The remarkable rise in the US stock market to five-year highs must make us ask — is this justified optimism? Or a fantasy?
There are true grounds of optimism in some respects. The US housing market appears to be recovering. Congress is working more efficiently to deal with fiscal policy, backing off from the cliff, and not using the debt ceiling for political leverage. Corporate profits are at all-time highs, while banks have recovered and are increasing lending and capital reserves. The Fed has promised to keep rates low until unemployment drops substantially, and unemployment is trending down. Overseas, interest rates for the PIGS (Portugal, Italy, Greece, and Spain) have come down substantially and stabilized, while the ECB has promised to do anything (anything!) needed to keep the Euro intact. China’s slow-down appears to be a soft landing with plenty of oomph left to keep growth rates at 7% or better, and Japan is aiming to pump up nominal GDP to beat back deflation.
All this seems good reason not to fight the Fed. And yet all these are mainly financial indicators. What of the underlying fiscal and political realities — namely prospects for economic growth, fiscal solvency, and political stability and solutions?
Here the future looks rather more bleak. The European Union still amounts to about one-quarter of the world’s GDP, and is stuck in neutral or reverse. The key engine of the EU — Germany — saw its economy shrink in the last quarter of 2012. While prospects are brighter for this year, the Bundesbank slashed its 2013 growth project to under 0.5%. Germany is suffering labor shortages, as immigrants find the language to hard to learn and still perceive hostility. “This idea that Germany is a powerhouse dragging the rest of Europe along with it is a bit of a myth to be honest,” said Philip Whyte, a senior research fellow at the Center for European Reform in London. “You have a very weak periphery and a core which is not as strong as everyone seems to believe.” Projections for Greece, Spain, and Italy are all for no or negative growth to continue. The UK’s economy also shank in Q4 2012, and with the government wedded to austerity policies, a triple-dip recession is expected for the first half of 2013. So it would be naive to expect anything more than zero growth in 2013 out of the EU.
That is not to mention the political risk — in both Italy and Spain, the cautious austerity governments are under pressure, in Italy from a resurgent populist campaign led by Silvio Berlusconi, and in Spain by a corruption scandal. Should these governments fall and be replaced by less cautious leaders, the Euro could again be under threat.
The U.S. is still nearly another one-quarter of the world economy (22%). And with cuts in government spending offsetting the resurgent growth in the private sector — as in the last quarter, when GDP growth was a tad negative — it would be foolish to expect more than 2% growth in GDP from the US this year.
That means one-half of the world economy will grow an average of 1% or less this year. For the global economy to grow at 4% in 2013, that means the other half of the global economy needs to grow at 7% — which will not happen. A very solid year of emerging market growth might produce an average of 5% gains across all these markets, producing global growth of 3%. But that is a bit optimistic; I think the slow down in Europe and the US will affect emerging markets, limiting their growth to 4%, producing a global growth rate closer to 2.5%. That is not bad — and if concentrated in raising middle class incomes, that could lift hundreds of millions into the global middle class of consumers. The problem is that growth may instead be concentrated on the rich and the poor, leaving the middle class mired for another year or more.
Corporate profits can continue to grow despite market stagnation, as companies cut workers, lower salaries, and expand into new markets overseas, replacing home production and local crafts with centrally manufactured and marketed goods and services.
Still, one has to wonder how long those profits will grow when overall economic growth is held back by stagnant wages, a shrinking middle class, and declining government spending. At some point, either a social revolt will demand a shift of national income back from corporate profits and elite gains to labor earnings, or those earnings will be unable to support any further economic growth.
Driverless cars, 3-D printing, central banks printing money, all these are good things. But they do not replace the basic equation that earnings, employment, and purchasing power must grow for business growth to be sustained. How we get back on the right track in the near term remains uncertain; and history would suggest this long depression still has several years to run.