eurozone and UK economies lurch towards a renewed recession

eurozone and UK economies lurch towards a renewed recession, the US recovery has surpassed expectations and appears to be firming for now.

The decoupling of the US from Europe is good news for global growth and points to the fact that the two regions have pursued very different fiscal policies over the past year. European nations have been forced to step on the spending brakes to control debt, while the US has been able to delay the switch from stimulus to austerity.

“We have no doubt that the UK is suffering from the severe fiscal austerity the government has put in place and this has contributed to the UK’s weaker economic performance relative to the US,” says Frank Engels, co-head of European economic research at Barclays Capital.

Barclays Capital estimates that these austerity measures have shaved 1,5 percentage points off UK GDP this year and will do so again in 2012 through their indirect impact on household demand and confidence, as well as the direct effect of lower government spending.

More than 100000 UK public servants have lost their jobs in the government’s drive to eliminate the UK’s structural budget deficit by 2015. (The previous government’s commitment was only to halve the deficit over the same period.)

Chancellor of the exchequer George Osborne’s argument is that the situation would have been worse if it hadn’t enacted a credible deficit reduction plan, since this would have risked the UK being dragged into the eurozone’s debt crisis. Instead, UK bond rates are at record lows, meaning the government is not facing higher borrowing costs. This has helped to support the economy at a time when borrowing costs are rising significantly across the eurozone, including the core economies of Spain, Belgium, France and Italy.

For this reason, Osborne is refusing to flinch from his plan, even in the face of worsening UK economic data.

The UK, like the US, benefits from being considered a safe haven fixed income (bond) market and for that reason can continue to borrow at reasonable rates. It is also not part of the eurozone. It could therefore be argued that the UK need not have tightened fiscal policy so aggressively.

“It could probably have got away with doing a bit less,” agrees Barclays Capital chief UK economist Simon Hayes, “but the UK government’s caution is understandable, given how brutal financial markets can be and how quickly they can shift an economy from being in the good bucket to the bad one .”

Eurozone economies clearly didn’t have any alternative. Investors have voted with their feet, driving up yields (hence borrowing costs) in the bond markets of those countries unable to demonstrate the political will to rein in government debt.

Italy is the latest example. Last week nervous investors pushed Italy’s yields back above 7% — the level at which peripheral EU countries sought bail outs. The Italian bond market is the third- biggest in the world, owing bond holders around € 2 trillion. It is simply too big to save.

The risk of a major fallout in Europe is increasing. While European Central Bank president Mario Draghi has said Europe will be heading towards a “mild recession” by year-end, the latest JP Morgan purchasing managers’ index for Europe suggests its problems are worse than the authorities are letting on and that the economy is probably already in an outright decline, says Sanlam Investment Management economist Arthur Kamp.

“It was hoped that reasonable growth would allow countries like Italy and Greece to work their way out of financial distress,” he says . “However, a double-dip recession will simply push up government debt levels.”

On the other hand, Kamp believes the US economy could grow by around 2% this year and hopefully, combined with Chinese economic growth , pull Europe back into positive growth territory.

The US economy has enjoyed a string of positive data releases over the past few weeks, which suggests the economy is on a firmer footing. Part of the reason is that the US has had the luxury of time to get a handle on its $15trillion debt mountain.

Thanks to the US having the world’s largest government debt (bond) market as well as the global reserve currency, not even the loss of its AAA credit rating in August had any material effect on US borrowing costs. The upshot is that the US has been able to delay any serious fiscal adjustment for at least another year.

In addition to the $775bn stimulus plan enacted in 2009, US president Barack Obama recently put forward a $447bn jobs plan. Though this additional stimulus has been rejected by the Senate, Obama still hopes to push it through in a piecemeal fashion.

The disbanding of the so-called debt “super committee” seems ominous but its work was about deciding where cuts would come from, not the extent of cuts. These will now be triggered automatically in line with Obama’s budget deal with the Republican party. This will wipe up to $2,4trillion off government spending over the next 10 years but these savings are heavily back-loaded towards the outer years in order to prevent depressing short-term growth.

The term being given to this juggling act of supporting short-term growth while promising long-term savings is “growth- friendly fiscal consolidation”. Over the course of the past year it has become the new consensus in developed economies.

SA’s approach is very much in line with this shift in global thinking. “Whereas over the past few months there was strong support for fiscal austerity, that has changed,” finance minister Pravin Gordhan told the FM recently. “There is now a much more nuanced approach which says: focus on growth and jobs in the short term because a focus on fiscal austerity won’t produce the goods.”

The problem is that you can’t solve debt with more debt indefinitely. Europe’s condition shows what happens when an economy eventually does apply the austerity brake . If this is what the US will look like from 2013 , then the future is indeed grim.

You Might Also Like :