The global cyclical recovery will continue
Summary: Three articles in this Wednesday and Thursday’s Wall Street Journal highlighted that data point to a continued cyclical recovery despite a lot of doom and gloom from all sides. Let me post extracts from those articles I would like to highlight and make a few comments of my own.
Europe’s longest recession since World War II appears to be on the verge of ending, driven by a surge in German growth that is helping to blunt the severe economic pain faced by many in the region, but is too modest to lift the global outlook.
A string of recent economic data, including a robust German industrial production report on Wednesday, has boosted hopes that the 17-member euro zone has returned to weak growth after six quarters of contraction. German industrial production in June jumped 2.4% from May, the country’s economy ministry said Wednesday, beyond economists’ expectations for a 0.3% gain.
The positive news from Germany followed an upbeat survey of purchasing managers in the euro zone last week and signs of slowing recessions in Italy and Spain—the region’s third- and fourth-largest economies. Across the Channel, the Bank of England upgraded its growth forecasts on Wednesday. And Portuguese unemployment fell for the first time in two years.
China’s economy is showing signs of stabilizing after a six-month slowdown, adding to better global economic prospects as the U.S. steadily improves and Europe edges out of recession.
July trade data released on Thursday showed stronger-than-expected global demand for China’s exports, good news for the key manufacturing sector. As important, a greater-than-expected increase in imports suggested strengthening demand in China’s domestic economy.
The data followed a survey of manufacturing companies released last week that showed modest expansion in Chinese factory activity in July.
Economic growth in Europe, the U.S. and Japan is set to pick up in the months ahead, while China and some other large developing economies will slow, according to the Organization for Economic Cooperation and Development’s composite leading indicators.
The leading indicators signal a shift in the drivers of global growth that since 2008 have been led by developing economies, but these are now struggling to recover from the effects of the financial crisis.
just as the euro zone appears set to return to modest growth, there are signs expansion in a number of large developing economies is set to weaken, with the leading indicators for June pointing to continued slowdowns in China, Brazil and Russia.
The shift in growth is likely to have a continuing impact on financial markets, with some of the capital that chased high growth and returns in developing economies being redirected toward developed ones.
The composite story these articles tell is the same one I have been telling for the past few months: we are still in a weak recovery from the financial crisis globally. Where Europe had been the laggard emerging markets are the weakest link. What does this mean for the global economy and markets?
First, I think it means that Europe will be stronger economically than many anticipate. After years of waiting for a collapse of the euro zone, the uptick in the economy will be a well-needed respite. Nevertheless, while the economies of the periphery might improve somewhat, they are not going back to robust levels of growth. And while that’s a problem delayed, it’s still a big problem. Remember, these countries have high private and public debt levels, poor demographics, no ability to generate excess inflation and depreciate the currency and only a partial and implicit backstop from the central bank. A respite is nice. But it doesn’t mean the crisis is over by a long shot. Over the medium term I expect a few upside surprises. But eventually we will see recession again and by that time the same questions about eurozone breakup will be asked.
Second, the US and Japan are going to grow faster because they have more stimulative policy mixes. I am concerned here as well that the problems are being papered over, however. As yet again, we have the same problems of high levels of private debt and levels of public debt that are high enough to limit political policy space despite currency sovereignty. The central bank in the US and Japan can print money and buy government liabilities. That takes default off the table and it puts Japan and the US in better shape than the euro zone over the medium-term. But it doesn’t bring back growth or solve the problem of high private debt levels. What happens in Japan or the US in a recession with policy rates at zero? I believe we are likely to see governments thinking about private debt jubilees or some other mechanism of erasing the mountains of private debt retarding credit growth.
Third, as I have been saying, policy makers in China will only allow the slowdown to go so far before they turn back to stimulus. What this means over the longer-term is not yet clear as there is a lot of back and forth about the sustainability of the Chinese export-driven, capital and infrastructure investment driven growth model. Bulls say build it and they will come. Bears say they won’t come nearly quickly enough and you’ll have to write this stuff down. I am more in the bear camp on this one. But over the medium-term stimulus will work and I believe it will kick in in earnest by 2014. The real problems will be in other emerging markets that are more commodity dependent because the commodity cycle has turned down as China attempts to reallocate resources. Even if China returns to some stimulus, it won’t be enough for the commodity countries. India is also struggling right now. The bottom line is that emerging markets are going to be laggards for a while with China’s growth very much dependent on how much pain policy makers are willing to take as they switch growth models.
The macro picture then is somewhat brighter right now in aggregate than it has been for a few months now. I wouldn’t call myself a bull. But I am upbeat. I think this can continue for a while.