The US, Eurozone and China are the three largest economies on earth. Each has been hoping the other two would help pull the global economy out of its seemingly never-ending malaise. Last week brought worrying signs, though, that while the eurozone’s woes aren’t easing, on-going concerns about monetary union are now impacting alternative growth centres too, imposing real damage on commercial activity in other parts of the globe.
For most of the past year, of course, the eurozone has been on the verge of a fully-blown economic collapse. Investor angst has further intensified in recent weeks, since inconclusive Greek elections on 6th May. It is now widely accepted that Greece could be thrown out of the euro, if it keeps thumbing its nose at the austerity measures imposed by member states bank-rolling Athens’ continued sovereign bail-out.
The possibility of a Greek exit, and the related contagion if investors lost faith in the solvency and future membership of other single currency “peripherals”, is taking its toll on the region’s real economy. The eurozone’s PMI Manufacturing Index plummeted to 45.1 in May, well below the 50-point level which indicates growth. After ten straight months of contraction, this marked a three-year low. The French Manufacturing PMI similarly slid from 46.9 to 44.7 last month, its Spanish equivalent from 43.5 to 42.0. Even Germany’s index faded to 45.2 from 46.2 in April, its lowest level since June 2009, the trough of the post-Lehman doldrums.
Little wonder, then, that eurozone unemployment just hit 11pc, a euro-era high. Spanish unemployment is an intolerable 24pc – the kind of level that could spark, not just protests, but serious civil unrest. As the economic and political pressure mounts, financial markets are showing signs of acute strain. Spain’s 10-year sovereign bond yield is once again approaching an unsustainable 7pc, its Italian equivalent back above 6pc. As the eurocrats toy with “Grexit”, Spain is trying to plug holes in regional budgets, while de-fusing the incendiary off-balance sheet liabilities of its rancid banking sector.
For now, Madrid needs a quick €19bn to recapitalize Spain’s third biggest bank. But investors are starting to realize that when it comes to the Eurozone’s fourth-biggest economy, an economy perhaps “too big to bail”, Bankia is just the tip of the liability iceberg. As such, the euro tumbled below $1.23 last week, to a 23-month low, with the Stoxx Europe 600 equity index giving up all its 2012 gains.
What also happened last week, though, was that the macro-data alarm bells began ringing so loudly elsewhere – particularly in the US and China – that they can no longer be ignored. So global investors are now focusing not just on the potential financial impact of Europe’s troubles – via contagion if there’s another “Minsky moment” – but on the real economic damage already being caused elsewhere by the eurozone’s current paralysis.
The US is spluttering badly. The country’s bellwether “payrolls report” showed only 69,000 new jobs in May, well below market expectations of 150,000-plus. The figure for April was revised down from 115,000 to 77,000. America’s first quarter GDP growth, meanwhile, having been marked at 2.2pc, was down-graded to 1.9pc. The Dow Jones Industrial Average, like its eurozone equivalent, is now at its lowest point this year.
So that leaves China. The People’s Republic is suffering too, because the eurozone is its biggest market, buying a fifth of all Chinese goods exports. In May, China’s Manufacturing PMI fell from 53.3 to 50.4 – its seventh successive monthly contraction. Real estate prices, the store of wealth for much of China’s middle-class, are now at a 16-month low. China grew by 7.9pc during the first three months of 2012, but this marked the sixth successive quarterly deceleration. Full-year GDP growth is on course to hit its lowest level since 1999.
Last month, China’s central bank lowered reserve ratios by 50 basis points, the third cut in six months, in a bid to boost the economy. But investors have lately been spooked by signs that Beijing is reluctant to really whack the “stimulus button”. In 2008, the Chinese government rushed to spend its way out of trouble, using reserves rather than more borrowing of course, in stark contrast to the Western world. The massive 4,000bn yuan package, then equivalent to $590bn, did the trick in terms of growth. Yet the lending boom it unleashed has raised fears of a bad-loan crisis, with China, uniquely among the large emerging markets, now seen as a candidate for a sub-prime crisis of its own.
“Current efforts for stabilising growth will not repeat the old way of three years ago,” boomed the state-run Xinhua newspaper last week. The fact that even China, with its $1,500bn of reserves, is worried about launching another mega bail-out should focus the minds of even the most determined optimists.
Back in the 1970s, the eurozone economies, then among the most dynamic on earth, generated 20pc of global growth. Over the last decade, this growth-share has fallen to 5pc. Yet the single currency area still accounts for over a fifth of the global economy. More fundamentally, the region’s banking sector is so distressed, and many of its governments so close to insolvency, that “Eurogeddon” could spark a world-wide shock-wave every bit as damaging as Lehman. And this time there is far less scope for fiscal and monetary bail-outs – not only in Europe, but in the US and elsewhere too.
The UK, of course, already in recession and reliant on the eurozone to buy more than half its exports, is among the most seriously exposed. In May, Britain’s Manufacturing PMI index nose-dived to 45.9, the weakest reading since May 2009, down from 50.2 the month before. This marked the second biggest one-month drop in 20 years.
Global markets are clearly skittish. The only thing that has stopped asset prices falling further, perhaps, is the belief that escalating market turmoil could push central banks into action – not just the ECB, but the Bank of England and Federal Reserve too. That’s why gold prices are firming up once again. It’s also why the dollar index, typically inversely correlated with investor risk appetite, has lately shown signs of reversal.
While the prospect of more QE has helped some “risk assets” in recent days, most investors are scrambling for “safety”. So 10-year US sovereign borrowing costs have fallen to a record low and gilt yields are at rock bottom too. On some 2-year German government bonds, yields went negative last week, with investors so desperate for a perceived “haven” that they’re willing to pay for the privilege of lending Berlin money.
We must ask ourselves though, as the global macro data deteriorates, and the eurocrats keep squabbling, are the “safe havens” really safe? The US and Germany, as well as the UK, have government debt-to-GDP ratios approaching 100pc, even more including off-balance sheets liabilities. With the Fed now poised to unleash QE3, more Bank of England money-printing on the cards, and even Germany now openly calling for more inflation, real terms losses, even on relatively short-term “safe” government paper, are practically guaranteed. And that’s assuming that the US, Germany and UK can manage to limit the damage to relatively low-impact “soft default” over the coming months and years, avoiding the horrors of an all-out creditors’ strike.
When the safe havens are no longer seen as safe, that is the moment when genuine panic ensures. That’s a question worth pondering, as we approach the pivotal Greek election re-run on June 17th.