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August 11, 2010

Analysis: Stumbling America, debt-strapped Europe, booming China

8:17am EDT
By Jeremy Gaunt, European Investment Correspondent
LONDON (Reuters) – Strip away all the complexities facing the world economy at the moment and you come down to three interlocking puzzles: America, Europe and China.
Stumbling America, debt-strapped Europe and booming China, that is.
The three face different, sometimes contradictory, challenges. Yet they are so intertwined in this era of globalization that it is hard to imagine how events in one could possibly not spill over into the other.
Jim O’Neill and his economics team at Goldman Sachs recently sought to boil down the risks facing the world economy — and, by extension, financial markets — to three neat questions.
— How deep will the U.S. economic slowdown be and what will the policy response be? (That’s two questions, actually, but let’s not nitpick).
— How much decoupling is possible between the U.S. economy and others which are growing well, notably China?
— Will sovereign and systemic risks intensify again or settle? (A clear reference to the euro zone, where the Greek debt crisis has gone to sleep but not disappeared.)
For the record, Goldman believes the answers will not necessarily signify trouble. “Our own forecasts envisage a period of some muddiness in the near term that ultimately resolves toward a more positive global view,” it says.
But it also notes there are fragilities in the economic system which require open-mindedness about the risks.
Burrow down a bit and you can come up with three subsections, part of which come courtesy of Mike Dicks, head of investment strategy at Barclays Wealth. They are:
— America: Will the U.S. consumer stop spending?
— Europe: Will attempts to control debt snuff out nascent signs of recovery?
— China: Will it make a policy mistake and douse rather than cool its economic engine?
GORDIAN KNOT
For all their differences, these three risks and subsets are so closely woven together that a positive outcome for all is probably necessary for the world economy to move out of its current phase unscathed.
It is not so much the vaunted three-speed economy as a three-legged stool, ready to tip if one support gives way.
Consider, for example, a dive in U.S. consumer spending from its already moderate level. If spending actually starts to match sentiment — and the recent jobs data does not bode well — a booming China would find its key market drying up.
Attempts by U.S. authorities to reverse the slide into a double-dip recession and even deflation would almost certainly involve printing even more dollars than is currently the case, undermining, through devaluation, the competitiveness of European exporters, among others.
As for Europe’s big problem, the debt crisis triggered earlier this year by fears of a Greek default has eased, supported by a huge bailout plan and a generally positive stress test on the region’s banks.
But few analysts believe the problem has gone away for good. Governments, cognizant of this, have embarked on a variety of austerity plans that could threaten what nascent growth there is — a worry for U.S. and Chinese exporters.
A renewed confidence crisis in Europe’s debt would not stay European for long. The U.S. deficit and debt pile is easily as worrying for those looking for fiscal balance as is Europe’s.
Turning to the third leg of the stool, Barclay’s Dicks argues that China poses the least problems. But that is a long way from saying that it can hold everything up on its own.
True, there are signs that China and other big emerging markets are beginning to create domestic demand. But it is early days and exporting is still the big game.
Controlling inflation in China is the biggest worry for economists, with fears mainly revolving around a policy mistake that will overdo the required slowdown.
As Dicks says: “We hope for a soft landing, but worry about a hard one.”
UNCERTAINTY
None of these fears may materialize, of course. U.S. consumers are renowned for their resilience. Chinese authorities can and do manage their economy tightly. Europe is currently showing signs of a rebound, not a rewind.
But the dangers are there and weighing both on authorities’ minds and on financial markets.
Where the world stands was graphically depicted in a recent report by the Ewing Marion Kauffman Foundation, which surveyed the opinions of influential economic bloggers.
As befits a study of the blogosphere, the foundation presented some of its findings in a “word cloud” made up of the most common words used by respondents to describe the U.S. economy.
One word stood out — “Uncertain.” Not terribly useful, but then that is the nature of uncertainty.
(Editing by Ruth Pitchford)
Tuesday, Aug. 10, 2010
Europe’s Recovery: Light at the End of the Tunnel?
By Leo Cendrowicz / Brussels
Only three months ago, the euro zone seemed on the verge of implosion — markets hammered the region over mounting debts, and economic commentators discussed which euro-zone country would go bankrupt first. But as Europeans head off for their August holidays, they leave with a welcome sense of relief and optimism about the continent’s economic situation.

