Gloom is lifting but future far from golden
“We have avoided collapse, but we need to guard against any relapse. 2013 will be a make-or-break year.” These were the words of Christine Lagarde, managing director of the International Monetary Fund, at the World Economic Forum last week. She was right. The business people, policymakers and pundits in Davos breathed a sigh of relief. For the first time since 2007, the focus of the discussion was not upon financial calamity. Yet the fact that the economies of the high-income countries have not fallen off their rickety bridge does not guarantee a swift return to growth. That may well come. But it is not yet ensured.
Confidence has improved. One indicator is the spread between the London interbank offered rate (Libor) and the overnight indexed swap rate (OIS), which offers a measure of the risk of default in the lending of banks to one another. These spreads have fallen to just 10 basis points in euros and 16 in US dollars. Stock markets have also recovered strongly from troughs in March 2009, particularly in the US. Spreads between the yields on sovereign bonds of vulnerable euro zone sovereigns and those on German Bunds have fallen substantially: in Italy, the spread fell from 5.3 percentage points in late July 2012 to 2.6 percentage points on January 25 2013; in Spain, it fell from 6.4 to 3.4 percentage points. As confidence in sovereigns has improved, so has that in banks.
Improvement in confidence is not limited to high-income countries. In its January Global Economic Prospects, the World Bank notes that “international capital flows to developing countries . . . have reached new highs”; that “developing country bond spreads . . . have declined by 127 basis points since June ”; and that “developing country stock markets have increased by 12.6 per cent since June”. This then is a global change.
What explains the rising optimism? One reason is that feared disasters – a break-up of the euro zone or a fall over the US fiscal cliff – have been avoided. Another is that substantial post-crisis adjustment has occurred, above all in the US, where private leverage and house prices have gone through a significant rebalancing: US private debt is back to 2003 levels relative to gross domestic product, for example. Yet another explanation is rising trust in the competence of policymakers. Above all, central bankers have used ultra-expansionary monetary policies to pull the economies for which they are responsible for a long time. The US Federal Reserve’s federal funds rate has been 0.25 per cent for more than four years, with more to come. Even the European Central Bank, the most cautious of the big central banks, has adopted what would have seemed an irresponsibly easy policy in any previous era, with interest rates at 0.75 per cent since last July.
Even so, the future seems far from golden. In an update of its forecasts for the World Economic Outlook, the International Monetary Fund has painted a far from rosy picture: growth of 2 per cent in the US, 1.2 per cent in Japan, 1.0 per cent in UK and -0.2 per cent in the euro zone this year, though the emerging and developing countries are forecast to be far stronger, with growth of 5.5 per cent. The two-speed world economy remains in place.