Friday, December 21, 2012

2012 - The year in review

2012 - The year in review
Antony P. Mueller

As we approach the end of the year it turns out that 2012 was a year when a lot happened but little changed.  There was a fierce presidential election campaign in the United States and after the results were in it was the same as before. China installed a new governmental body yet it is hard to tell the difference between the new administration and the old. Almost every day throughout the year the European debt crisis was in the news but by the end of 2012 the situation is neither better nor much worse than at the beginning of the year. Likewise, the debt situation of the United States is as severe as at the beginning of 2012 with no solid improvement of the economy over the year. While 2012 may go down in history as the year of much ado about nothing, 2013 may be the year of the great change.

Economic growth

There is little prospect for very much higher growth rates than what we’ve experienced over the past couple of years. Maybe the world economy is already in something that could be called the “Great Stagnation”. In 2012 each quarter looked as if the rest of the world were following Japan which entered stagnation in the early 1990s and has been in it ever since despite fierce monetary easing and massive government spending. The lessons from the Japanese experience have not yet been learnt. The main lesson says that to adapt to low growth is better than trying to fight it. In dealing with this new kind of stagnation conventional macroeconomic policies are of no avail. On the contrary: they do more harm than good. Firstly, instead of boosting economic activity, they structurally weaken the economy and, secondly, whereas the macroeconomic stimulus programs do not work they leave behind a mountain of public debt and wreak havoc with the financial system due to the policy of extremely low interest rates.

Price inflation

The world is drowning in liquidity created by central banks but an equivalent rise of inflation has not yet 
happened. Most of the newly created money is sitting on the sidelines. Commercial banks use the reserves as a cushion of safety while companies hoard cash partly as protection against potential risks, partly because managers feel that there are no lucrative projects out there. The global price level has remained relatively stable because of international competition. As long as the “Great Stagnation” continues, there is a limit to rising prices. It is only if the phase of stagnation were to give way to stronger economic growth that the price level may increase. As to prices we live in the paradoxical situation that the way out of the stagnation will probably be accompanied by a drastically rising price level which in turn would mean that such as recovery would most likely be short lived. Here, too, the lesson of 2012 is to adapt to the unavoidable and to be careful with political activism.

Official unemployment rates have come down in the United States not so much because of a pick-up of economic activity, but because the share of discouraged worked has been rising. While the officially published statistics shows a decrease, the broader measure shows an increase of the already high level of unemployment. The situation is even bleaker in the European crisis states such as Greece, Portugal and Spain. Although the overall economic situation is better in Italy or France, unemployment in these countries has risen from their already high level. These persistent high levels of unemployment pose a huge burden on public finances which gets squeezed from both sides as social expenditure increase while revenues fall.

Global trade

Although many parts of the world economy are in turmoil, international trade has kept up fairly good over the past year and it seems as if the process of specialization were to continue on a global scale. Yet most of the old problems are still with us and the year 2012 has brought not only no solution but also got us not much closer to a solution. The huge international trade imbalances have not disappeared. The US is still stuck with a gigantic trade deficit which means that the country depends on foreign funds. The counterpart to the United States is China that records persistent trade surpluses and by the same token provides funds to be invested overseas, particularly in US government bonds. China, along with Japan, is the main international financier of the American trade deficit. It is hard to tell how much longer such an imbalance could continue. Theoretically it will end when it is no longer beneficial for either side. This point is getting closer. The US has become more fearful about its debt problem while China must consider a shift of its production from exports to the interior market. This process will take a long time but it looks as if we are already in the early stages of such a shift, which may continue for many years to come. 

International debt

The year 2012 may well be remembered as the year of the European debt crisis. Hardly a day has gone by without some news ticker announcing the end of the euro, the break-up of the European Union and the collapse of the European economy. Yet nothing of this kind has happened. Greece is still a member of the euro zone and its latest debt buy-program was successfully accomplished. In the meantime the US moves closer to its “fiscal cliff” and is facing new downgrades of its debt. The US has abstained from austerity partly because 2012 was an election year. This means the United States will now have a lot to do in order to catch up. While the current political discussions concentrate on how to avoid the fiscal cliff, a fall over the fiscal cliff is probably the best thing that could happen now to America because it would force the US government and Congress to address the American debt problem in the manner of urgency and seriousness which is needed.  


2013 promises to become an interesting year – which means that for most people it won’t be a pleasant time. If there should be a more remarkable uptick of economic activity, price inflation most likely will emerge with it and the recovery would prove to be unsustainable. Mass unemployment will continue in the US and in Europe and pose a heavy burden on public finances. The European debt crisis is not yet over while the hot phase of the US debt crisis is about to begin. There is little prospect for Japan to get out of slump while at the same time China’s growth rates will get lower. Brazil, another member of the ominous BRICs, has tanked in 2012 and the prospects for economic growth in 2013 are not much better. The same holds for Russia. India has all the potential but is hampered by many obstacles to become a strong economy. The world economy and world politics is full of tensions waiting to erupt.
While 2012 was a year in which many things happened but little changed, 2013 may be the year when a few key events may well cause drastic change.

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