The Global Economy No. 9 - December 20, 2011


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The Global Economy No. 9 - December 20, 2011: Although 2011 was the year of the debt crisis, challenges still remain in 2012 – not least for the euro zone

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The Global Economy No. 9 - December 20, 2011

  1. 1. The Global EconomyMonthly letter from Swedbank’s Economic Research Departmentby Cecilia Hermansson No. 9 • 20 December 2011 Although 2011 was the year of the debt crisis, challenges still remain in 2012 – not least for the euro zone  2011 will go down in history as the year of the debt crises. Budget problems have shaken the financial markets in the euro zone as well as the US, causing economic pessimism, credit austerity and declining confidence. Anger and social tension have followed in the wake of cutbacks and increased unemployment.  The economic recovery will clearly slow in 2012, including in emerging countries, which will nevertheless strengthen their economic and political positions globally. The recession will mainly complicate efforts by the euro zone’s crisis countries to clean up their fiscal mess. The euro zone is muddling through and the euro won’t collapse despite high financing costs and credit downgrades. Without stabilising its institutional framework, however, the currency union won’t be able to handle future crises. The reform work in the euro zone must continue, and more summits should be expected next year.2011: The year the recovery got sidetracked 2. Debt crisis and fiscal austerityand the debt crisis intensified Looking back, the last year has been dominated by1. The recovery faded late in the year the debt crisis in the euro zone, the UK and the US.The growth rate in the worlds largest economies The Greek crisis entered a second phase in 2011.was higher at the beginning of 2011 than at the A growing acceptance that the country wasend. Purchasing managers indexes suggested fairly insolvent and would have to default on its paymentsrapid industrial growth early in the year before forced private lenders to accept their losses.pointing to production losses. Economic pessimism Moreover, Greece got a lower interest rate as partincreased during the summer, when most of the support package, and after the referendumeconomies showed signs of a faltering recovery. debacle former PM George Papandreou steppedThe exception as the US, where optimism about down in favour of a technocratic government led bygrowth has risen since the first half-year. Lucas Papademos. At the same time financial and fiscal conditions in Ireland have improved since itIndustrial production and leading indicators in the OECD implemented reforms which created confidence, 65 although economic conditions have further 60 deteriorated. There is still uncertainty whether Portugal will need more support, and despite reform 55 efforts risk premiums are holding firm (the interest 50 rate differential vs. Germany rose during the year from 3.7 to 11.7 percentage points). 45 40 USA The most obvious trend at the end of 2011 was the UK Japan spread of the crisis from the periphery to the core. 35 E u ro la n d C h in a In addition to Belgium, France and Finland, where In d ia 30 G lo b a l risk premiums rose slightly and the threat of a credit downgrade was a concern, Germany also felt the 25 07 08 09 10 11 turbulence in connection with the issuance of S o u rc e : R e u te rs E c o W in Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740 E-mail: Internet: Responsible publisher: Cecilia Hermansson, +46-8- 5859 7720, Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897
  2. 2. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 9 • 20 December 2011government bonds and with its increasingly shaky banks in the euro system as well as certaincommercial banks. countries within and outside the EU could help somewhat, but at the same time shows crisisThe UK has continued to follow a path of fiscal management in the euro zone is far from optimal.conservatism with an austerity package of 122billion pounds in 2011/2012. The government hopes Interest rate differentials against German 10-year bondsto reduce its debt ratio from over 100% of GDP to 3560% in 2025. The budget cuts are reducing demand 30and creating social and political tension. At the 25same time the UK is benefitting from low borrowingcosts and long maturities on its government bonds. Percentage points 20 15The US is having difficulty compromising on how tostabilise its debt burden in the medium term, in 10 G re e c eaddition to disagreement on short-term fiscal policy. 