2013, a hopeful challenge looms in a hopeless setting
Going into the new year, developments will continue to be shaped by the 3GDs, i.e. the Great Deleveraging in the United States, the Great Divergence in Europe and the Great Dynamics in emerging economies. Nevertheless, they imply three very different economic dynamics on a twelve month horizon.
Regarding the world economy as a whole, we distinguish two possible directions after the end of Q1 2013, by which time a number of important risks are expected to have been addressed by policy makers. Our central scenario is optimistic. It assumes a return of growth over the second half, on the back of constructive outcomes on the following main issues: the fiscal cliff and the debt ceiling in the United States and a few more steps in the process towards resolving the European debt crisis. In accordance with an alternative scenario, some or all of these issues would not, or will be only partially addressed and have a negative impact on economic growth rates as well as risk assets in financial markets.
US economy: likely to accelerate in the second half
The Great Deleveraging in the United States is progressively shifting into a new phase. After four years of deleveraging in the private sector (private debt/GDP decreasing by 6 percentage points between 2008 and 2009 and 14 percentage points between 2009 and 2012), the sector looks set to re-leverage, as it is currently running a financial surplus. A better anchoring of the increasing trend in consumer and corporate credit therefore appears a reasonable assumption. With private real estate prices starting to increase, mortgages may also start to rise, leading in fine to more selfsustained US GDP growth, which may accelerate during the second half of 2013. Meanwhile, the US government is not likely to start its own phase of deleveraging going into the new year. In the short run, the US economy faces two very specific – and systemic – risks: 1) the fiscal cliff and 2) the renegotiation of the debt ceiling. Regarding the first, the worst outcome could see tax increases shave 4% off GDP growth. However, this outcome is not our core scenario as a deal to extend tax cuts (such as the Bush era tax cuts, i.e. 1.6% of GDP), is likely to be reached in Congress. Our core scenario is based on our belief that Congress will push through measures to curb the negative effects of the fiscal cliff to around one percentage point of growth. Regarding the debt ceiling, it will have to be raised by early March at the latest. A deal between Republicans and Democrats appears to be the most likely outcome, as the national interest should prevail for both parties. We suggest reassessing the political situation in the US towards the end of the first quarter of 2013. Once the negative effects of the fiscal cliff and the debt ceiling hurdle have been addressed, the improvement in fundamentals pertaining to the private sector in the United States is likely to provide an ever more support to consumption and investment. Thus, job creation dynamics may progressively improve with growing investment, as households and businesses gradually start re-leveraging. Furthermore, the Federal Reserve (Fed) is expected to continue to purchase mortgage backed securities (MBS) under its QE3 programme until employment conditions improve significantly. As a result of US fundamentals, and in a central scenario, US GDP growth may well pick up from 1.5% in the first half of the year to 3% in the second.
Europe: a feeling of recession on the cards
In Europe, the Great Divergence (i.e. the divergence between slowing economic growth rates and increasing debt levels) which underlies the European systemic debt crisis, is most likely to be exacerbated by lacklustre GDP growth and stifled competitiveness over the next year. Regarding the debt situation, having used the first two of the three main options to address the states’ over-indebtedness, i.e. 1) transfers – mainly through the European Stability Mechanism (ESM) – and 2) monetisation under the European Central Bank’s long-lerm refinancing operations (LTROs) and OMTs, the euro area’s authorities and the IMF are likely to acknowledge the increasing need to implement 3) a restructuring of the public debts of Greece, Spain, Portugal, Ireland and even, perhaps, Italy. The public acknowledgment of this need may well come by year-end or at the beginning of 2013. As a result, having addressed the liquidity component of European systemic risk through the ECB’s QE-like interventions (LTROs and OMTs), the solvency component may also, albeit very slowly, be addressed. Looking beyond 2013, Europe may, through a Banking Union and perhaps even a Fiscal Union, return to growth and higher competitiveness, further addressing the solvency component of systemic risk. Thus, with the right policies, from a state of fragmentation, Europe could reach normalisation. But clearly, this is not likely to happen within the next 12 months, unless a major competitive – possibly through economic policy – shock occurs. Hence, with the underlying forces of the Great Divergence deeply rooted, growth in Europe is likely to remain subdued at around 0%, giving rise to a feeling of recession.
Sustainable growth in emerging economies
The Great Dynamics of emerging economies could lead to sustained GDP growth rates, well above those seen in developed ones: if required, governments in these economies and their central banks have reassuring leeway to adopt further expansionary economic policies. With regards to China in particular, its economy is likely to see its real growth rate bottom out around 7.5% going into 2013. With authorities likely to intervene with the appropriate monetary and fiscal measures if growth does temporarily fall below 7%, the scenario of a hard landing in China seems unlikely.
Globally, there are some risks to our optimistic scenario, due to limited visibility on developments in the US and the European economies, which largely depend on political decisions. The negotiations associated with the fiscal cliff and the debt ceiling in the US, as well as the slow progress towards resolving the European debt crisis may hurt growth rates significantly under an alternative scenario.
In such a scenario, growth in the US would come in below 2% and Europe would experience a recession.