THE outlook for the global economy in 2012 is clear, but it
isn't pretty: recession in Europe, anaemic growth at best in the United States,
and a sharp slowdown in China and in 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. And
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 – growing at a snail's pace since 2010 – faces
considerable downside risks from the eurozone crisis. It must also contend with
significant fiscal drag, 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 the major advanced economies, the United
Kingdom is double-dipping as front-loaded 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 US and especially eurozone demand.
Having sought to cool the property market by reining in
runaway prices, Chinese leaders will be hard put to restart growth.
They are not alone. On the policy side the US, Europe, and
Japan, too, have been postponing the serious economic, fiscal and financial
reforms needed to restore sustainable and balanced growth.
Private and public sector deleveraging in the advanced
economies has barely begun, with the balance sheets of households, banks and
financial institutions as well as 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 over-investment 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 – between
the US and China (and other emerging-market economies), and within the eurozone
between the core and the periphery – 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. And, with global growth weakening further in 2012, those
battles could escalate into trade wars.
Finally, 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 non-issue 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 thus creditworthiness
– rather than liquidity.
Meanwhile, fiscal policy is constrained by the rise of
deficits and debts, bond vigilantes, and new fiscal rules in Europe.
Backstopping and bailing out financial institutions is politically unpopular,
while near-insolvent governments don't have the money to do so.
And 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 world views, goals and
interests of advanced economies and emerging markets come into conflict.
As a result, dealing with stock imbalances – 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. To paraphrase Bette Davis in All About Eve,
"Fasten your seatbelts, it's going to be a bumpy year!"
- Reuters