A Grim Global Outlook
The outlook for the global economy continues to get bleaker and bleaker. This week the focus remains on the euro as European leaders are meeting for the twentieth time in two years to discuss and attempt to resolve an increasingly hopeless financial situation. The two day summit in Brussels is more contentious than ever, pitting the embattled profligate countries of Southern Europe aligned with newly elected French President Hollande against the disillusioned Germans eager to distance themselves from any more bailouts or debt exposure.
The situation in the Eurozone is fluid to put it mildly. Spain continues to struggle financially as its banks hover over the abyss of insolvency, ominously watching their short term (6 month government bonds) borrowing costs triple Tuesday. Italy is not fairing any better – their six month borrowing rates rose a whopping three percentage points during a bond auction earlier this week. Meanwhile, the newly elected Greek government is trying to maintain its fledgling coalition by renegotiating a deal with the Eurozone to ease its austerity requirements, their Election Day promise.
With divisions hardening and financial crisis intensifying it is not a surprise that investor confidence is withering and the euro continues to fall in value. At its core, the main issue beleaguering the Eurozone is debt contagion. Spanish Prime Minister Rajoy put it succinctly, “The most urgent issue is the one of financing. We can’t keep funding ourselves for a long time at the prices we’re currently funding ourselves.”
Who will pay Europe’s debt is the principle question. There is a famous saying, “everyone is your brother until the rent comes due.” As Europe’s paymaster, Germany can certainly relate. Hollande and his Italian and Spanish counterparts want Germany to shoulder more of the burden, asking the ECB to issue Eurobonds. The Germans object. “As long as I’m alive,” Chancellor Merkel reportedly said, we will not accept any solution that requires more pooled debt at our expense.
Hard Landings in Emerging Markets
As fractured as things are in Europe, troubling signs are beginning to arise in emerging economies too. Indian Prime Minister Manmohan Singh met with government officials Wednesday to discuss souring investor confidence in India. As foreign investment has dipped, the Indian economy has slowed to its lowest growth rate in nearly a decade. The rupee has sunk to all-time lows against the dollar, inflation is high, and the government is struggling to cope with enlarged fiscal and current account deficits.
To arrest these trends, Singh, no stranger to boosting economic growth, has taken charge of the finance ministry. Singh is credited with engineering major reforms in the early 90s, which paved the way for India’s economic jolt. But his task is much more difficult this time around. India’s growth rate has fallen sharply in early 2012 to 5.3%, down from over 9% in the first quarter of last year. If Singh wants to “restart India’s growth story” he will need to implement drastic reform in everything from insurance to tax policy – not an easy task.
With the global economy stressed particularly in the West, China may stand to lose the most. Problems are starting to pile up in Beijing. Chinese leaders continue to wrestle with a property and construction bubble, spiraling local government debt, and huge gaps between rich and poor. Further, government growth projections have been adjusted in the current Chinese five year plan. It projects annual growth at a meager 7%, well below its near steady 10% growth over the last two decades.
Growth is paramount in China. Without it, supporting its huge population is nearly impossible. China’s export based economic model may be their undoing. When foreign markets cannot buy Chinese goods, especially western markets, China falters. The euro crisis is a big problem because Europe comprises 20% of their export market.
Given the worsening situation in Europe and elsewhere China could be headed for what analysts call a “hard landing.” Significantly lower growth rates in China could produce social unrest and major instability. Finance Professor Franklin Allen of Wharton Business School views a hard landing in China as unlikely, unless the euro blows up that is. The IMF agrees with his assessment; they believe a worsening euro crisis could bring China’s growth levels down to a dangerous 4%.
Revised Forecast in US
At home, financial analysts are flexing to the continuously erratic stock market, up one day down the next. US economic indicators have given somewhat mixed signals. Some reports show housing prices are beginning to stabilize, a very positive sign for the US economy. But other news has not been so good. According to Bloomberg, consumer confidence is at five month lows, probably driven by last month’s disappointing jobs report.
After a somewhat promising start to the New Year, the US economy is returning to its recent sluggishness. As a result, the FED revised its rosy projections for 2012, predicting that unemployment will remain high and growth tepid for the next couple years. US corporations have felt the pinch too, seeing declines in overseas revenues resulting from the global slow-down.
Nevertheless, it’s the US banking industry that has received most of the attention of late. Earlier this month Moody’s Investors Services downgraded 15 major financial institutions, Citigroup among them, dealing yet another blow to Wall Street’s already sullied reputation. JP Morgan has also come under fire not just for losing billions in risky bets but for suppressing a report on the municipal bond market completed last year. JP Morgan’s report, which was only distributed to privileged investors, revealed that the municipal bond market is far more indebted than originally suspected. It is worth noting that JP Morgan underwrites many US muni bonds.
Bad to Worse?
In the aggregate and that’s all that matters at this point, the world economy is steaming into rough seas ahead. Though there is a possibility that the Eurozone could survive, that emerging markets could return to sustainable levels of growth, and US markets could rebound sooner and stronger than anticipated, the chances of that happening are remote. The more likely outcome will be a global economic rebalancing, a restructuring of the world economy. It would unquestionably be a painful process, but a more sustainable and healthier world may emerge in the end.
Cameron Macgregor is a former naval officer and USNA grad. He is writing his first book.