In the past three months, stock markets worldwide have lost almost $9 trillion. In the absence of decisive, credible and internationally coordinated actions, the prospects of the world economy will be increasingly overshadowed by global stagnation, except for emerging Asia.
The world economy is deteriorating faster than anticipated. In April, stock markets worldwide soared to $59.2 trillion; in May and June, markets lost almost $2.9 trillion. In July, these losses more than doubled to close to $6 trillion.
In other words, during the past three months, stock markets across the world have lost almost $9 trillion – that is, some 15% from their peak in April.
At the same time, stagnation in all leading advanced economies has deteriorated significantly. “We have magneto trouble,” Keynes said in the 1930s. Today, the stakes are globally interdependent and, thus, far higher.
In the coming weeks, the world economy will have to cope with new, converging risks.
United States: From Stagnation to Uncertainty
In order to sustain its triple-A status, Washington needed an effective debt deal and a credible, long-term deficit-plan. A transparent one-stage, $4 trillion deal, perhaps over a decade, might have done the job.
However, the final compromise was a not-so-transparent two-stage, $2+ trillion deal. It was too opaque, too little, too late. And as if the economic crisis was not serious enough, the political drama associated with the deal process virtually ensured the downgrade.
The debate over the S&P downgrade misses the point: Killing the messenger will not destroy the message – Washington’s fiscally unsustainable trajectory.
The consequences were only to be expected. In the past few days – after some signs of recovery – Wall Street has suffered from the worst sell-off on Wall Street since fall 2008.
As the Fed announced that it would hold short-term interest rates near zero through mid-2013, it basically acknowledged that U.S. economy is about to face another two years of economic stagnation, uncertainty and volatility.
After almost three years of on-and-off global crisis, the structural prospects in the leading advanced economies (G-7) are now gloomier than ever since October 2008.
In Japan, GDP growth for fiscal 2011 has been revised to about 0%. The triple crisis will increase the gross public debt, which is already hovering at more than 210% of the GDP. In the medium-term, larger fiscal deficits and decreasing household saving rate are likely to push Japan toward a savings crisis.
In the short-term, however, the worst triggers of turmoil are originating from the Eurozone.
The Eurozone: Triple-A Pressures
Since spring 2010, Brussels has not only failed in crisis management, but may also have contributed to its progressive deterioration. During the past year, hundreds of billions of euros have been committed to the bailouts of Greece (EUR 110 billion), Ireland (EUR 115 billion), and Portugal (EUR 78 billion) and Greece déjà vu (EUR 109 billion).
As long as the crisis economies each represented less than 3% of the total Eurozone GDP, Brussels could defuse the crises. That, however, came with a dangerous trade-off. In the process, the risks of the insolvent crisis economies in the periphery of the Eurozone were shifted to the core of the region. As a result, uncertainty is climbing in the European banking system and in the European Central Bank System. In 2010, the Eurozone stress tests were not very stressful; in 2011, questions continue to fuel speculation and rumor mills.
With its current instruments, Brussels can no longer defuse the impending challenges. Initially, the spotlight hit Spain, which is suffering from debt of EUR 640 billion, while 20% of the work force is unemployed. After Madrid, markets targeted Rome. In Italy, the debt amounts to EUR 1.8 trillion. Unlike Greece or Portugal, these two nations – Italy and Spain – represent more than a quarter of the entire Eurozone GDP.
In the past few days, French markets have been in turmoil. That is only a taste of what’s to come. France is no longer immune to possible spillovers from the Eurozone crisis.
The UK has $1.8 trillion in total debt. As was only to be expected, the austerity measures have done little to support recovery. On the contrary, these measures are now contributing to riots, which have spread from London to other metropolitan centers.
Only Germany has a real triple-A economy, but it faces political volatility. Many, if not most, Germans no longer support Chancellor Merkel’s efforts to insure the Eurozone crisis economies.
Gloomy Days Are Here Again
In the U.S., the Eurozone, and Japan, efforts to muddle through the aftermath of the global crisis have failed.
As the Eurozone is deteriorating, pressures are increasing on most remaining triple-A countries: the major economies (France, Germany, UK), and even the tiny Nordics (Denmark, Finland, Norway, Sweden) and continentals (Austria, Switzerland).
The Nordics enjoy good fundamentals, but their growth is predicated on exports to the Eurozone. In the future, they, too, must revise and refocus their growth models. In Switzerland, quantitative easing has been seized to reduce pressure on the currency.
During the past decade, the high growth of the large emerging economies (China, India, Brazil, and Russia) has served as the most powerful growth engine for the world economy. Over time, this secular trend will only strengthen. In the near-term, some growth engines must cope with overheating, inflation, asset bubbles, and soaring food and energy prices.
If the leading advanced economies resort to more quantitative easing in the coming months, they will endanger the remaining growth engines of the world economy.
In the aftermath of political reforms, expectations have risen across North Africa and the Middle East. But a crisis of rising expectations is now erupting across the region. Unlike political reforms, economic development requires time; and time is running out in the region. In the markets, these tensions will translate to rising food and energy prices.
Already a month ago, it was relatively clear that, global growth would slow in the second half of the year 2011, due to the debt and default problems in the leading advanced economies (Eurozone, the United States, and Japan), and overheating in the large emerging economies (China, India, Brazil, Russia).
Today – given the deterioration of the Eurozone, the U.S. debt-ceiling debacle followed by the S&P downgrade – the fragile, multispeed recovery of the world economy is now threatened by converging, adverse trends.
In the absence of decisive, credible and internationally coordinated actions, the potential for a global storm is no longer just on the rise, but more than likely to materialize in the coming months.