The Global Economy No. 9 - December 20, 2011: Although 2011 was the year of the debt crisis, challenges still remain in 2012 – not least for the euro zone

1. The Global Economy
Monthly letter from Swedbank’s Economic Research Department
by Cecilia Hermansson No. 9 • 20 December 2011
Although 2011 was the year of the debt crisis, challenges
still remain in 2012 – not least for the euro zone
 2011 will go down in history as the year of the debt crises. Budget problems have
shaken the financial markets in the euro zone as well as the US, causing
economic pessimism, credit austerity and declining confidence. Anger and social
tension have followed in the wake of cutbacks and increased unemployment.
 The economic recovery will clearly slow in 2012, including in emerging countries,
which will nevertheless strengthen their economic and political positions globally.
The recession will mainly complicate efforts by the euro zone’s crisis countries to
clean up their fiscal mess. The euro zone is muddling through and the euro won’t
collapse despite high financing costs and credit downgrades. Without stabilising its
institutional framework, however, the currency union won’t be able to handle future
crises. The reform work in the euro zone must continue, and more summits should
be expected next year.
2011: The year the recovery got sidetracked 2. Debt crisis and fiscal austerity
and the debt crisis intensified
Looking back, the last year has been dominated by
1. The recovery faded late in the year the debt crisis in the euro zone, the UK and the US.
The growth rate in the world's largest economies The Greek crisis entered a second phase in 2011.
was higher at the beginning of 2011 than at the A growing acceptance that the country was
end. Purchasing managers indexes suggested fairly insolvent and would have to default on its payments
rapid industrial growth early in the year before forced private lenders to accept their losses.
pointing to production losses. Economic pessimism Moreover, Greece got a lower interest rate as part
increased during the summer, when most of the support package, and after the referendum
economies showed signs of a faltering recovery. debacle former PM George Papandreou stepped
The exception as the US, where optimism about down in favour of a technocratic government led by
growth has risen since the first half-year. Lucas Papademos. At the same time financial and
fiscal conditions in Ireland have improved since it
Industrial production and leading indicators in the OECD
implemented reforms which created confidence,
65
although economic conditions have further
60 deteriorated. There is still uncertainty whether
Portugal will need more support, and despite reform
55
efforts risk premiums are holding firm (the interest
50 rate differential vs. Germany rose during the year
from 3.7 to 11.7 percentage points).
45
40 USA
The most obvious trend at the end of 2011 was the
UK
Japan spread of the crisis from the periphery to the core.
35 E u ro la n d
C h in a In addition to Belgium, France and Finland, where
In d ia
30 G lo b a l risk premiums rose slightly and the threat of a credit
downgrade was a concern, Germany also felt the
25
07 08 09 10 11
turbulence in connection with the issuance of
S o u rc e : R e u te rs E c o W in
Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740
E-mail: ek.sekr@swedbank.se Internet: www.swedbank.com Responsible publisher: Cecilia Hermansson, +46-8-
5859 7720, Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897

2. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 9 • 20 December 2011
government bonds and with its increasingly shaky banks in the euro system as well as certain
commercial banks. countries within and outside the EU could help
somewhat, but at the same time shows crisis
The UK has continued to follow a path of fiscal management in the euro zone is far from optimal.
conservatism with an austerity package of 122
billion pounds in 2011/2012. The government hopes Interest rate differentials against German 10-year bonds
to reduce its debt ratio from over 100% of GDP to 35
60% in 2025. The budget cuts are reducing demand 30
and creating social and political tension. At the
25
same time the UK is benefitting from low borrowing
costs and long maturities on its government bonds.
Percentage points
20
15
The US is having difficulty compromising on how to
stabilise its debt burden in the medium term, in 10 G re e c e
addition to disagreement on short-term fiscal policy. 5
Ir e la n d
Spai
At the last moment the debt ceiling was raised and n
It a ly
P o r tu g a l
tax cuts were extended, but only for short time. 0
UK F ra n c e B e lg iu m Sweden
Uncertainty will remain for some time after the -5
07 08 09 10 11
presidential election in November.
