The year started with a brace of extraordinary events: the Arab Spring and Japanese tsunami, causing economic shocks and deep dislocations around the world. Fears of a global recession then loomed large. The extraordinary fall in global markets in August and September was testament to these concerns.
The euro crisis was undoubtedly the dominant reason. The outline of a deal to address Greece’s unmanageable debt load proved too late to prevent contagion from spreading to Italy and Spain and even touching countries like France and Austria.
This pressure culminated in EU leaders (except David Cameron) declaring a euro-plus pact, which outlined concrete steps towards a fiscal union to complement the shared currency and to develop a liquidity provider as a backstop for banks. This could solve the immediate crisis, but the structure still needs work to generate growth.
Euro countries need budget discipline – something that bond markets aren’t used to imposing. However, that’s changing as part of the summit proposals, which include automatic penalties for violations of fiscal rules. And bond markets certainly differentiate now among borrowers. This could be vital, since countries will arguably respond to bond market pressure more than sanctions.
The Eurozone now needs a liquidity backstop like the IMF provides for the global economy. The attempt to create a temporary rescue fund (or EFSF) isn’t working because it’s limited by the fiscal capacity of the six AAA-rated countries in the Eurozone. A currency needs a central bank that is the lender of last resort to provide liquidity. The ECB doesn’t have that role. The crucial question is whether the EU summit deal provides the fiscal compact that might allow it to step up.
In the longer term, there’s also the question of exit. There are two criteria for being in an optimal currency area: trade integration and convergence of incomes. All 17 countries trade largely with each other, so the first is met. The second is tougher. For a country to grow sustainably in a monetary union requires it to be competitive. It can’t come from devaluing the exchange rate, so it has to be based on low cost and higher productivity. If a country doesn’t share growth prospects, then it’s not viable to share a currency.
Euro exit has been raised by German Chancellor Angela Merkel and French President Nicolas Sarkozy, so it’s become a question of coping with the consequences. This leads back to needing those key sources of support: liquidity backstop (EFSF or the IMF) and preferably a central bank that can step in – if it all goes wrong.
The ongoing debt crisis also puts Europe’s banking system under increasing stress. The European Banking Authority wants banks to recapitalise by €114.5bn (£96.16bn). Bloomberg reports that banks want to trim their balance sheets by €750bn in the next two years to raise the capital. It could mean another credit crunch.
Spencer Dale, the Bank of England’s chief economist, told me Britain could suffer a repeat of 2008 and that unless UK banks relatively quickly issue unsecured term debt “there’s a real risk that credit conditions in our economy could tighten further”.
The UK economy is already in recession according to John Llewellyn, an adviser to the Treasury. That echoes the forecast by the OECD that Britain is in a “mild recession” and is consistent with the flat growth expected by the Bank of England until the middle of 2013.
2012 also looks in danger of repeating the global recession of 2008. I recently hosted a panel of leading economists and they all warn that the world economy looks fragile. Standard Chartered’s chief economist Gerard Lyons – the most accurate economic forecaster in the world according to our assessment – sees the global economy growing at only 2.2 per cent but it’s a tale of two worlds: the fragile West, and the resilient East.
In the first half of 2012, Standard Chartered forecasts a deep recession in Europe, and that the US will grow at just 2 per cent. Even though emerging economies won’t be entirely de-coupled from Western woes, he expects that they will manage to grow as they’re better diversified than three years ago. We face another challenging year, but there are still some bright spots.
Linda Yueh is economics correspondent for Bloomberg Television. Watch The Economy and Yueh on Bloomberg Television from 26 December. Times at www.bloomberg.com/tv
Growth next year will be a tale of two worlds: a fragile West, and the resilient East