The global economy as a whole has been hit by the crisis in “old Europe” but in three different ways.
Three facets of the same macroeconomic scenario
Europe
The next European plan is still shrouded in uncertainty. We may be heading for a plan based on the Eureca project designed by the very Roland Berger cabinet which came up with the Treuhandstalt agency dealing with newly reunified Germany. This plan, which has had so far little publicity, suggests setting up a European institution to look after privatising EUR 125bn of Greek assets. That would reduce the country’s debt to GDP ratio to bearable levels, stimulate growth without impacting demand with austerity measures and also assuage worries over contagion.
Looking beyond the Greek issue and any systemic risk that might follow, economic slowdown is likely to come true because of (i) companies taking a wait-and-see attitude amid systemic institutional instability, (ii) a vast coordinated scheme to tighten up fiscal measures and (ii) a possible clamp down on lending that could send Europe’s overvalued property markets into depression territory. If the UK example is anything to go on, austerity coupled with falling property prices entails stagnation or contraction in domestic demand. Should the same trend be observed on the continent, there could be serious consequences for banks which are already struggling.
US
There are two areas where the US is ahead of Europe: banks have deleveraged and the property market has been through its correction. According to the IMF, US bank leverage is now only 12 compared to 26 in the euro zone. Property prices have fallen to levels in line with household income. In fact, set against low long term interest rates, they have even become attractive. Even so, it is difficult to see this as a source of autonomous growth. High unemployment is destroying the wage dynamic and fiscal tightening is on the agenda even if it is still unclear to what extent.
Companies, meanwhile, have the cash and profitability levels to invest but the end of fiscal incentives in 2012 might trigger a fall in corporate investment next year. We feel that a property market rebound would change the picture but we can neither count on this happening nor rule it out. But altogether, the US economy still enjoys a more moderate risk profile than Europe.
Emerging countries
Generally speaking, emerging countries rebounded during the crisis thanks to strong loan growth and loose monetary policies imported from the US so as to stabilise currencies against the US dollar. The emerging zone has, as a result, inherited a triple challenge of leverage, inflation and property bubbles. Just as in the US from 2000 onwards, part of the credit boom was totally unreasonable.
China, for example, saw the development of opaque shadow banking which took advantage of property developers who are now in difficulty. In Brazil, the default rate on prohibitively expensive consumer credit is rising sharply. Over the short term, this all means that emerging country assets are not acting as the safe havens they were meant to be. However, over the medium term, emerging countries still have much brighter economic prospects as their assets are generally trading at a discount. The time will come when these markets will be worth buying again.
If the worst case occurs – Europe falling into recession and stagnation in the US- the likelihood is that emerging countries will not only find it difficult to come to the rescue of mature economies but may well fall victim themselves to accidents resulting from the global downturn. Economic history shows that a combination of bubbles, inflation and economic slowdown should encourage investors to be very cautious. Japan at the beginning of the 1990s and the subprime crisis are good examples. [...]