Last week, the European Central Bank kept interest rates at record lows and said the economy in the third quarter was looking better than expected as rising demand for industrial products, overall optimism and declining German unemployment boosted the general mood. (See the best business deals of 2009.)

In euro-zone powerhouse Germany, industrial orders jumped by 3.2% in June, more than twice the rate analysts had expected. Last month, the Economic Sentiment Indicator — which measures euro-zone confidence in the economic outlook — rose to the highest in more than two years. Meanwhile, the costs of insuring against countries defaulting are at a two-month low, bond spreads are tightening, and the cost of borrowing for governments is falling.

To those who portended its demise, the euro zone’s turnaround has been astonishing. Even last month, Dutch bank ING issued a report, “Quantifying the Unthinkable,” warning that a full-fledged disintegration of the euro zone would trigger the worst economic crisis in modern history. Such talk now seems banished. (See pictures of the global financial crisis.)

“I’m surprised by how rapidly the euro zone has stabilized,” says Karel Lannoo, CEO at the Centre for European Policy Studies, a Brussels-based think tank. “In May, I was very pessimistic about the euro zone. But the debt crisis was a wake-up call to policymakers to put the house in order, and they have done a lot to deal with it.”

In May, the E.U. and the International Monetary Fund (IMF) agreed on a $1 trillion rescue package for euro-zone countries that run into dire financial straits. At the same time, key E.U. members, including Greece and other vulnerable Mediterranean countries, began austerity programs to restore their fiscal health and reassure markets. And last month, the E.U. conducted stress tests on banks, which seem to have done the trick of convincing markets that Europe’s financial institutions are not hiding billions of euros of toxic debts. (See pictures of riots in Greece.)

The tentative optimism in Europe contrasts with the news from the U. S., where there is mounting evidence that the already sluggish recovery has lost momentum. U.S. economic growth slowed to an annualized 2.4% in the second quarter of the year, barely enough to support new job creation. Last week, the Labor Department reported that the number of people out of work rose by 131,000 in July. At the same time, the U.S. Federal Reserve also hinted it was prepared to print more money to support a faltering economic recovery if necessary. America’s loss may be Europe’s gain, as investors return to Europe seeking — of all things — stability. (See TIME’s Curious Capitalist blog with more on last week’s figures.)

Who remembers that three months ago there were heady predictions of dollar parity with the euro? In May, the euro hit $1.215, a four-year low against the dollar. It had already dropped 16% since the start of the year, and was still considered overvalued: analysts at UBS predicted it would fall to $1.10 by the end of the year. Yet on Monday, the euro was at $1.33, while the dollar itself was sliding, falling to a 15-year low against the yen. (Comment on this story.)

However, the E.U. still faces challenges. While growth is back, it is uneven. Germany is surging, but in Greece and Spain, output is flatlining, growth prospects are dim and their economies need more than budget cuts to improve overall competitiveness. Many governments are likely to face serious social tension as their austerity programs start to bite. Last month, while praising European leaders for their quick response to the debt crisis, the IMF warned that “underlying problems” with how Europe monitors its economies have yet to be resolved, and it urged governments to keep a more watchful eye on their budgets. Many economists predict that Greece will default on its debt, even if the default comes a few years down the line.

“We should not feel relaxed,” says Joachim Scheide, head of the Forecasting Center at the Kiel Institute for the World Economy in Germany. “The crisis is not yet over. The outlook is good, but it is concentrated on Germany. The E.U. as a whole will probably feel a deceleration of growth as the overall world economy slows.” (See pictures of the dangers of printing money in Germany.)

The sovereign debt crisis has exposed how complacency has long been a problem for Europe, especially when it comes to economic policymaking. But for now, European leaders can enjoy their summer break, content that the existential threats that appeared to be eating at the euro zone just a few short months ago have retreated.

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