Global investor sentiment is now not only split down the middle, but the split is getting deeper and wider. The optimists and pessimists are further apart than ever. Those who insist “the worst is behind us” are clashing with those who fear we could face another big lurch. I’ve noticed lately that such forecast polarization is often apparent even within individuals. Seasoned financial professionals flit from bullish to bearish, from “risk on” to “risk off”, sometimes within the same conversation. There is profound uncertainty, with recent share price rises seeming to compound the sense of confusion, rather than providing “relief”.
The outlook for the world economy – at least the Western world – seems grim. The International Monetary Fund’s newly updated World Economic Outlook says global growth will be significantly weaker than previously thought, with the eurozone as a whole likely to go into recession, even if another “Lehman moment” is avoided.
It’s easy to criticize Mitt Romney. The former Massachusetts governor and erstwhile runaway leader in the Republican nomination race has had a bad two weeks. First Romney learnt that, having “won” the opening Iowa caucus, he actually lost on a re-count. In the South Carolina primary, he was trounced by Newt Gingrich after a lackluster debate performance.
Romney then bungled his personal tax return, insisting he wouldn’t make it public for months, then releasing it anyway. This is bad timing for the man seeking to be the first Mormon President. The still-fluid Florida primary is this week. There’s just a month before “Super-Tuesday” – when Republicans in 10 states pick their candidate – and the Presidential election itself is only nine months away.
“Nothing is safe that does not show it can bear discussion and publicity”. These words, among the many pearls uttered by the celebrated 19th century historian Lord Acton, have often come to me in recent years, as the sub-prime crisis has unfolded. They’ve been particularly on my mind over the last week or so, as I’ve watched events in the eurozone.
Investor sentiment in Western Europe appears to have improved over the last few days. In the aftermath of last weekend’s French sovereign downgrade, financial markets have staged a counter-intuitive rally, with European equities reaching a five-month high on Thursday. At the same time, and perhaps even more surprisingly, France and Spain between them off-loaded no less than €14.6bn of government paper last week, at relatively favourable borrowing costs.
The UK government claims Britain is a safe haven”. On the surface, that looks true. Ten-year sovereign yields dipped below 2pc during the last week of 2011. As Chancellor George Osborne often points out, UK state borrowing costs are now similar to those of Germany. In fact, they are at their lowest since the late 19th century. For the Tory high command, benign market interest rates are the ultimate justification for their “austerity” programme. The coalition has apparently convinced global investors its commitment to fiscal probity is deadly serious.
Labour’s economics team and their media cheerleaders conversely claim, ad nauseum, that the government has cut public spending “too far and too fast”. The Tories retort that Labour’s old-fashioned Keynesian alternative – to borrow and spend much more – would be disastrous. If Shadow Chancellor Ed Balls got his way, and the government let public spending rip, the UK would instantly lose its triple-AAA credit-rating and the country would have trouble rolling over its huge debts. A creditors’ strike would ensue, resulting in unpaid state wages, a plunging currency, spiking inflation and serious social unrest. On that score, the government is correct.
The global economy will grow by around 3pc this year, down from 4pc in 2011. The US should manage a 2pc expansion, while Britain and the eurozone will struggle. A West European recession, the UK included, now looks unavoidable. The emerging markets, meanwhile, will keep forging ahead during 2012. Even if China slows a bit, the world’s second-largest economy should expand by 8-9pc. The “big four” emerging markets – China, India, Russia and Brazil – now make up a quarter of the global economy. These “emerging giants” will account for the lion’s share of world growth in 2012, just as they did in each of the last three years.
Such countries aren’t insulated from the Western world’s sovereign debt debacle. Far from it. But with lower debts, much higher reserves, relatively stable banking systems, and trading ever more between themselves, the emerging markets will out-pace the “advanced industrialized nations” this year too.
A serious global slowdown looks likely in 2012 – or, at least, that’s the way conventional wisdom is shifting. The eurozone, of course, remains the epicentre of world-wide angst, its debt crisis threatening to cause havoc across an economy about the same size as that of America. Eurozone sovereign yields eased slightly last week, but massive questions remain.
Will the “Merkozy” plan work? Will Germany print money? Will monetary union be slimmed-down in a relatively ordered manner, with some smaller countries leaving? Or will the entire structure collapse, the Pan-European edifice crashing down amidst chaos and recrimination? No-one knows. But the stakes are now so high, and the doubts so acute, that just the threat of a “euroquake” has brought the global economy, in the eyes of some, to the brink of recession.
Angela Merkel “vows to build fiscal union,” we were told on Friday, after the German Chancellor’s speech to the Bundestag. I just don’t buy it. Market denizens are desperate for “fiscal union” before the end of the year. The phrase is code for the mighty Germany agreeing to stand behind the liabilities of the more profligate single currency members – something that frazzled debt markets crave.
Berlin will only allow the European Central Bank to let rip, the argument goes, firing up the “virtual” printing press like the US Federal Reserve and the Bank of England, if Germany exerts more control over the spending of other eurozone governments. So “fiscal union”, while under-pinning bond prices, would also spark the mother of all equity market rallies, as the ECB sprayed-out QE funny money. Shares would surge across the globe – which would be nice, just in time for Christmas.
The Anglo-Saxon world is feeling smug this weekend. UK and US policymakers are counting their blessings they’re not directly embroiled in the historic debacle that is the single currency. This euro-crisis is obviously very seriously undermining global investor sentiment. The negative impact on growth, both in Britain and the States, is clear. It is axiomatic that the financial chaos stemming from a fully-blown, market-induced “euroquake” would cause deep aftershocks everywhere, not least across the rest of the Western world.
There is palpable relief, though, in London and Washington, that attention is now squarely on the eurozone’s woes. That makes life easier for the deeply-indebted Anglo-Saxon governments – which is particularly welcome for Chancellor George Osborne, given that he’s about to give his Autumn Statement. Osborne’s speech writers will, no doubt, make much of the fact that UK government bond yields last week went below those of their German counterparts. That happened, though, not because the coalition’s debt-reduction plan became more credible. On the contrary, the upending of the UK’s growth assumptions has made it even less likely that Britain’s fiscal numbers will add up.
“There’s no such thing as an orderly break-up”, argued my friend, a perceptive and highly-educated man, as we discussed the eurozone over dinner. His argument was that a down-sizing of the single currency should be resisted at all costs.
“The prospect of one or more countries leaving, or being forcefully ejected, is now very real, whether you like it or not,” I replied. “So we should face reality, take the decision, prepare for it now, and do what we can to manage the transition, rather than enduring the horrendous consequences of a market-imposed outcome”.
European debt and equity markets ended a tumultuous week with a rally on Friday. So shares in the US and across the rest of the world rose too. But the threat of a “euroquake” – a systemic collapse which would make Lehman Brothers look tame – is by no means over. Far from it.
Europe’s leaders don’t know how to solve this crisis because they don’t know what they want. Should attempts be made to hold the eurozone together, with Greece staying in? Or should the threat to expel Athens be followed through, at the risk of causing further defections, with monetary union being reduced to a Franco-German rump? This is an enormous question, which only Germany can answer. Until an answer is forthcoming, chaos will continue to ensue.