America, the euro zone and the emerging world are heading in different directions
THIS year has turned out to be a surprisingly good one for the world economy. Global output has probably risen by close to 5%, well above its trend rate and a lot faster than forecasters were expecting 12 months ago. Most of the dangers that frightened financial markets during the year have failed to materialise. China’s economy has not suffered a hard landing. America’s mid-year slowdown did not become a double-dip recession. Granted, the troubles of the euro area’s peripheral economies have proved all too real. Yet the euro zone as a whole has grown at a decent rate for an ageing continent, thanks to oomph from Germany, the fastest-growing big rich economy in 2010.
Consumer and business confidence is rising in most parts of the world; global manufacturing is accelerating; and financial markets are buoyant. The MSCI index of global share prices has climbed by 20% since early July. Investors today are shrugging off news far more ominous than that which rattled them earlier this year, from the soaring debt yields in the euro zone’s periphery to news of rising inflation in China.
On the rise, on the edge, on the never-never
Begin with the big emerging markets, by far the biggest contributors to global growth this year. From Shenzhen to São Paulo these economies have been on a tear. Spare capacity has been used up. Where it can, foreign capital is pouring in. Isolated worries about asset bubbles have been replaced by a fear of broader overheating. China is the prime example (see article) but by no means alone. With Brazilian shops packed with shoppers, inflation there has surged above 5% and imports in November were 44% higher than the previous year.
Cheap money is often the problem. Though the slump of 2009 is a distant memory, monetary conditions are still extraordinarily loose, thanks, in many places, to efforts to hold down currencies (again, China leads in this respect). This combination is unsustainable. To stop prices accelerating, most emerging economies will need tighter policies next year. If they do too much, their growth could slow sharply. If they do too little, they invite higher inflation and a bigger tightening later. Either way, the chances of a macroeconomic shock emanating from the emerging world are rising steeply.
In the short term growth will surely slow, if only because of government spending cuts. In core countries, notably Germany, this fiscal consolidation is voluntary, even masochistic. The embattled economies on the periphery, such as Ireland, Portugal and Greece, have less choice and a grim future. Empirical evidence suggests that countries in a currency union are unlikely to be able to improve their competitiveness quickly by screwing down wages and prices (see article). Worse, the financial consequences of a shift to a world where a euro-area country can go bust are only just becoming clear. Not only do too many euro-zone governments owe too much, but Europe’s entire banking model, which is based on thorough integration across borders, may need revisiting (see article). These difficulties would tax the most enlightened policymakers. The euro zone’s political leaders, alas, are a fractious and underwhelming lot. An even bigger mess seems all but certain in 2011.
America’s economy, too, will shift, but in a different direction. Unlike Europe’s, America’s macroeconomic policy mix has just moved decisively away from austerity. The tax-cut agreement reached on December 7th by Barack Obama and congressional Republicans was far bigger than expected. Not only did it extend George Bush’s expiring tax breaks for two years, but it also added more than 2% of GDP in new breaks for 2011 (see article). When this is coupled with the continued bond-buying of the Federal Reserve, America is injecting itself with another dose of stimulus steroids just when Europe is checking into rehab and enduring cold turkey.
The result of this could be that American output grows by as much as 4% next year. That is nicely above trend and enough to reduce unemployment, although not quickly. But America’s politicians are taking a risk, too. Even though their country’s long-term budget outlook is famously dire, Mr Obama and the Republicans did not even try to find an agreement on medium-term fiscal consolidation this week. Various proposals to fix the deficit look set to gather dust (see article). Bondholders, who have been very forgiving of the printer of the world’s chief reserve currency, greeted the tax deal by selling Treasuries. Some investors, no doubt, see faster growth on the way; but a growing number are worried about the size of America’s fiscal hole. If those worries take hold, the United States could even see a bond-market bust in 2011.