By John H. Makin

From: www.aei.org,  January 10, 2012

The world saw such extraordinary uncertainty in 2011 that a simple failure to repeat that debilitating climate of uncertainty in 2012 may engender a moderate recovery, especially in the US economy. Hints of such a recovery in the United States have already appeared in the jobs market (in the form of a lower unemployment rate and lower initial jobs claims), stronger consumption figures, and even the heretofore moribund housing sector. Fourth-quarter growth may exceed a 3 percent rate. As a result, despite continued elevated tensions surrounding Europe’s sovereign-debt crisis and uncertainty about the sustainability of strong growth in China, US equity markets have strengthened, and we are seeing some modest improvements in the outlook for the US economy.

The year 2011 was to have been a time of extended economic recovery and further healing of the substantial wounds inflicted by the 2007–08 financial crisis. In the United States, 2010 ended with additional, though controversial, QE2 stimulus from the US Federal Reserve that saw the central bank adding to its balance sheet. The US Congress chimed in with another stimulus package that cut the payroll tax owed by virtually all working households by 2 percentage points (about $120 billion), extended expiring long-term unemployment benefits for another year, and boosted incentives for capital spending. Most analysts, myself included, were expecting close to a 4 percent growth rate, at least during the first half of 2011.

As it turned out, growth during the first three quarters of 2011 averaged just above a 1 percent annual rate, far short of the pace expected. An apparent pickup in the growth pace in the fourth quarter was coupled with the previously noted drop in the unemployment rate. Despite that, the pace of US economic growth in 2011, especially during the second half of the year, was disappointing, just as growth in Europe and China has been.

An extraordinary series of shocks in 2011 substantially increased the uncertainty tied to operating in the financial sector as well as in the production (real) sector of the economy. First, the widespread unrest in the oil-producing Middle East witnessed in the “Arab Spring” uprisings contributed to a sharp rise in oil prices that absorbed most of the boost in disposable income linked to the payroll tax cuts and the extension of unemployment benefits. And in March, the extraordinary Japanese tsunami and nuclear disaster imposed tragic human costs while interrupting supply chains, especially in the automotive and electronics industries and in overall supplies of energy. These negative economic shocks were amplified by financial shocks generated by the US debt-ceiling crisis in July and a sharp intensification of the European sovereign-debt crisis after midyear.

Uncertainty Is More Problematic Than Risk

The distinction between risk and uncertainty introduced by Frank Knight in his classic Risk, Uncertainty, and Profit[1] is especially relevant to assessing the damage to the real economy emanating from the Arab Spring and Japanese tsunami disruptions to the supply chain. Supply chain risks derive from deviations from normal delivery times, quantified based on past experience. However, these disrupting events caused more damaging supply chain uncertainty, sharply elevated by the tsunami damage, and oil supply availability uncertainty, boosted by the Arab Spring disruptions, leading to increased supply times highly difficult to quantify in magnitude and duration. These elevated uncertainties significantly impaired production throughout a highly integrated supply chain. Companies were unable to accurately gauge the pace and quantity of parts and oil deliveries to smooth the flow of production.

It seems logical that supply chain conditions would sharply improve once the uncertainty shock stemming from such situations was resolved, yielding a bounce in production and demand like that observed during the fourth quarter in the United States. Europe and China did not show similar resilience. In Europe, the rapid second-half intensification of the sovereign-debt crisis and the associated sharp rise in financial uncertainty, distinct from the rise in real (production) uncertainty associated with Arab Spring tensions and the Japanese tsunami, sharply depressed European demand growth so that it approached a zero or negative pace by year’s end. In China, the need to tighten credit policy and attendant disruptions in the country’s highly leveraged real estate sector elevated uncertainty and served as another financial shock that slowed second-half growth in the world’s second-largest economy.

The unusual elevation of negative real economic shocks during the first half of 2011 deriving from the Arab Spring and tsunami situations were followed in the second half of the year by two negative financial shocks, both of which boosted financial uncertainty. First, the July-August US debt-ceiling crisis, complete with threats of disruptive government shutdowns and unprecedented American default on debt-service payments, as well as an actual one-notch downgrade of US debt by one of the ratings agencies (Standard & Poor’s), boosted financial uncertainty and tempered the US economic recovery that might have flowed from some reduction in oil prices and an easing of Japanese supply disruptions.

The second negative financial shock was Europe’s resurgent sovereign-debt crisis. It is interesting to note that the rise in US financial uncertainty and the attendant, more serious, rise in European and global financial uncertainty linked to the sharp fourth-quarter intensification of the sovereign-debt crisis, more directly damaged financial markets than it did the real economy, at least in the United States. After September, as US growth began to improve from the tepid pace of the first half, the rise in uncertainty following the US debt-ceiling crisis and the European sovereign-debt crisis impeded the recovery of financial markets. It appears, however, that Europe’s real economy has suffered from the uncertainties tied to its worsening financial crisis. The question that lingers as we enter 2012 is whether the modest US growth recovery can persist while European growth slows. We are really back to asking if the US economy can decouple, at least partially, from Europe’s struggling economy.