S o u r c e : R e u te r s E c o W in
3. The euro zone’s imperfect institutional structure
4. The roles and actions of central banks
At the same time that it struggles with a debt crisis,
There are clearly differences in the roles that
the euro zone is facing a lack of institutional
central banks are playing during the debt crisis in
bulwarks. The summits have come in quick
the UK (Bank of England, BOE), Japan (Bank of
succession in 2011, with the result that budget
Japan, BOJ) and the US (Federal Reserve, Fed)
discipline has improved. The new rules are similar
compared with the euro zone (European Central
to the previously ratified Stability and Growth Pact,
Bank, ECB).
but now include semi-automatic sanctions and a
ceiling for the structural deficit of 0.5% of GDP. The ECB has inherited from the German
Bundesbank a distaste for using its printing presses
The financial market hasn’t been impressed with
to battle the fiscal crisis in the euro zone.
political decisions. The focus has increasingly
(Hyper)inflation is the biggest threat. The treaty
turned to what is still needed for a well-functioning
prevents the ECB from buying government bonds
currency union. Financing costs for crisis countries
(monetary financing) except in the second-hand
remain unsustainable. The problem of weak
market. The BOE and Fed can use quantitative
competitiveness and growth hasn’t been resolved
easing (their printing presses) to keep long-term
by greater budget discipline. There seems to be far
interest rates low and help their governments
to go before we see a fiscal union and unified bank
finance debt. These two central banks are less
regulator at the euro level. Politicians have shown
fearful of inflation, and in fact growth is a bigger
little interest in a eurobond market. The ECB’s role
threat. For the BOJ, the goal has been to fight
is still limited to supporting financial stability by
deflation and a stronger yen while helping the
ensuring that banks have liquidity without directly
financial sector.
being able to support countries in fiscal crisis.
The ECB (and Germany) also sees a risk if the
If rescue funds like the European Financial Stability
crisis countries receive help from purchases of their
Facility (EFSF) and the upcoming European
bonds in order to keep the risk premiums in check,
Stability Mechanism (ESM) had sufficient support
because it reduces the incentive to tighten their
mechanisms at their disposal in the form of enough
fiscal belts and implement structural reforms. The
funds, the market would have no reason to worry,
ECB feels that support for the crisis countries
but since the funds are essentially incomplete
should primarily come from rescue funds overseen
(though not in terms of rhetoric), there is still
by politicians, i.e., the EFSF and ESM. Looking at
uncertainty what might happen if Italy and Spain’s
the size of the quantitative easing, there is clearly a
financing problems reach the point where they can't
big difference between the ECB on the one hand
contribute to the EFSF. The fact that the ESM’s
and the three other central banks on the other. As a
launch has been pushed forward is positive, but the
share of GDP, quantitative easing represents nearly
details have yet to be worked out. Giving the IMF
20% of GDP in the UK and 13-14% in the US and
access to more funds through national central
Japan, but only just over 2% in the euro zone.
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3. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 9 • 20 December 2011
The ECB is therefore looking for other ways to gained ground and with few exceptions (e.g.,
improve stability in the financial markets. Long-term Latvia) the governments that have pushed for
loans with looser collateral are one way, permitting austerity were voted out of office. In Greece and
direct loans to banks and indirect loans to Italy, technocratic governments took over pending
governments. Also, when you analyse the internal reforms to strengthen market confidence in these
financing between the euro system’s central banks, countries.
it becomes apparent that Germany, the Netherlands
and Finland are lending to France, Ireland and In the US, a super committee was created to draft a
crisis countries in southern Europe. budget proposal for Congress. It never presented
one, however, and instead the automatic cuts
5. Credit crunch is hurting the recovery agreed to in order to raise the debt ceiling in August
will be triggered. There is an unusually strong
The financial market’s concerns intensified during aversion to compromise between the Republicans
the summer, mainly due to growing economic and Democrats right now. A presidential election is
pessimism, the debt crisis and weaker confidence. coming up, and the political cost to accept
This was in addition to the risk of credit crunch in proposals that are unacceptable to party partisans
the euro zone, which was exacerbated by falling is high. The Republicans have decided to say no to
bank shares, higher risk premiums and demands tax hikes and the Democrats to say no to spending
for higher capital reserves as early as last summer cuts. As a result, there are few driving forces
(June). The timing of the requirement that banks implying that US debt will be stabilised and stimulus
must recapitalise at a minimum core tier 1 capital measures to encourage growth will be extended.
