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Heading for the second leg of the double dip?

By Benedict De Meulemeester

By Benedict De Meulemeester on 10/10/2011

The IMF has lowered its forecast for global economic growth in 2012 to 4%, down from 5% growth in 2010. Even if this seems limited, it would mean standstill and even recession in many economies of the Western world. The IMF cites two main worries:

  1. The EU debt crisis seems to be running out of control. The policy of helping the Greeks only if they adopt ever more severe savings programs is clearly counter-productive. It pushes the Greek economy into a deeper and deeper crisis. With an imploding economy, it will become impossible for the Greeks to pay back their debts.
  2. The US economy is growing, but at a very slow rate. It proves very hard for the US to find new sources of economic growth. The old recipe of stimulating consumption in the US doesn’t work, as the American citizens are still trying to reduce the high debt levels they built up by over-consumption in the two previous decades.

 The IMF points out that there is a broader issue at hand, a reshaping of globalization. In the period 1990 – 2008, globalization was based on the following trade pattern. US policymakers stimulated their economy by lowering interest rates. American citizens borrowed increasing amounts of money to be able to spend much more than they could afford. A lot of that money was spent on consumer goods produced in emerging economies such as China, causing double digit growth in these countries. This strong economic growth caused commodity prices in general and energy prices in particular to spike sharply. Debt accumulated in the US, capital accumulated in emerging economies and commodity producers such as Saudi-Arabia. This balance got a perverse streak when the accumulated capital in emerging and commodity countries became the source of borrowing to the US. This mechanism resembles a drug dealer that borrows drug money to his junkie clients so that they can buy more drugs. Ever more sophisticated leverage instruments, like Credit Default Swaps (CDS) stimulated the excessive borrowing.

 The spike in commodity prices was one of the main causes for the balance to derail. By 2008, Americans had to pay 4 times more for heating their homes and – most importantly - driving their gas-guzzling cars. Due to this increasing cost of life, more and more Americans could no longer pay back their mortgages on their houses. Due to the extreme level of leverage, this caused a broad systemic crisis of the financial sector and a subsequent deep economic recession as consumers worldwide stopped consuming.

 To rebalance the world’s economy, the IMF points out that we need to make a double movement. The established economies of the US and to a lesser degree Western-Europe need to become less dependent on imports, the emerging economies need to become less dependent on exports. In the West-, we need to focus on the development of innovative, high-value industries that we can export to countries like China. The emerging economies have to bolster the development of a middle class that engages in the mass consumption necessary to stimulate home-grown demand. The economic developments of the past two years have shown that we are engaging in this rebalancing act. The Chinese economy returned to double-digit growth remarkably rapidly after the catastrophe of 2008. This was due to stimulus programs that lured the growing Chinese middle class into consuming more. Brazil is another good example of a growing emerging economy thanks to growing middle class consumption. Germany, and in its slipstream Belgium, have been good examples of how Western economies focused on export of high value goods and services can benefit from the economic growth in the emerging economies.

 The rebalancing act is being played out, but it remains a very delicate one. Two events seem to be undermining it at this moment. The first one is the continuing systemic weakness of the banking sector. It is unbelievable that a middle-sized bank such as Belgian-French Dexia, has built up a position in Greek debt paper that becomes unsustainable. Where are the risk management practices of these institutions? The events with Dexia show that it is not unthinkable that we might see a bank toppling like Lehman Brothers did in 2008, causing a chain reaction that brings the financial functioning of this world to a standstill. The second event that is troublesome is the slow pace of growth in the US, which is having a very hard time to re-invent itself as an export-oriented economy.

 The solutions will have to come from politicians. European politicians will need to find a workable solution for Greece. US politicians need to find solutions so that they become exporters to emerging economies. Politicians worldwide have to take measures to curb the risk-taking, downward-spiral causing behavior of the financial sector. There is an urgent need for bold economic policies. The good news is that economists seem to agree more and more on what policies are needed. The bad news is that politicians seem to lack the guts to enforce those policies. A world leader like Angela Merkel, seems to be so scared of the public opinion in her country, that her treatment of the Greek debt crisis becomes self-destructive. Barak Obama, is blocked by the extreme bi-partizanship of American politics, with a republican majority in Congress which is increasingly inspired by 18th century economics (Tea Party) and that blocks every attempt to deal with the economic situation with ideological arguments.

 Sometimes, the economy doesn’t need political intervention to find a new balance. However, if we look at the current figures, it doesn’t seem to be doing that. The chances that we are heading for the second leg of the double dip, increase with every day that the world’s political leaders wait to attack issues like the Greek debt crisis head-on. So far, the energy prices remain at a relatively high level. We are not in the phase of economic decline yet. However, we do see energy demand levels that start to drop, although some of that might be explained by higher than average temperatures in September. Anyway, we recommend everyone to keep in mind the possibility of an economic recession leading to a downtrend of energy prices in the next months. And we hope that this will not happen.


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