5 Ir e la n d SpaiAt the last moment the debt ceiling was raised and n It a ly P o r tu g a ltax cuts were extended, but only for short time. 0 UK F ra n c e B e lg iu m SwedenUncertainty will remain for some time after the -5 07 08 09 10 11presidential election in November. S o u r c e : R e u te r s E c o W in3. The euro zone’s imperfect institutional structure 4. The roles and actions of central banksAt the same time that it struggles with a debt crisis, There are clearly differences in the roles thatthe euro zone is facing a lack of institutional central banks are playing during the debt crisis inbulwarks. The summits have come in quick the UK (Bank of England, BOE), Japan (Bank ofsuccession in 2011, with the result that budget Japan, BOJ) and the US (Federal Reserve, Fed)discipline has improved. The new rules are similar compared with the euro zone (European Centralto the previously ratified Stability and Growth Pact, Bank, ECB).but now include semi-automatic sanctions and aceiling for the structural deficit of 0.5% of GDP. The ECB has inherited from the German Bundesbank a distaste for using its printing pressesThe financial market hasn’t been impressed with to battle the fiscal crisis in the euro zone.political decisions. The focus has increasingly (Hyper)inflation is the biggest threat. The treatyturned to what is still needed for a well-functioning prevents the ECB from buying government bondscurrency union. Financing costs for crisis countries (monetary financing) except in the second-handremain unsustainable. The problem of weak market. The BOE and Fed can use quantitativecompetitiveness and growth hasn’t been resolved easing (their printing presses) to keep long-termby greater budget discipline. There seems to be far interest rates low and help their governmentsto go before we see a fiscal union and unified bank finance debt. These two central banks are lessregulator at the euro level. Politicians have shown fearful of inflation, and in fact growth is a biggerlittle interest in a eurobond market. The ECB’s role threat. For the BOJ, the goal has been to fightis still limited to supporting financial stability by deflation and a stronger yen while helping theensuring that banks have liquidity without directly financial sector.being able to support countries in fiscal crisis. The ECB (and Germany) also sees a risk if theIf rescue funds like the European Financial Stability crisis countries receive help from purchases of theirFacility (EFSF) and the upcoming European bonds in order to keep the risk premiums in check,Stability Mechanism (ESM) had sufficient support because it reduces the incentive to tighten theirmechanisms at their disposal in the form of enough fiscal belts and implement structural reforms. Thefunds, the market would have no reason to worry, ECB feels that support for the crisis countriesbut since the funds are essentially incomplete should primarily come from rescue funds overseen(though not in terms of rhetoric), there is still by politicians, i.e., the EFSF and ESM. Looking atuncertainty what might happen if Italy and Spain’s the size of the quantitative easing, there is clearly afinancing problems reach the point where they cant big difference between the ECB on the one handcontribute to the EFSF. The fact that the ESM’s and the three other central banks on the other. As alaunch has been pushed forward is positive, but the share of GDP, quantitative easing represents nearlydetails have yet to be worked out. Giving the IMF 20% of GDP in the UK and 13-14% in the US andaccess to more funds through national central Japan, but only just over 2% in the euro zone. 2 (5)
  3. 3. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 9 • 20 December 2011The ECB is therefore looking for other ways to gained ground and with few exceptions (e.g.,improve stability in the financial markets. Long-term Latvia) the governments that have pushed forloans with looser collateral are one way, permitting austerity were voted out of office. In Greece anddirect loans to banks and indirect loans to Italy, technocratic governments took over pendinggovernments. Also, when you analyse the internal reforms to strengthen market confidence in thesefinancing between the euro system’s central banks, becomes apparent that Germany, the Netherlandsand Finland are lending to France, Ireland and In the US, a super committee was created to draft acrisis countries in southern Europe. budget proposal for Congress. It never presented one, however, and instead the automatic cuts5. Credit crunch is hurting the recovery agreed to in order to raise the debt ceiling in August will be triggered. There is an unusually strongThe financial market’s concerns intensified during aversion to compromise between the Republicansthe summer, mainly due to growing economic and Democrats right now. A presidential election ispessimism, the debt crisis and weaker confidence. coming up, and the political cost to acceptThis was in addition to the risk of credit crunch in proposals that are unacceptable to party partisansthe euro zone, which was exacerbated by falling is high. The Republicans have decided to say no tobank shares, higher risk premiums and demands tax hikes and the Democrats to say no to spendingfor higher capital reserves as early as last summer cuts. As a result, there are few driving forces(June). The timing of the requirement that banks implying that US debt will be stabilised and stimulusmust recapitalise at a minimum core tier 1 capital measures to encourage growth will be extended.ratio of 9% can be questioned, since it is far fromcertain that the rescue funds are working yet. Since the political system is unlikely to change and absent a willingness to compromise, hopes areThe only conclusion is that the banks are trying to instead being placed on the presidential electiontrim their balance sheets to meet the higher and a new majority in the two chambers ofrequirements. Add that to a jittery financial market Congress. We think it is more likely that