Tuesday, June 8, 2010

Is Global Growth Slowing After All?

The presumption that the Eurozone fiscal crisis will be a pivotal factor that will have an adverse effect on global economic growth ahead has been widely adopted by financial markets in recent weeks. While such a potential risk cannot be dismissed, we remain skeptical as to how significant its negative effect on the U.S. (or, global, for that matter) economy will ultimately be.

The OECD, for one, is not so sure. Two weeks ago, it released an upward revised estimate for economic growth in its member countries for 2010 and beyond compared to its previous forecast issued in November 2009. In its latest forecast, it now expects growth to rise by 2.7% this year versus 1.9% in its previous, "pre- Eurozone fiscal crisis" estimate, while it has also revised higher its growth estimate for 2011 to 2.8% from 2.5% previously.

The OECD's upgraded forecast, while acknowledging the growing risks stemming from the instability in sovereign debt markets, is based on the reality of rising global trade flows. This trend is, to a considerable degree fueled by the sharp fall of the euro since late last year and the ongoing strength in growth in China and other key emerging market economies.

Even in the eurozone, which has been squarely in the eye of the fiscal storm recently, it is still not clear whether the net effect of the fiscal austerity measures sweeping its member countries will have a bigger contractionary effect on growth than the benefit to growth derived from the boost to the bloc's exports to other non-euro countries- courtesy of the weaker euro. The latter effect, is in fact, quite powerful, as the euro has not declined by over 20% since late last year against the U.S. dollar alone but also against the yuan, allowing eurozone exports to gain competitive ground globally at the expense of China.

The news coming out of Germany (the world's second biggest exporter) in the last two days highlights that ambiguity best. Factory orders surged in April by 2.8%, after an upward revised 5.1% increase in March, driven by a 5.5% spike in export orders from countries outside the euro area. Also, just this morning, Germany's industrial production numbers showed a solid gain of 0.9% in April, suggesting that the economic recovery in the biggest eurozone economy (and a global exports powerhouse) is moving forward at a good clip.

The single most important channel via which any protracted sovereign debt market instability can influence the U.S. economic recovery is the sharp pullback in equities and its possible adverse effect on consumer spending in the months ahead. Again, the uptrend in personal spending is unlikely to be derailed by a 10% or so erosion in the equity market- particularly if this proves to be a relatively short-lived affair. Moreover, a partial offset to the adverse impact of equities on household spending is provided by the recent sharp increase in mortgage refinancing activity- again, the direct result of the eurozone' fiscal crisis having led to lower market and mortgage rates lately.

Risks to the prospects for the U.S economic recovery do exist and the extend to which the sovereign debt situation deteriorates requires close monitoring in the months ahead. However, in the heat of the moment, there is at times a tendency to underestimate the resilience and complexity of the U.S. economy, and this is a risk we also need to guard against.

Anthony Karydakis

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