2011 to bring recovery, inflation, more euro-pain
The author is a Reuters Breakingviews columnist. The opinions expressed are his own
In 2010, little more than a year after celebrations of the euro’s 10th birthday, the very survival of the currency of the world’s largest economic bloc came under threat – a reminder that the world’s economic foundations are never completely stable. So a prediction that the world will do better than expected in 2011 comes with big caveats.
It has taken extreme measures, primarily ultra-loose monetary policy and much debt creation in the United States and Europe, to recover from the Great Recession. In the process, the seeds of future crises may have been sown — perhaps even in China, the bastion of growth through the recent crisis.
As the year turns, the edges of the euro zone remain the world’s central economic drama. Greece and Ireland have received bailouts. Portugal is making efforts to cut its fiscal deficit, but its very poor trade position – with a current account deficit that is close to one tenth of GDP — and weak banks make an Iberian bailout a near-certainty early in 2011.
Spain may need one, too. It suffers from big government spending and trade deficits. Madrid’s repair efforts are complicated by the autonomy enjoyed by regional governments and unemployment of 20 percent. If a Spanish bailout happens, Italy and Belgium could be next. But these countries should be more resilient. They have stronger industrial sectors, lower external financing needs and higher savings levels.
Despite continuing upheaval, the euro zone will still grow in 2011. Germany’s pick-up in growth reflects the world’s. France and Italy aren’t in such bad shape, either. German exports are again growing fast and will receive further impetus from a weak euro. That’s likely given ongoing uncertainty and low European Central Bank interest rates. A substantial drop to a level of, say, $1.10 by the end of 2011 isn’t impossible.
The dollar, meanwhile, should be on the recovery road. Money-printing by the Federal Reserve and ultra-low Treasury yields have weakened it. Both should end in 2011. After three years the U.S. consumer will stir – cheered by a housing market that appears to have bottomed. A virtuous circle of falling unemployment and rising consumer spending looks possible. U.S. growth may be stronger than markets expect.
That will help Asia’s exporters, led by Japan and China. Chinese growth looks set to remain strong, even though the government is trying to reduce the pace of money supply growth. India, too, is racing ahead, despite high inflation and rising interest rates. New consumers are emerging in Asia. The demand for food, copper, cement, electricity and oil keeps growing. So the commodity price inflation seen in the second half of 2010 may continue and could worsen. Inflation is already a big problem in some emerging economies. It’s likely to break out soon in the West.
In the United States, inflation – especially coupled with accelerating growth – would force the Fed to consider raising interest rates. Though it seems unlikely now, that could happen before the end of 2011. Bond markets that prospered through the deflationary crisis would be hit. Stock investors would have to weigh higher growth against more expensive money.
The result: a resuscitated world, but not a wholly healthy one. In almost every major economy, government deficit and debt will have climbed steeply. The United States will have shown its great capacity to borrow, but even Uncle Sam will have to shift towards unaccustomed austerity. Until that happens, the U.S. consumer and a mammoth trade deficit of some $40 billion a month will again be one side of the world’s imbalances.
For its part, China has maintained growth by permitting soaring foreign exchange reserves and money supply while increasing exports. The Middle Kingdom’s controlled currency is another cause of global economic imbalances. The government might allow the yuan to appreciate sharply if it finds inflation rising fast, which may well happen. But the leadership will also be wary of damaging the export sector and its jobs.
The structure of China’s economy and the staggering money supply growth everywhere during the Great Recession might stoke future crises. But faster global recovery and the return of inflation should be 2011’s main themes, punctuated by euro zone aftershocks. Not to mention the inevitable unforeseen surprises, both good and bad.