So, we’ve seen a bounce in the American and Australian economies recently. In the US, September has proved better than August with a modest lift in the manufacturing indices, consumer confidence and stable service sector activity, even if personal consumption has stalled. Markets are betting on a decent employment number tomorrow night.
In Australia, we’ve had a couple of months of better (but far from stellar) data, with a big bounce in consumer confidence, decent retail sales, a nice reversal in building approval, as well as runaway exports. There are also rumours of increased mortgage activity but nothing showing up yet in indices. I pin most of this on the general acceptance that rates have peaked, which began in late July.
For both of these economies, these positive outcomes have transpired against a dire background of deteriorating stock markets driven by ceaseless bumbling in Europe and declining global growth. So, it is time to ask, can we get through this OK?
I would like to say yes. I would like to say that the cycle is turning up again. There is one reason I can think of for why it might. The collapse of commodity prices, especially oil, has freed up some greater consumptive power.
But, sadly, I just don’t buy it. This is a head fake, a false signal, a bull trap. Why so?
A few weeks ago, the IMF answered the question nicely:
Relative to our previous World Economic Outlook last April, the economic recovery has become much more uncertain. The world economy suffers from the confluence of two adverse developments. The first is a much slower recovery in advanced economies since the beginning of the year, a development we largely failed to perceive as it was happening. The second is a large increase in fiscal and financial uncertainty, which has been particularly pronounced since August. Each of these developments is worrisome—their combination and their interactions more so. Strong policies are urgently needed to improve the outlook and reduce the risks.
Growth, which had been strong in 2010, decreased in 2011. This slowdown did not initially cause too much worry. We had forecast some slowdown, due to the end of the inventory cycle and fiscal consolidation. One-time events, from the earthquake and tsunami in Japan to shocks to the supply of oil, offered plausible explanations for a further slowdown. And the initial U.S. data understated the size of the slowdown itself. Now that the numbers are in, it is clear that more was going on.
What was going on was the stalling of the two rebalancing acts, which we have argued in many previous issues of the World Economic Outlook are needed to deliver “strong, balanced and sustainable” growth.
…The first leg is fiscal policy. Fiscal consolidation cannot be too fast or it will kill growth. It cannot be too slow or it will kill credibility. The speed must depend on individual country circumstances, but the key continues to be credible medium-term consolidation.
…The second leg is financial measures. Fiscal uncertainty will not go away overnight. And even under the most optimistic assumptions, growth in advanced economies will remain low for some time.
…The third leg is external rebalancing. It is hard to see how, even with the policy measures listed above, domestic demand in the United States and other economies hit by the crisis can, by itself, ensure sufficient growth. Thus, exports from the United States and crisis-hit economies must increase, and, by implication, net exports from the rest of the world must decrease. A number of Asian economies, in particular China, have large current account surpluses and have indicated plans to rebalance from foreign to domestic demand. These plans cannot be implemented overnight. But they must be implemented as fast as possible. Only with this global rebalancing can we hope for stronger growth in advanced economies and, by implication, for the rest of the world.
I know, I know, the IMF has a questionable record, but on this occasion they look spot on to me. The US has planned (if not yet in detail) roughly 1.5% of GDP in fiscal cuts for next year. Europe has ongoing austerity and blowback on its banks. It may be able to pass the Greek bailout but larger measures are far distant and will require greater crisis to move forward. Driven by this troubled backdrop the $US has begun to rise and without further quantitative easing will continue to do so, choking off external demand for US goods. This will also continue to damage commodity prices, which will retard emerging market growth, even if it benefits China some.
That’s it. Not that complicated. There’s simply no evidence for how a virtuous cycle can form in the global economy next year. Conversely, there is evidence that a negative feedback loop is forming and will continue to do so.
That doesn’t mean we won’t get a big bear market rally. We probably will on some new European progress. Markets clearly want it. But in the end, the macroeconomic settings as they are currently projected will win.
