The World in 2013 – Prospects and Pitfalls February 14, 2013Posted by Ishmael Chibvuri in Latest Articles!!!.
Scan the forecasts of the world’s mainstream economists and you can’t help but feel guardedly optimistic about the year ahead. Global economic growth is expected to average around 2.5%, with some upside potential if things go well. The USA, still the world’s largest economy, should grow by around 2%; Europe might get into positive figures, and China could hit 8% if the final quarter growth of 2012 is carried into 2013.
In South Africa we can expect the economy to expand by around 2.8%, which is not great but neither is it a train wreck. Are these signs, almost six years later, that the “Great Recession” is finally behind us? Perhaps, but it may be a bit soon to be cracking open the Dom Perignon. While there are reasons to be hopeful there are also a number of potential nasties lurking in the wings.
On the positive side, the actions of the European Central Bank seem to have averted the collapse of the euro. Certain of the peripheral European economies are still weak, with major unemployment issues, but green shoots of hope are emerging.
For example, problem children Spain, Portugal and Ireland have shown higher growth in exports than Germany since 2011, and have significantly reduced their balance of payment deficits. Even Greece has reduced its deficit to 3.5% of GDP, down from 15% in 2008. Bond rates have also fallen in Spain and Ireland, allowing these previously beleaguered economies to borrow more cheaply. Most importantly, despite rumblings from the German people, Germany seems firmly committed to holding the EU together.
In America Obama starts his second term in office, unencumbered now by concerns over re-election. The fiscal cliff has been avoided, constraints imposed by global oil supplies are receding due to the development of shale resources in the US, and improved economic growth is in sight. And China, the world’s number two economy, seems set for a period of stable GDP growth of around 7.5% to 8% per annum.
Unfortunately, Murphy’s Law reminds us that if things can go wrong they more than likely will. While this is unduly pessimistic, there are undoubtedly a number of issues that could put a spoke in the wheel of the global economic recovery. Let’s consider the potential pitfalls on a country-by-country basis:
Perhaps the biggest potential threat to growth in America this year relates to issues around its debt situation. As things stand, America is going to bump up against its debt ceiling sometime in the first quarter of 2013. The debt ceiling refers to the maximum amount that the USA can borrow at any time, and currently stands at $16.394 trillion. The problem is that American spending is out of hand, yet the needs are such that the current administration must shortly convince Congress to raise the debt ceiling again.
To illustrate the extent of the problem, when the debt ceiling issue raised its head early in 2011 Congress signed off on a $2.4 trillion increase in the borrowing level. Attached to this deal was an agreement that certain tax concessions would be phased out, other taxes would rise, and government spending would be slashed. This had to happen at the beginning of 2013, thereby giving rise to the “fiscal cliff” problem at the end of 2012.
By the end of 2012 it became clear that the agreed measures would have a disastrous effect on America’s economy, knocking an expected 4 percentage points off 2013 growth and plunging the country back into recession. And so Obama needed Congress to agree to a greatly watered-down version of the original agreement. As we now know an eleventh-hour deal saw a slight increase in taxes, and a deferral of the spending cuts for a further two months. But a problem deferred is not a problem solved, hence the increasing concerns over the debt ceiling negotiations.
The fact that America managed to spend $2.4 trillion in less than two years is worrying a lot of people, particularly the Republicans in Congress. Any increase in the debt ceiling is therefore bound to be tied in to tough agreements on near and long-term spending. The nature of these agreements will significantly impact America’s economic growth this year; the more they impose spending cuts, the greater the “fiscal drag” and the lower the economic growth in 2013.
There is however a larger issue at stake. In recent years the world has watched with growing unease as America’s debt levels have burgeoned. Based on present forecast levels of GDP growth, the expected increase in the debt ceiling will allow the USA to maintain its debt to GDP ratio at stable levels for the next six years or so. This is reassuring to those who are going to lend to the US in the future, as it suggests stability and the likelihood that the debt will be repaid.
However, if spending cuts limit or stall the expected economic growth, borrowing as a percentage of GDP is going to climb. This leads to a vicious circle, as a smaller economy means lower government revenues and a decreased ability to repay debt. Investors are going to be increasingly unlikely to buy new US bonds, leading to the unthinkable but very real danger that America could default on its debts. The effects on markets world-wide would be disastrous, and could trigger another global financial crisis.
While this may appear to be a doomsday scenario, an increasing number of commentators are becoming concerned at America’s unwillingness to come to terms with its spending and debt issues. Economists refer to the “substantial fiscal adjustment” that must come in the USA, and acknowledge that this will be a reality for years to come. However, the further “the can is kicked down the road,” to be dealt with in the future, the higher the debt ceiling and the greater the possibility that an unexpected economic setback could plunge America, and the world, into crisis.
Europe (and others)
The Eurasia Group, a consultancy which assesses geopolitical and geo-economic risks, warns that Europe needs to find a formula for restoring economic growth on a broader basis. Until such time as it does so, “the Eurozone cannot be put in the rear-view mirror. We’re not quite there in 2013.”
As discussed earlier, export initiatives seem to be throwing certain troubled Eurozone states a lifeline. However, it must be said that much of their export growth came in the first half of 2012, when the euro was weaker. It has since strengthened by some 14% against the yen, for instance, a factor that has already hurt exports. The reasons for the strengthening of the euro lie in the fact that other major global currencies have weakened. At first glance this seems strange, but becomes clear with further analysis. The explanation, however, represents another cloud on the economic horizon.
At the beginning of the financial crisis one of the big fears was that protectionism might break out. In other words, countries might be inclined via import duties and other mechanisms to limit imports while at the same time attempting to grow their exports. This was one of the errors made in the 1930s, resulting in a prolonging of the depression. Luckily protectionism did not occur this time around, as at one of the first G20 meetings in 2008 countries agreed that co-operation would be more beneficial for all than confrontation.