ratio of 9% can be questioned, since it is far from
certain that the rescue funds are working yet. Since the political system is unlikely to change and
absent a willingness to compromise, hopes are
The only conclusion is that the banks are trying to instead being placed on the presidential election
trim their balance sheets to meet the higher and a new majority in the two chambers of
requirements. Add that to a jittery financial market Congress. We think it is more likely that we’ll have
and it explains why they are holding onto their to wait until 2014 rather than 2013 before a new
liquidity or placing it overnight with the ECB, which budget is presented that significantly changes the
is now seeing record-high investments as the result debt situation.
of a poorly functioning credit market. This means
less lending to businesses and households, further 8. Global trade is slowing – but there is some hope
impacting growth prospects. By changing collateral in terms of trade policy
requirements and offering long-term loans, the ECB
has tried to find ways to indirectly sustain Compared with early 2011, export volume is higher,
commercial lending, but it isn't certain banks have though it fell in September from the previous month.
the same priorities. In emerging countries, exports have trended lower
since March, but August was relatively positive.
6. The EU’s growing discord
Export volumes from selected regions/countries (index)
At the end of 2011, culminating with the summit on 320
December 9, a schism arose between the UK on 300 Global
280
the one hand and the euro zone led by Germany 260
USA
and France on the other. The UK is concerned 240
Japan
Euro Zone
about London’s position in the financial market and 220
200 Emerging Markets
could not accept the proposed amendments to the 180 Asia
treaty that would strengthen fiscal coordination. 160
Since the UK is important to the EU and the EU is 140
120
important to the UK, the last word hasn't been said, 100
and Germany (but certainly not France) should be 80
able to push the parties to reopen a dialogue and
avoid isolating the UK and other non-euro
countries.
Multilateral trade negotiations, the so-called Doha
7. Technocratic governments and a dysfunctional Round, have been paralysed since 2008 and
political system in the US essentially declared dead due to a lack of
agreement between poor and wealthy countries.
2011 saw governments come and go like other
The protectionist tendencies we have seen in the
years, but the difference was that technocrats
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4. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 9 • 20 December 2011
wake of the fiscal crisis and global recession have 10. The Arab Spring – uncertainty about democracy
been a factor. There are some bright spots in terms and economy
of global trade, however, and the Doha Round isn't
totally dead yet. Developments in the Arab world and northern Africa
were among the surprises in 2011. Although
First of all, Russia has after many years of dictatorships have disappeared, it doesn’t mean
negotiations become a member of the World Trade democracies have taken over. More time, more
Organization (WTO). It was the only major country elections and more economic development are
outside the multilateral framework. needed before we can say that conditions have
brightened for the people of the region. High
Secondly, 42 countries (most of them wealthy) have expectations are being placed on economic policy,
signed a plurilateral agreement whereby several will but it will be hard to meet them.
take the lead and open up areas of trade for other
countries that have signed this limited pact. Thus 11. Japan – tsunami and nuclear accident
far the emphasis has been on procurements and
The situation in Japan was also completely
services. It is worth noting that China hasn’t been
unexpected and caused great concern in Japan and
asked to sign, since there are doubts about its
around the world. This is especially true of the
many local and regional authorities. It is the US that
region affected by the tsunami. At the same time
is mainly pushing the process. It “wants to turn the
there were political consequences, and the
page” and feels the pact can be used as a template
government was forced to step down. The
for other agreements. On the other hand, there is a
Fukushima accident also affected other countries,
great deal of opposition from many emerging
particularly Germany, where the results of state
countries, which are conducting parallel
elections were unexpected and the future of nuclear
negotiations on agriculture, industry and services,
power was called into question.
and which prefer a multilateral agreement like the
Doha Round. In Japan, it will take time for the region to heal, the
9. Climate agreement – progress in acknowledging
economy to clearly recover and the people to go
the need to minimise damage back to living normally. For the global economy, the
impact was less than expected, although structural
The EU summit in December overshadowed the decisions on energy and nuclear power could be
agreement at the climate conference in Durban, affected for some time to come.
South Africa. Until the very end it seemed that the
12. Commodity markets held up better than financial
meeting would end in a total collapse. That wasn't
markets
the case, but the results were less than
encouraging. The best that can be said about the Crude oil prices have fallen, as have the prices of
conference is that it minimised the damage: industrial metals and foods. Compared with other
asset prices in financial markets, commodity prices
 The Kyoto Protocol is still alive, and another performed fairly strongly.
wave of emissions cuts has been agreed to, but
the details have yet to be worked out. Commodity prices and share prices globally
450
 A legally binding pact – the Durban Platform – W o r ld
400 C o m m o d ity
has been reached, including by reluctant signers P r ic e s
such as China, India, Brazil and the US, but 350
even though it has to be adopted by 2015 there 300
is still the possibility of a delay until 2020.