we’ll haveand it explains why they are holding onto their to wait until 2014 rather than 2013 before a newliquidity or placing it overnight with the ECB, which budget is presented that significantly changes theis now seeing record-high investments as the result debt situation.of a poorly functioning credit market. This meansless lending to businesses and households, further 8. Global trade is slowing – but there is some hopeimpacting growth prospects. By changing collateral in terms of trade policyrequirements and offering long-term loans, the ECBhas tried to find ways to indirectly sustain Compared with early 2011, export volume is higher,commercial lending, but it isnt certain banks have though it fell in September from the previous month.the same priorities. In emerging countries, exports have trended lower since March, but August was relatively positive.6. The EU’s growing discord Export volumes from selected regions/countries (index)At the end of 2011, culminating with the summit on 320December 9, a schism arose between the UK on 300 Global 280the one hand and the euro zone led by Germany 260 USAand France on the other. The UK is concerned 240 Japan Euro Zoneabout London’s position in the financial market and 220 200 Emerging Marketscould not accept the proposed amendments to the 180 Asiatreaty that would strengthen fiscal coordination. 160Since the UK is important to the EU and the EU is 140 120important to the UK, the last word hasnt been said, 100and Germany (but certainly not France) should be 80able to push the parties to reopen a dialogue andavoid isolating the UK and other non-eurocountries. Multilateral trade negotiations, the so-called Doha7. Technocratic governments and a dysfunctional Round, have been paralysed since 2008 and political system in the US essentially declared dead due to a lack of agreement between poor and wealthy countries.2011 saw governments come and go like other The protectionist tendencies we have seen in theyears, but the difference was that technocrats 3 (5)
  4. 4. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 9 • 20 December 2011wake of the fiscal crisis and global recession have 10. The Arab Spring – uncertainty about democracybeen a factor. There are some bright spots in terms and economyof global trade, however, and the Doha Round isnttotally dead yet. Developments in the Arab world and northern Africa were among the surprises in 2011. AlthoughFirst of all, Russia has after many years of dictatorships have disappeared, it doesn’t meannegotiations become a member of the World Trade democracies have taken over. More time, moreOrganization (WTO). It was the only major country elections and more economic development areoutside the multilateral framework. needed before we can say that conditions have brightened for the people of the region. HighSecondly, 42 countries (most of them wealthy) have expectations are being placed on economic policy,signed a plurilateral agreement whereby several will but it will be hard to meet them.take the lead and open up areas of trade for othercountries that have signed this limited pact. Thus 11. Japan – tsunami and nuclear accidentfar the emphasis has been on procurements and The situation in Japan was also completelyservices. It is worth noting that China hasn’t been unexpected and caused great concern in Japan andasked to sign, since there are doubts about its around the world. This is especially true of themany local and regional authorities. It is the US that region affected by the tsunami. At the same timeis mainly pushing the process. It “wants to turn the there were political consequences, and thepage” and feels the pact can be used as a template government was forced to step down. Thefor other agreements. On the other hand, there is a Fukushima accident also affected other countries,great deal of opposition from many emerging particularly Germany, where the results of statecountries, which are conducting parallel elections were unexpected and the future of nuclearnegotiations on agriculture, industry and services, power was called into question.and which prefer a multilateral agreement like theDoha Round. In Japan, it will take time for the region to heal, the9. Climate agreement – progress in acknowledging economy to clearly recover and the people to go the need to minimise damage back to living normally. For the global economy, the impact was less than expected, although structuralThe EU summit in December overshadowed the decisions on energy and nuclear power could beagreement at the climate conference in Durban, affected for some time to come.South Africa. Until the very end it seemed that the 12. Commodity markets held up better than financialmeeting would end in a total collapse. That wasnt marketsthe case, but the results were less thanencouraging. The best that can be said about the Crude oil prices have fallen, as have the prices ofconference is that it minimised the damage: industrial metals and foods. Compared with other asset prices in financial markets, commodity prices The Kyoto Protocol is still alive, and another performed fairly strongly. wave of emissions cuts has been agreed to, but the details have yet to be worked out. Commodity prices and share prices globally 450 A legally binding pact – the Durban Platform – W o r ld 400 C o m m o d