That Stalling Feeling
NEW YORK – Despite the series of low-probability, high-impact events that have hit the global economy in 2011, financial markets continued to rise happily until a month or so ago. The year began with rising food, oil, and commodity prices, giving rise to the specter of high inflation. Then massive turmoil erupted in the Middle East, further ratcheting up oil prices. Then came Japan’s terrible earthquake, which severely damaged both its economy and global supply chains. And then Greece, Ireland, and Portugal lost access to credit markets, requiring bailout packages from the International Monetary Fund and the European Union.
But that was not the end of it. Although Greece was bailed out a year ago, Plan A has now clearly failed. Greece will require another official bailout – or a bail-in of private creditors, an option that is fueling heated disagreement among European policymakers.
Lately, concerns about America’s unsustainable fiscal deficits have, likewise, resulted in ugly political infighting, almost leading to a government shutdown. A similar battle is now brewing about America’s “debt ceiling,” which, if unresolved, introduces the risk of a “technical” default on US public debt.
Until recently, markets seemed to discount these shocks; apart from a few days when panic about Japan or the Middle East caused a correction, they continued their upward march. But, since the end of April, a more persistent correction in global equity markets has set in, driven by worries that economic growth in the United States and worldwide may be slowing sharply.
Data from the US, the United Kingdom, the periphery of the eurozone, Japan, and even emerging-market economies is signaling that part of the global economy – especially advanced economies – may be stalling, if not dropping into a double-dip recession. Global risk-aversion has also increased, as the option of further “extend and pretend” or “delay and pray” on Greece is becoming less desirable, and the specter of a disorderly workout is becoming more likely.
Optimists argue that the global economy has merely hit a “soft patch.” Firms and consumers reacted to this year’s shocks by “temporarily” slowing consumption, capital spending, and job creation. As long as the shocks don’t worsen (and as some become less acute), confidence and growth will recover in the second half of the year, and stock markets will rally again.
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But there are good reasons to believe that we are experiencing a more persistent slump. First, the problems of the eurozone periphery are in some cases problems of actual insolvency, not illiquidity: large and rising public and private deficits and debt; damaged financial systems that need to be cleaned up and recapitalized; massive loss of competitiveness; lack of economic growth; and rising unemployment. It is no longer possible to deny that public and/or private debts in Greece, Ireland, and Portugal will need to be restructured.
Second, the factors slowing US growth are chronic. These include slow but persistent private and public-sector deleveraging; rising oil prices; weak job creation; another downturn in the housing market; severe fiscal problems at the state and local level; and an unsustainable deficit and debt burden at the federal level.
Third, economic growth has been flat on average in the UK over the last couple of quarters, with front-loaded fiscal austerity coming at a time when rising inflation is preventing the Bank of England from easing monetary policy. Indeed, inflation may even force the Bank to raise interest rates by the fall. And Japan is already slipping back into recession because of the earthquake.
All of these economies were already growing anemically and below trend, as the ongoing process of deleveraging required a slowdown of public and private spending in order to increase saving rates and reduce debts. And now, in addition to the string of “black swan” events that advanced economies have faced this year, monetary and fiscal stimulus has been removed in most of them, or soon will be.
If what is happening now turns out to be something worse than a temporary soft patch, the market correction will continue further, thus weakening growth as the negative wealth effects of falling equity markets reduce private spending. And, unlike in 2007-2010, when every negative shock and market downturn was countered by more policy action by governments, this time around policymakers are running out of ammunition, and thus may be unable to trigger more asset reflation and jump-start the real economy.
This lack of policy bullets is reflected in most advanced economies’ embrace of some form of austerity, in order to avoid a fiscal train wreck down the line. Public debt is already high, and many sovereigns are near distress, so governments’ ability to backstop their banks via more bailouts, guarantees, and ring-fencing of questionable assets is severely constrained. Another round of so-called “quantitative easing” by monetary authorities may not occur as inflation is rising – albeit slowly – in most advanced economies.
If the latest global economic data reflect something more serious than a hiccup, and markets and economies continue to slow, policymakers could well find themselves empty-handed. If that happens, the risk of stall speed or an outright double-dip recession would rise sharply in many advanced economies.