Solving Europe doesn’t avoid recession
James Saft is a Reuters columnist. The opinions expressed are his own.
The question isn’t “will Europe tip the world into recession?” but rather how much worse the euro crisis will make the recession that is already chugging down the tracks.
Markets have been transfixed by the European debt crisis, with its dozens of moving pieces, and its potential to reshape the monetary and political map, to topple banks and to deal a massive shock to the global economy, trade and confidence. High-level meetings in Washington over the weekend were, once again, inconclusive. Some hope for a euro super bazooka bailout vehicle, though such a fund faces obstacles and its chances for lasting success are far from clear.
Investors are right to worry about the unraveling of Europe, but wrong to conflate averting disaster there with a return to rude economic health.
The economic data globally tell a story of weakening demand and dwindling confidence, both in the main developed economies and in formerly fast-growing parts of the rest of the world. The extent to which this is driven by fears of European meltdown is open to debate, but it seems clear that it is far from being the world’s only problem.
In the U.S., the well-respected Economic Cycle Research Institute’s weekly index of leading economic indicators fell again last week, taking a four-week rolling average to -6.7 percent, the steepest such decline in almost a year. Housing is still a source of weakness, joblessness, at 9.1 percent threatens to grow and the Fed’s latest effort to sump pump the economy by driving longer-term interest rates lower fill few people with much confidence.
The Flash Markit Eurozone Services Purchasing Managers’ Index for Europe, a broad-based indicator for the most volatile and important part of the economy, fell to 49.1 this month from August’s 51.5, below the 50 level that is supposed to indicate contraction. Little wonder, given the turmoil and unease there, but still worse than economists’ expectations.
Perhaps even more tellingly, the HSBC China Flash PMI, this time measuring the manufacturing sector, fell to 49.4 from August’s final 49.9. That tells you that the weakness in the U.S. and Europe are really being felt in emerging markets. While a so-called global recession would for China only mean growth falls below the 8 percent benchmark, you can bet that kind of growth there will have knock-on and self-reinforcing effects elsewhere.
Copper futures, which are highly sensitive to growth, fell by about 2.5 percent on Monday in New York, heading for a 15 percent three-day fall, the biggest since the juddering days of October 2008.
THE FIRE THIS TIME
We could easily be looking at a recession in both Europe and the U.S., an outcome that would, in consequence, make dealing with the current agenda more difficult.
Corporate profits will be hit, and companies, already hoarding cash and slow to expand, will shrink further into their shells, delaying investment and perhaps shedding additional jobs.
Tax revenues too will slide, worsening the debt problems and credit profiles of sovereign borrowers and again potentially setting off a self-reinforcing round of budget cuts, layoffs and yet more revenue shortfalls. That could prompt further rating cuts, and will definitely cause the bonds of the more fiscally challenged nations to sell off. The U.S.’s place as safe haven may actually be reinforced, sparing the U.S. from a bond market rout, but deflation will again be part of the discussion.
It is hard to argue for higher equity market valuations under these circumstances, which either indicates further falls or more extreme central bank intervention, whichever is politically easier.
This is not to say what happens in Europe is not important; the next month had better include a comprehensive and credible plan to buy a couple of years’ grace.
“The outcome of the European debt crisis is probably pretty binary: either Europe lets Italy go bust, or Italy and Europe prevent such a disaster,” Berenberg Bank economist Holger Schmieding told clients.
“Once markets start to believe that Italy and Spain are safe, markets and the European economy could recover nicely. We see an 85 percent probability that the euro zone will get it right in the end.”
That 85 percent figure seems optimistic to me, but even if disaster is averted, the fundamental reasons for the global slowdown cum recession remain: balance sheets are being repaired, debt repaid and in consequence demand will be poor. That’s really not going to change until enough of the debt has been forgiven, defaulted or inflated away.
Europe, like Lehman Brothers before it, is an impetus that pushes that snowball downhill, but even without Europe the hill is just as steep and the snow is just as deep.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)