ity has been reached, including by reluctant signers P r ic e s such as China, India, Brazil and the US, but 350 even though it has to be adopted by 2015 there 300 is still the possibility of a delay until 2020. Index 250As a result, the agreement will not be much help in 200preventing average temperatures from rising by two 150degrees Celsius, as hoped, which would have F T S E W o r ldrequired an earlier starting date. As the climate 100 S h a r e P r ic e sconference clearly showed, the biggest outstanding 50 03 04 05 06 07 08 09 10 11issue is how the burden should be shared between S o u r c e : R e u te r s E c o W inrich and poor countries, including whether to choosea historic or a forward-looking perspective when Inventory conditions, continued high demanddelegating responsibility. (especially in emerging economies) and residual speculation could partly explain this. Given that 4 (5)
  5. 5. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 9 • 20 December 2011supply shortages have shrunk and demand is falling as well as in 2010-2011. Even if the recession isntdue to the soft global economy, commodity prices as severe as in 2008-2009, there is a risk that theshould also trend lower going forward. recovery after the slowdown in 2012 will be weak. There are few political tools available to stimulate13. Occupy Wall Street – criticism of capitalism and the economy to the same extent, yet the causes of growing income gaps the downturn still remain. Putting governments on a more stable fiscal footing takes time, which meansAt the beginning of 2011 I wrote about “an that demand will remain sluggish even after 2012,increasingly angry world”. It is clear that the in the wake of new austerity programmes in Europerevolution in the Arab world was the product of as well as Japan and the US.growing frustration and a sense of powerlessness inthe face of repression and onerous economic In 2012 monetary policy will be further eased, i.e.,conditions for many citizens. In wealthier parts of in emerging countries, and in the West, wherethe world, more people are questioning the skewed some austerity has already begun, e.g., in Norway,distribution of income. Even in the US, where the Sweden and Australia. At a time of fiscal austerity,issue is usually pushed aside, income inequality demand and price pressures will ease, which willcould impact political developments next year. also hold commodity prices in check and allow for a monetary stimulus.Occupy Wall Street and the movement that spreadglobally had a hard time defining its mission, but the In 2012 the EMU framework will be further refined,unconditional support for US banks and huge but in small steps. The euro countries will muddleincome disparity are undoubtedly going to impact through in the years to come despite weak growthnext years election. In Europe, austerity has and higher financing costs. If politicians fail to makebrought on social and political tension. Increased progress toward a stronger fiscal cooperation, aunemployment, mainly among young people, and single bank regulator, a eurobond market and alimits on the flexibility of current and future stronger role for central bank, there is a risk that thegovernments to implement economic policies is EMU, due to insufficient rescue funds, will becreating resentment. It is becoming increasingly unable to handle future crises.important that governments are able to formulategrowth-oriented structural policies that force There will be several interesting political momentspreviously strong interest groups to take a backseat in 2012, including presidential elections in Russia,by strengthening tax policies and reducing France and the US. But it is just as interesting tocorruption. study the developments outside the prevailing establishment, certainly with the help of social2012: Recession in many Western countries media. This is true in the West, but perhaps evenand less room for economic policy more so in emerging countries, including in theThe recovery will slacken next year. In several crisis Arab world and China. The whole world is alsocountries GDP will shrink. Countries whose watching anxiously what happens in North Koreaimbalances are not as great will also see a after the death of the “Dear Leader”.slowdown, though they possibly could maintainweak growth. Activity is also slowing in emerging Cecilia Hermanssoncountries, but from a higher level, and they will bebetter able to sustain their growth rates, though notSwedbankEconomic Research Department Swedbank’s monthly The Global Economy newsletter is published as a service to ourSE-105 34 Stockholm, Sweden customers. We believe that we have used reliable sources and methods in the preparationPhone +46-8-5859 7740 of the analyses reported in this publication. However, we cannot guarantee the accuracy completeness of the report and cannot be held responsible for any error or omission in underlying material or its use. Readers are encouraged to base any (investment) decisionsLegally responsible publisher on other material as well. Neither Swedbank nor its employees may be held responsible forCecilia Hermansson, +46-88-5859 7720. losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’sMagnus Alvesson, +46-8-5859 3341 monthly The Global Economy newsletter.Jörgen Kennemar, +46-8-5859 7730 5 (5)