Sat, May 05, 2012 - Page 8 News List

Doubt plagues world’s economy

By Gerard Lyons

The optimism seen in global financial markets during the first three months of the year is already giving way to renewed uncertainty about the outlook for the world economy.

In the autumn of last year, financial markets feared a double-dip recession in the US, a hard landing for China’s economy and a collapse in the eurozone. None of these things happened, as economic data in both the US and China proved stronger than the markets feared, and the actions of the European Central Bank (ECB) pulled the eurozone back from the brink.

I did not share the fears about the US and China, but it was interesting to observe how market sentiment moved from one extreme of too much pessimism to the other extreme of over-optimism during this period. This helps to explain the rallies seen in the first quarter of this year. Now, market sentiment is adjusting to a situation somewhere in between.

This makes sense. The world economy continues to recover after the crisis, but the picture varies greatly: A fragile West contrasts with a resilient East.

Across Asia and many parts of the emerging world economies are in much better shape, but even in these regions, the picture varies. In China, for instance, the economy is cooling after the authorities tightened policy last year in order to squeeze inflation. Now, the focus in China is both on political change and on moving the economy to the next stage of development.

In the US, meanwhile, the good news is that the economy is continuing to grow, but the bad news is that the recovery is not particularly strong. It is steady, not spectacular. In the US, like the UK, the biggest firms appear in good shape, with healthy balance sheets, but for now, they appear reluctant to invest. There is still an overhang of debt, and it will take time for people and firms to deleverage. In addition, whereas the UK government has already taken big strides to try and reduce its deficit, in the US many of these problems are being left until after the presidential election.

Although the outcome for the world economy will be heavily influenced by the US and China, it is developments in the eurozone that continue to drive sentiment. The biggest threat facing the global economy is a collapse of one or more of the economies in the eurozone.

That is why markets were so relieved by the actions of the ECB. In December last year, the bank provided cheap three-year money to banks that wanted to borrow. The success of that led the ECB to repeat the exercise in February this year. Its actions removed the immediate fear of a funding crisis for banks across continental Europe, and provided valuable time for the eurozone to address its problems.

Recent months have highlighted three types of adjustment, none of which is particularly popular.

First, if the economies on the periphery were not in the eurozone, they would now be seeing major currency devaluations, but because they are in the eurozone, they are having to endure “internal devaluations” instead, which are squeezing their economies very hard. The result is recession and rising unemployment.

It is difficult for the markets to know which of these economies is the most important to focus on. Is it Greece, which may need further external help as its recession deepens? Is it Ireland, which has done all that has been asked of it but has slipped back into recession? Or is it Portugal, which some fear may be the next in trouble after Greece? Or is it Italy, the biggest peripheral economy, where an unelected government is now pushing through cuts demanded by Germany (among others)? Or is it Spain, where the government was elected only last autumn on a mandate of austerity but is already running into trouble as youth unemployment rises? To these one could add worries about France, where the presidential election adds to political, as well as economic uncertainty in Europe.

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