2012: Global Recovery or False Dawn?

It’s not just the warm winter or early spring – the global economy really is looking brighter now than in the dark days of November.

US growth has been accelerating, unemployment falling, and Obama’s re-election chances improving. The EU appears to have gotten a handle on its debt crisis, for now, and a spiral from Recession to Depression has been averted.

‘Super Mario’ (Draghi) has pulled a (Ben) Bernanke, stuffing European banks with cash. It would be a stretch to say that confidence has returned, but Armageddon is no longer feared imminent.

As a result, stock markets are powering ahead, the euro has rallied, capital is flowing to emerging markets, and commodity prices have spiked. It’s ‘Risk On’ as financial traders might say, and time to make hay.

Ireland has enjoyed a run of good news stories, bookended by the Obama and Jinping visits.  Investor confidence is returning that we can pull through without default. While this may be cold comfort to our ranks of unemployed, improvement in Ireland’s credibility abroad and a sustained global recovery are crucial to our own prospects for broad-based recovery and a return to ‘full’ employment.

Ireland is a small open economy where exports are about 100% of GDP. With imports of 80% of GDP, our positive trade balance makes up about 20% of our overall economy, and it is the only part showing meaningful growth.

Growth projections for Irish exports looked over-ambitious on budget day. Today, they look fanciful. Perhaps the biggest risks to global growth, and our export-led recovery, are Austerity, Debt, Oil and China.

Concerted global stimulus in the early days of the financial crisis helped prevent a Depression. Disaster averted, stimulus is being withdrawn and greater emphasis placed on debt sustainability. This phenomenon is not confined to Europe’s periphery.

The UK and Europe’s core are leading the austerity charge, while the US will follow suit in earnest once the 2012 election is in the rear view mirror. The fiscal pain is being eased somewhat through looser monetary policy everywhere, including in Europe since late 2011, but austerity will remain a drag on growth in developed markets for years to come.

The deflationary impact of fiscal austerity is compounded by an immense overhang of private sector debt, and Ireland is perhaps the most acutely affected. Increasing incidence of mortgage distress is only the tip of the iceberg. Over-indebted businesses and consumers are prioritizing repayment and saving over investment and spending. As these effects reinforce each other, domestic demand remains anemic.

Higher oil prices put recovery at risk by sapping the domestic demand of oil importers, and Ireland is one of the most highly dependent oil importers on the planet. Stronger than expected US and emerging market economies are stoking demand, while political volatility in the Middle East constrains supply. These factors conspire to put oil prices within striking distance of all-time highs, and the most immediate risk is of a spike higher, not lower.

China is the big economic success story of recent decades, growing by 10% per year on average since Deng Xiaoping initiated reforms in 1978. Half a billion people have been lifted from poverty. In turn, Chinese growth is driving commodity-led booms in Brazil, Russia and much of sub-Saharan Africa. In 2011, China became the second largest economy in the world, overtaking Japan. At current growth rates, it will be top dog by 2020 or soon after.

China’s export dominated growth model may be running out of road, however, and rebalancing in favour of domestic demand will become increasingly important. Moreover, regional growth imbalances have created incipient property bubbles, while the overall growth rate itself has slowed somewhat. China’s leaders appreciate these challenges and have begun taking necessary steps.

Transition brings risks, and China is currently undergoing two: the rebalancing of its economy, described above, and a political changing of the guard, notably to Ireland’s recent distinguished visitor. The urgency of the former will take a back seat to smoothing the latter. In the short term, this means China following the lead of the developed world by loosening monetary policy to boost credit.

Resorting to printing money has replaced concerted fiscal stimulus as the tool of choice for global policy-makers. This is an economic experiment on a mass scale. It may feel like it’s working right now, and it may well be the right course of action, but the long-term risks and ultimate beneficiaries are as yet unclear.

So, is the global economy’s glass half full, or half empty? Unfortunately, economists can’t predict the future, and they may not be able to tell us before it’s too late whether what we are seeing is light at the end of the tunnel, or an oncoming train.