News Column

2012 Economic Outlook: Debt Hangover

Feb. 15, 2012

Juan Solana, Chief Economist

The year started with positive economic news on many fronts -- record corporate profits, high manufacturing indexes, sharp growth in private payrolls, record low mortgage rates, increase in existing home sales and consumer confidence rising higher than expected.

But there are two key issues in the global economy that will determine economic performance for the years to come: How the world economy is going to cope with the economic collapse, or dismal performance in the best case, of the European economies (about a quarter of the global GDP), and how the global economic forces are going to deal with the resulting dramatic shift in economic power from G7 economies to Asia and Latin America.

While European economies are shrinking -- Germany saw a negative 0.25 percent growth in the fourth quarter of 2011, Britain registered a 0.2 percent decline and Spain's economy contracted by 0.3 percent -- GDP in the U.S. grew 2.8 percent in the same period, 2 percentage points short of expectations.

The U.S. economy is forecast to grow around 2 percent this year and the next. This economic growth will not produce a dramatic decrease in unemployment, leaving the rate at the high end of 8 percent. Inflation will remain tamed as will interest rates. Despite lower interest rates, the debt deleveraging process undermines both private and business consumption and will not produce the desired effects of demand-driven economic growth. With government spending also on a global retreat, only increased production and consumption in Asia and Latin America could drive U.S. and European economies to grow.

Economic projections in this scenario are very unstable because of the unknown effect of self-reinforcing economic contracting dynamics in Europe. As governments cut spending to pay debts, economies contract -- not only directly from reduced government spending, but also from a derived and multiplied effect as spending is reduced throughout the economy. As the economy contracts, indebted countries may find their debt to gross domestic product ratio increasing despite the effort to reduce debt. Current efforts by the European Central Bank to provide liquidity to banks to pursue the buying of public debt calmed the markets at the beginning of the year. However, the draconian debt refinancing schedule that many key European countries face in 2012 can make those problems return sooner rather than later.

The debt reduction process is taking different paths on either side of the Atlantic. While some private debt reduction as a percentage of GDP has already taken place in the U.S., debt in most European countries continues to increase. While the U.S. government has maintained spending during the time private debt reduction is taking place, European governments are forced to adjust public finances ahead of the private debt-reduction adjustments, thus reinforcing the downward spiral of increasing debt levels as the economy continues shrinking.

Uncertainties in Europe produce real negative effects on the U.S. economy. U.S. companies may hold cash instead of investing before uncertainty in Europe clears; revenues of U.S. companies exposed to European markets can decrease; demand for U.S. products in Europe contracts; European tourism to the U.S. will decrease sharply; and the U.S. has a high exposure to European sovereign debt. As demand for euros shift s to U.S. dollars, this may appreciate the dollar, thus negatively impacting competitiveness of all U.S. exports.

Global Economic Power Changing Quickly
The dramatic shift, in a short period of time, of the global balance of power will be one of the outcomes of the 2008 financial crisis and Great Recession. While the advanced economies were responsible for almost 70 percent of the global GDP in 2009, their production will represent just 59 percent in 2016, a loss of 11 percentage points in just eight years. The result will be a multipolar world with no leading country or group and less leadership power to push the global economy forward. The G7 will no longer represent the majority of the world's GDP: its cur- rent share will drop from 53 percent in 2009 to 44 percent in 2016.

2011 Job Trends and Outlook for 2012
The U.S. economy created 1.6 million nonfarm jobs in 2011, a slight increase from the 1.1 million jobs created in 2010. The private sector created 1.9 million jobs while the government posted a decrease of 280,000 jobs.

Most private-sector jobs created were in the service sector (1.6 million jobs) while the goods-producing sector added 362,000 jobs. All components of the goods-producing sector (mining, construction and manufacturing) added jobs. Worth noticing is 225,000 manufacturing jobs created, positive job growth in construction and a year-over- year 11 percent growth in mining jobs. As a sign of the recovery of the auto industry, the motor vehicles subsector added 35,000 jobs in 2011 and the motor vehicle and part dealers services added 50,000 jobs.

The leading job-creating industries in the private service sector were retail trade (240,000 more jobs), professional and business services (452,000 more jobs), educational services (427,000 more jobs), health care (350,000 more jobs), and leisure and hospitality (268,000 more jobs).

For 2012, professional business, education, health care, retail, and leisure and hospitality will be posting meaningful month-to-month job gains. In the goods-producing sector, mining, motor vehicles and manufacturing will continue to post job gains with, probably, modest gains in construction jobs. The government sector is expected to continue to post job losses.

As another year of slow growth grinds to a close, positive expectations continue to face negative adjustments in global markets, especially the twin downward spirals of debt and unemployment. The change to a multipolar economy will continue to inject its own uncertainties, but there is hope on the horizon. We are seeing upward jobs growth in key sectors, especially construction and automaking. While the U.S. economy is growing more slowly than expected, it is growing. The key to recovery lies in overcoming uncertainty. Excess caution may bring another dismal year.

Source: (c) 2012. All rights reserved.

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