However, Simon Derrick, chief currency strategist at Bank of New York Mellon, has warned of an outbreak of currency wars. It appears that, when growth is hard to come by, currency manipulation can achieve the same aims as protectionism. Although it is harder to detect Derrick believes that we are now seeing evidence of it.
The first culprit is Japan, who under new Prime Minister Shinzo Abe recently launched a 10.3 trillion yen stimulus package to boost the stagnant Japanese economy. He also urged the Bank of Japan to adopt a looser monetary policy and a higher inflation target, a signal seen by many as a deliberate attempt to drive the yen lower to boost exports.
One might see this as a legitimate economic policy to address Japan’s undeniable problems. The only snag is that Japan has pledged, in G20 meetings, not to do this. The reasons for compliance are clear when one considers the plight of South Korea, Japan’s biggest competitor in electronics, cars and other products. Thanks to Japanese initiatives to weaken the yen, South Korea has seen its currency strengthen by 22% against the yen since mid-2012.
This has hit Korean exporters, such as car manufacturer Hyundai, particularly hard. It has also led the Bank of Korea to intervene in the currency markets in an attempt to weaken its own currency, the won. It appears then that the first shots have been fired in the currency war between two of Asia’s largest exporters.
Japan is not the only country to appreciate the desirability in these times of a weaker currency. Since the global financial crisis began, America has quietly been pursuing a weak dollar policy via Ben Bernanke’s repeated bouts of quantitative easing (which has the same effect as printing more money; inflation rises and the currency weakens). The results are clear; the average value of the dollar is 12% down on its pre-crisis levels, and 31% below its value of a decade ago.
It is significant that the three biggest currencies in the world are the dollar, the euro and the yen. As we have seen, currency manipulation by Japan and America means that the euro can no longer compete in export markets with the dollar and yen.
The danger in all of this is not just an outbreak of all-out currency wars, but that a decline in exports in Germany and some of the peripheral European economies could threaten their wellbeing and stifle the fragile recovery in Europe. Jean-Claude Juncker, head of the Euro-group of finance ministers, said a couple of weeks ago that the euro’s rise “had taken it to dangerously high levels.” A worse-case scenario could see the collapse of Greece, Italy or Spain, and the demise of the euro itself. The consequences for markets and the global economy would be dire.
Although China’s growth in 2012 was its lowest in 13 years, it is believed that the country can continue to grow at around 7.5% to 8% per year for the foreseeable future. China does face a few economic headwinds: weaker demand from its major export markets such as the US, the Eurozone and Japan; increasing property prices which must be managed so as to avoid a property bubble; and surging levels of local government borrowing, coupled with questionable investments at the local level.
However, any threat to the global economy from China is not expected to be of an economic nature. According to the Eurasia Group, China’s already confrontational relationship with Japan “is probably the single most important, and dangerous, geopolitical conflict on the horizon in 2013.”
Worryingly, Japan is not the only nation involved. Eurasia Group notes that a more nationalistic China has veered away from its previous “charm offensive” approach to Southeast Asia, while simultaneously becoming more assertive in northeast Asia. America in turn has renewed its strategic and economic commitment to the region, thereby providing support to the many regional states seeking closer ties with the US. This has not gone down well in Beijing, leading to growing tension between the world’s two most important powers.
In his 2010 article on “The World in 2011,” Marketviews writer Charles Wilson had this to say:
“The relationship between the two (America and China) is perhaps analogous to the relationship, 100 years ago, between the world’s financial centre, Britain and its most dynamic industrial economy, Germany. Then, as today, there was a fine line between symbiosis and rivalry. Could a deterioration of political relationships between America and China today (over trade, Taiwan, Tibet, Korea…) trigger another major conflict like the one that happened in 1914? China’s rapid rise, and America’s equally rapid loss of power have created a dangerous situation. With the exception of the peaceful transition from Britain to the US after the First World War, such global power shifts have always involved armed conflict.”
A number of the concerns raised by Charles are still valid today, and might even be exacerbated by China’s increasingly belligerent attitude. The consequences arising from an armed conflict between America and China are not worth contemplating, however, and for all of our sakes we can only hope that this does not occur in 2013 or any other year.
Whilst adverse economic developments in South Africa’s main export markets (i.e. the USA, Japan and the Eurozone) could impact negatively on growth prospects, the greatest threats to prosperity in 2013 are more likely to be internal than external.
In the first instance, we are likely to see more populism as a strategy by the ANC, to maintain its base among the urban and rural poor. The danger of greater state intervention in mining and mining-related manufacturing is also a real one, as is the exertion in general of greater political influence over this sector.
We can also expect to see social spending initiatives, greater public sector employment, and more aggressive land reform policies in the run-up to the 2014 elections. Increased social unrest is also likely in 2013, spurred initially by retrenchments in the mining industry and spreading to the urban and peri-urban areas in the form of service delivery protests. There is also the risk of political violence as the ANC and opposition parties begin to prepare for national elections in 2014. All of this will add spending pressures on the ANC government and sap any reform momentum. Given the potential downside pressures, we may be lucky to see growth of 2.8% in 2013.
In the light of the above analysis it appears that we are still to shake off the hangover caused by the worst economic slowdown since the Great Depression. Fundamental economic problems must still be addressed in a number of the developed countries, while political risk continues to bedevil the developing nations. It can only be hoped that cool heads will prevail, and that we come to look back on 2013 as a further step along the winding road to recovery.
Given the potential for higher global inflation and heightened geopolitical tensions, the old safe haven of gold might be a worthwhile investment in 2013, even at current prices. Stock markets also tend to fare well in inflationary times, particularly those companies which can pass on inflationary cost increases to customers.