The resilience of the US economy, relative to Europe and China, during the second half of 2011 may be due simply to the fact that the debt-ceiling crisis amounted to a less serious negative financial shock than did Europe’s intensified sovereign-debt crisis. The American debt-ceiling crisis raised uncertainty about the current and future path of American government finances, while the foreign sovereign-debt crisis centered on the solvency of large European banks. The banks are more important lenders to the European economy than American banks are in the American economy.

That said, the tight interconnection between European and American credit markets means that a substantial level of uncertainty still surrounds the solvency of the American banking system and its ability to serve as an active financial intermediary going forward. Further, the Bank for International Settlements and other financial regulators for enhancements of bank capital continue to pressure European and American banks toward more deleveraging and attendant additional constraints on credit availability to help finance growth and productive capacity and demand for output.

America’s Better Policy Environment

Another reason the US trend toward second-half recovery in 2011 may extend into 2012 is its more favorable policy environment, at least in the short run, than Europe’s. During 2011, the Fed consistently signaled its willingness to keep interest rates lower for long periods to support the financial sector and the real economy by removing the fear of a rise in interest rates. The Fed has also undertaken Operation Twist to lower long-term interest rates and provide extra support for the weak American housing sector.

On the fiscal policy front, American legislators of all stripes switched smoothly in the fourth quarter from talk of deficit reduction mandated by the debt-ceiling agreement to talk of extending again the fiscal stimulus enacted in December 2010. After political maneuvering in December 2011 that elevated uncertainty surrounding full reimplementation of the 2010 stimulus measures, Congress will likely pass in February 2012 a full-year extension of the measures, amounting to about $300 billion of extra stimulus.

European policymakers’ stance has been less supportive than even the ad hoc stance of US policymakers. Southern Europe’s larger debtors have been forced to implement sharply tighter fiscal policies as a condition for receiving funds they will require for short-term debt service. The European Central Bank (ECB) actually raised interest rates twice at midyear before fully reversing the increases in the fourth quarter. Under its new, more pragmatic leader, Mario Draghi, the ECB has provided more support for stressed sovereign-bond markets. Late in December, European banks were permitted to borrow nearly ?500 billion of extra funds for up to three years in an attempt to reduce stresses tied to higher liquidity needs that could engender solvency problems. That said, so far there is little evidence that the ECB liquidity injection has induced banks to extend more credit.

Modest Improvement Possible in 2012

A glimmer of good news emanated from China at the end of 2011 even while the overall outlook for the Chinese economy for 2012 remains uncertain. Inflation has slowed markedly, so there may be a chance for some easing of the tighter credit conditions that have been imposed to moderate real estate speculation. For now, such easing is not evident, and Chinese exports have slowed noticeably as the rest of the world economy, especially Europe, has slowed. But additional Chinese tightening seems unlikely, in contrast to the situation a year ago when inflation was still accelerating and real estate speculation was more intense.

Although Europe will continue to struggle with its growing sovereign-debt crisis in 2012, the United States may benefit from the perception that its relative position is improving. Both monetary and fiscal policy settings are still accommodative. Growth appeared to be accelerating at year’s end. Meanwhile, even though the Middle East unrest is likely to continue, its marginal impact on oil prices may be less this year than in the last, implying less of a drag on disposable household incomes. The supply disruptions tied to Japan’s tsunami and nuclear disaster are likely to continue to moderate, too.

Just as the elevation of real and financial uncertainty in 2011 produced a drag on growth, probably about 1 percentage point off the underlying US growth rate, a reduction in uncertainty may boost US growth by about a percentage point during 2012. Even if the underlying growth rate slips to 2 percent, less uncertainty could help to produce an overall 3 percent growth rate in 2012. This would continue the GDP growth pace already evident in the United States from the fourth quarter 2011 data currently in hand.

Deciphering the growth outlook for Europe and China is more problematic, even given the chance of a pleasant surprise in the United States. Although China may benefit from less need to check accelerating inflation, successfully modulating credit restraints, especially in the volatile real estate sector, is a difficult maneuver. In Europe, the banks appear unprepared or unable to extend credit given the weakness of their balance sheets. The primary result of the ECB’s making additional credit available in December was an increase in ECB deposits, suggesting that the efforts to boost credit growth in Europe still amount to pushing on a string.

Uncertainty operates like a tax on the economy. It increases the cost of production by boosting the volatility of input deliveries and impeding the flow of credit through financial intermediaries or financial markets. Demand for output suffers simultaneously as consumers become more cautious in the face of less predictable income streams. Growth slows. Uncertainty, of course, will not go away during 2012, but if it moderates just a little, this should be a better year for some economies and investors. Let’s hope so. We could certainly do without a repeat of 2011.

John H. Makin (jmakin@aei.org) is a resident scholar at AEI.

Note
1. Frank H. Knight, Risk, Uncertainty, and Profit (Boston: Houghton Mifflin, 1921).

I Commenti sono chiusi