister, has little credibility among international investors. Political uncertainty is adding to nervousness. Next week could bring some relief if Germany’s parliament backs proposals to strengthen the European Union’s bail-out fund. Yet even those steps might prove inadequate. Chancellor Angela Merkel’s grip on her supporters is wobbling, and German patience with the eurozone’s fiscal miscreants has already been tested to the limit.
Acting as backstop is the ECB. It has massively expanded its government bond-buying programme in the past six weeks – despite fierce resistance in Germany – but made clear this is temporary. To head off funding problems at banks, the ECB could also expand its offers of unlimited loans or relax rules on the collateral needed for its liquidity. With the eurozone economy on the brink of recession, the ECB could soon cut its main interest rate. A change of its president at the end of October could add uncertainty.
Central banks
The cavalry is not what it was, Robin Harding reports. If the past few years have proved anything, it is that the rapid restoration of full employment is not within the power of central banks. Rather than saddling up to ride to the rescue of the world economy,the world’s central bankers have in the past week or two been digging grimly into defensive positions, determined to use all of their limited weaponry to fight off the economic peril that they fear is coming their way.
“Most of the economic policies that support robust economic growth in the long run are outside the province of the central bank,” Ben Bernanke, US Federal Reserve chairman, told fellow central bankers in August.
Despite those words, the Fed this week launched Operation Twist – a $400bn programme aimed at driving down long-term interest rates by buying long-dated Treasury securities with money raised from selling short-term bonds.
The Twist was bolder than markets expected but did not cheer them up. “I feel that this will have little effect on the overall economy and simply shows that the Fed is powerless against the fundamental problems facing the economy,” noted Steven Ricchiuto of Mizuho Securities in New York.
The trouble is that US consumers and European governments need to pay down their debts. No matter how low the interest rate, only a few will borrow and spend. The Bank of England looks set to try more quantitative easing; the ECB may well be forced to reverse interest rate rises. It is one line of defence – but it may not be enough.
Markets
Markets have been hinting for some weeks at an ever-increasing probability of recession, Richard Milne reports. The most gloomy asset class by far has been bonds where, as investors go in search of safety, market interest rates for government debt have plummeted. Germany’s are at an all-time low; US and UK rates are at the lowest for, respectively, 65 years and 112 years. “Treasuries today are not pricing in a recession but a depression,” argues Paul Griffiths of Aberdeen Asset Management.
Others argue special forces, including central bank purchases and unusually low official interest rates in most developed countries, are at work in bond markets. Good economic news, if it comes, could cause yields to shoot up, they argue.
But equity markets are also showing significant signs of distress. German and French stock markets have shed a third of their value since their peaks this year while US and UK shares have fallen by almost a fifth, a loss that would put them in bear market territory. Such drops have often – but not always – been associated with recessions.
Andrew Parry, head of Hermes Sourcecap, a UK investor, says that equities will periodically rally and then collapse, a phenomenon Japan has experienced for the past 20 years as bonds have outperformed equities. “Japan is not the perfect roadmap but [today’s events are] playing out like that more and more,” he adds.
Perhaps the biggest danger is of the tail wagging the dog, with markets tipping economies into recession. Companies globally are in fine fettle, with strong balance sheets, but market turmoil gives them little incentive to invest or for consumers to spend.
US politics
For the past 60 years, the global economy has had an answer to any woe: the American consumer, Robin Harding reports.
Citizens of the world’s largest economy have shown such animal spirits, such willingness to buy and build and do, that their demand has pulled the rest through all economic turmoil. Their appetites drove growth in the 2000s.
But since the housing crash began, they have been trying to pay down their debts. The government stepped in with a fiscal stimulus to replace their demand in 2009 and 2010 – but that is now fading away.
Poisonous politics means that the stimulus is unlikely to be replaced in full.President Barack Obama proposes a $447bn plan, most of which is based on short-term relief from payroll taxes for business and workers.
In the end, at least some tax relief is likely to be passed by Congress. Putting more money in the pockets of American workers appeals to Democrats and Republicans alike. But the dysfunction of Washington means the bill is unlikely to pass in a way that inspires confidence in business and workers.
For the third time this year, Congress is embroiled in an argument that could lead to a shutdown of the federal government, this time over whether spending on natural disasters should be offset by savings elsewhere. A shutdown is unlikely – but it highlights the continued rancour of political debate.
One thing that could steady nerves in the global economy is rational and determined US policy. Recent escapades on Capitol Hill, plus a looming presidential election campaign that promises to be bitter, do not offer much hope of that.
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