Index
250
As a result, the agreement will not be much help in 200
preventing average temperatures from rising by two 150
degrees Celsius, as hoped, which would have
F T S E W o r ld
required an earlier starting date. As the climate 100
S h a r e P r ic e s
conference clearly showed, the biggest outstanding 50
03 04 05 06 07 08 09 10 11
issue is how the burden should be shared between S o u r c e : R e u te r s E c o W in
rich and poor countries, including whether to choose
a historic or a forward-looking perspective when Inventory conditions, continued high demand
delegating responsibility. (especially in emerging economies) and residual
speculation could partly explain this. Given that
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5. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 9 • 20 December 2011
supply shortages have shrunk and demand is falling as well as in 2010-2011. Even if the recession isn't
due to the soft global economy, commodity prices as severe as in 2008-2009, there is a risk that the
should also trend lower going forward. recovery after the slowdown in 2012 will be weak.
There are few political tools available to stimulate
13. Occupy Wall Street – criticism of capitalism and the economy to the same extent, yet the causes of
growing income gaps the downturn still remain. Putting governments on a
more stable fiscal footing takes time, which means
At the beginning of 2011 I wrote about “an
that demand will remain sluggish even after 2012,
increasingly angry world”. It is clear that the
in the wake of new austerity programmes in Europe
revolution in the Arab world was the product of
as well as Japan and the US.
growing frustration and a sense of powerlessness in
the face of repression and onerous economic In 2012 monetary policy will be further eased, i.e.,
conditions for many citizens. In wealthier parts of in emerging countries, and in the West, where
the world, more people are questioning the skewed some austerity has already begun, e.g., in Norway,
distribution of income. Even in the US, where the Sweden and Australia. At a time of fiscal austerity,
issue is usually pushed aside, income inequality demand and price pressures will ease, which will
could impact political developments next year. also hold commodity prices in check and allow for a
monetary stimulus.
Occupy Wall Street and the movement that spread
globally had a hard time defining its mission, but the In 2012 the EMU framework will be further refined,
unconditional support for US banks and huge but in small steps. The euro countries will muddle
income disparity are undoubtedly going to impact through in the years to come despite weak growth
next year's election. In Europe, austerity has and higher financing costs. If politicians fail to make
brought on social and political tension. Increased progress toward a stronger fiscal cooperation, a
unemployment, mainly among young people, and single bank regulator, a eurobond market and a
limits on the flexibility of current and future stronger role for central bank, there is a risk that the
governments to implement economic policies is EMU, due to insufficient rescue funds, will be
creating resentment. It is becoming increasingly unable to handle future crises.
important that governments are able to formulate
growth-oriented structural policies that force There will be several interesting political moments
previously strong interest groups to take a backseat in 2012, including presidential elections in Russia,
by strengthening tax policies and reducing France and the US. But it is just as interesting to
corruption. study the developments outside the prevailing
establishment, certainly with the help of social
2012: Recession in many Western countries media. This is true in the West, but perhaps even
and less room for economic policy more so in emerging countries, including in the
The recovery will slacken next year. In several crisis Arab world and China. The whole world is also
countries GDP will shrink. Countries whose watching anxiously what happens in North Korea
imbalances are not as great will also see a after the death of the “Dear Leader”.
slowdown, though they possibly could maintain
weak growth. Activity is also slowing in emerging Cecilia Hermansson
countries, but from a higher level, and they will be
better able to sustain their growth rates, though not
Swedbank
Economic Research Department Swedbank’s monthly The Global Economy newsletter is published as a service to our
SE-105 34 Stockholm, Sweden customers. We believe that we have used reliable sources and methods in the preparation
Phone +46-8-5859 7740 of the analyses reported in this publication. However, we cannot guarantee the accuracy or
ek.sekr@swedbank.se completeness of the report and cannot be held responsible for any error or omission in the
www.swedbank.se underlying material or its use. Readers are encouraged to base any (investment) decisions
Legally responsible publisher on other material as well. Neither Swedbank nor its employees may be held responsible for
Cecilia Hermansson, +46-88-5859 7720. losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s
Magnus Alvesson, +46-8-5859 3341 monthly The Global Economy newsletter.
Jörgen Kennemar, +46-8-5859 7730
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