Helpless and stranded?

Having actively observed the recent occurrences in the developed economies as well as their financial market, our board has been left with such a question. At least a year ago the world came to think that the nightmare was over and the economies of developed countries started to recover as a result of the government fiscal measures starting to take effect. And what is happening now? Almost instantly, the world economy has started to produce new signs of extreme weakness on both coasts of the Atlantic. The old disease seems to be returning and the expected recovery is gradually starting to become more distant.

In some way I can call myself a victim of the early menaces that are arising. At first, I have far too optimistic about the

short-term growth prospects of the major economies, mainly because the US debt problem that actually arose in early spring was somehow dampened in did not appear until the very end of July. Furthermore, the events happening during the past 3 weeks have completely devastated my plans to create another portfolio for myself consisting solely of index funds, at least in the nearest future. 🙂 Oh well… maybe it is even better for me as it would be painful to witness the markets falling sharply…

This early review is fully devoted to the problems and adverse prospects the world economy is currently facing (at the same time the article cycle about BRIC countries is under way of creation and will be available in the nearest time) and in some way I am going to counter-argue my recent article about the pace of recovery and its short-term prospects.

Even further beyond the doubts of Italy’s and Spain’s solvency and the disputes about prudent fiscal policy in the US, the most worrying problem of the day is the inability of the abovementioned regions to create employment and bring the countries back to growth. Only a few weeks ago it was rather insensible to prognosticate a new recession in the EU and US (as was also mentioned in one of the previous reviews), and now even the earnest optimists (like me) agree that we are in the worst point since the Great Recession starting in 2008.

“The second trimester has been severely worse than the first in the Eurozone,” claims Marie Diron, the director of European macroeconomic research at Oxford University Economics department. She adds that “it is rather improbable that principal countries of the monetary union such as Germany and France could fall in the clutches of the possible recession.” This cannot be said about Spain or Italy, especially given the worsening of public debt in these countries.

It is still impossible to encounter the latest macroeconomic data of the EU (Eurostat has delayed the announcement until August 16th), yet experts note that the economy suffered a huge slowdown in comparison to 2.5% growth observed in January-March. The European Commission itself predicts the figure to be 1.5% this trimester (too optimistic, to say the least…).

As underlined by the strategic economist of Radobank, Elwin de Groot, the dampening of economic activity has to be expressed in terms of hard and painful recovery after a “huge-magnitude financial crisis”. “We’re recovering from the crisis and there always has to be a period when only modest growth is expected,” he says, “and we are exactly fulfilling this scenario”. The data indicating minuscule growth in several European countries confirm his notion.

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In the United States, the outlook seems to be far less promising than in Europe. The world’s first economy has shown a bare 0.8% year-on-year growth in the last six months, a pace that is insufficient to create more employment. Private consumption remains feeble and manufacturing shows no signs of growth. The unemployment rate, which has exceeded 8% for the past 30 months, is currently 9.1%. These figures, which were announced on Tuesday, slightly surpassed previous expectations yet was insufficient to overturn the existing pessimism among private and financial sectors. The Economist has indicated in its recent article that the US has a 60% probability of turning into negative growth during the next half a year.

Investment banks in the UK claim that there are reasons to be concerned about the future growth of the world economy, but not to an extent that investors should start instantly selling their assets. “We’re not in 2008, and many enterprises are in much better financial shape than when Lehman Brothers crashed. Profits are likely to plunge, yet the Syy piilee baccaratin luonteessa: peli tarjoaa eraan pienimmista talon eduista ja parhaista voittotodennakoisyyksista ja siksi se on houkutellut mukaan pelaajia pelaamaan suurella rahalla. outlook for dividends is likely to be very positive”.

So what has triggered such rapid developments in the major economies? Nouriel Roubini (yes, the one that predicted the real estate bubble in the US in 2006, US’s sluggish recovery in 2009 and that eurozone will soon collapse) posted in his Twitter account that the political and monetary authorities are left with “no ammunition to fight the ongoing crisis”.

The short-term interest rates are astonishingly low (0.29% in the US and 1.5% in the eurozone). The governments, severely indebted and astounded by the enormous pressure in the markets, cut their expenses and postpone investment that could facilitate growth (seems as though they have poor knowledge of Keynesian economics). Banks themselves cannot lend since they do not have easy access to liquidity due to different limits and regulations imposed by the state. And, of course, companies are the one that get punished the most, since they have to cut down on their capacities and downgrade their profit prospects due to bad access to credits and weak consumption.

The private sector, also constrained by the mortgages they had taken in the boom years and concerned about being sacked from their jobs, limits their consumption to unprecedentedly low levels. Roubini has indicated in a recent interview to Spanish press that “Painful times are arising due to private and government indebtedness in the rich economies. There are still ways to evade the downturn, but immediate measures should be taken for this purpose”.

The most recent data about consumption clearly speak in favour of the abovementioned facts. Sales in the EU have decreased by 0.3% in April-June compared to the same period last year after having shrunk 0.2% in the first trimester

Another unequivocal symptom of falling economic activity is the price of crude oil: the prices of Brent have fallen by 10% in just one week. And naturally, the performance of major indices is also catastrophic: DJIA has recorded a nearly 10% loss during the month, whereas such indices as Eurostoxx fell by over 16%, a fall even more eminent than after the Japanese tsunami.

How is it possible that the most powerful nations have fallen into such abyss? Experts agree on one main argument: the indecision of European leaders and harsh disputes between democrats and republicans in the US has put under doubt the ability of politicians to defend common interests and has also fostered uncertainty in the financial markets. As Marie Diron mentions that “There is no obvious reason why should the prospects of Spain or Italy be downgraded. It only puts unnecessary pressure in the financial markets and honestly its main concern is the lack of politicians to take the initiative and save the euro.”

The famous economist Paul Krugman offers a classical Keynesian model to recover from the crisis: increase public spending to facilitate employment and maintaining the interest rates at historically low levels. The governments should spend now to enjoy the fruits in the future despite that the public debt rises. Others insist that austerity measures should continue which will surely renew confidence in the financial markets since governments will show some kind of fiscal stability.

And what about emerging economies? Stay tuned for the next reviews devoted to this topic…