Disaster Can Wait
SHANGHAI – Nowadays there is no shortage of pundits, economic or otherwise, warning of impending disaster. If right, they are hailed as seers; if wrong, chances are that no one will remember. So here’s a forecast: there will be no shortage of predictions that 2012 is shaping up as a disastrous year.
My view is different: 2012 will not be a year of crisis, but nor will it bring an end to our current economic troubles. Rather, it will be a year of muddling through.
Many people think that 2012 will be the make-or-break year for Europe – either a quantum leap in European integration, with the creation of a fiscal union and the issuance of Eurobonds, or the eurozone’s disintegration, igniting the mother of all financial crises.
In fact, neither scenario is plausible. The collapse of the eurozone would, of course, be an economic and financial calamity. But that is precisely why the European Central Bank will overcome its reluctance and intervene in the Italian and Spanish bond markets, and why the Italian and Spanish governments will, in the end, use that breathing space to complete the reforms that the ECB requires as a quid pro quo.
To be sure, Europe will not be spared the pain of a recession. A botched bank-recapitalization plan and the cloud of uncertainty hanging over the euro mean that recession is already baked in. Moreover, the pro-growth reforms needed in countries like Italy will almost certainly make things worse before they make them better. The initial effect of reducing hiring and firing costs, for example, will be layoffs of redundant workers. But investors look ahead, so reforms that promise an eventual return to growth should reassure them.
While the eurozone is unlikely to collapse in 2012, there will be no definitive answer to the question of whether the euro will survive, because there will be no quantum leap in European integration. Treaty revisions take time to draft – and more time to ratify. Efforts to strengthen Europe’s fiscal rules, for example, will take the form of bilateral agreements between governments, rather than changes in the European Union’s Lisbon Treaty.
It is a sad state of affairs when a recession qualifies as muddling through. But such is the European condition.
Consider next the United States. While recent data suggest that the economy is doing better – all signs are that GDP will have expanded at a 3% annual rate in the fourth quarter of 2011 – it is important not get carried away.
Fiscal support for the expansion will continue to be withdrawn. And, while the housing market shows some signs of stabilizing, prices will remain weighed down by the large shadow inventory of homes in foreclosure and held by banks.
These considerations suggest that the acceleration of US growth that began in the third quarter of 2011 is unlikely to be sustained. At the same time, if growth slows significantly, the US Federal Reserve will undoubtedly respond with another round of quantitative easing – QE3 by another name. Thus, while growth next year is likely to fall well short of 3%, the US should be able to avoid a double-dip recession.
Finally, China should grow by 7.5-8% in 2012. This is muddling through, Chinese style –considerably slower growth than the double-digit rates of the past, but not the hard landing that purveyors of doom and gloom warn is inevitable.
I am more pessimistic than institutions like the World Bank and International Monetary Fund, which anticipate Chinese growth in 2012 of 8.5-9% – forecasts that do not take into account the sharp cooling of China’s housing market. Although weakening housing demand has not yet shown up in lower prices, the volume of transactions has fallen off dramatically. And where volumes lead, prices eventually follow.
Fortunately, China is still enough of a planned economy that officials can mobilize policies to cushion the impact. If construction plummets, for example, the authorities can reduce reserve requirements, as they recently did, thereby encouraging banks to lend to other sectors. And, if the European and US economies avoid the worst, Chinese exports will hold up.
Thus, if all of the global economy’s largest pieces fall into place, there is no reason why 2012 should be a disaster. But muddling through cannot continue forever. Europe needs to draw a line under its crisis and figure out how to grow. The US needs to overcome its political polarization and policy gridlock. And China needs to rebalance its economy – shifting from construction and exports to household consumption as the main engine of growth – while it still has time.
Of course, if none of this happens – or if not enough of it does – 2013 could turn out to be the annus horribilis of the perma-bears’ dreams.
Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley. His most recent book is Exorbitant Privilege: The Rise and Fall of the Dollar.