Thursday, 19 January 2012

Global economic recovery - what will be the ‘new normal’?

By Stephen Spratt

Getting back to normal is taking a long time. Not so long ago there was much talk of recovery; yesterday the World Bank warned emerging economies to prepare for a ‘global economic meltdown’ if the Euro Crisis continues to deteriorate, as it very well might.

Concerns about the Eurozone – and developed countries generally – have tended to be tempered by confidence in emerging economies as drivers of global growth. Again, things are no longer looking so good. Brazil’s central bank is cutting interest rates to spur growth after a contraction in the economy at the end of last year. India is implementing an emergency $35 billion stimulus programme, after growth slowed from 9 to 7%. Even China is beginning to look vulnerable.

Most countries would be more than happy with the annualised growth rate of 8.9% that China achieved in the fourth quarter of 2011, but this was down from 9.7% in the first quarter, and the year as a whole saw the lowest growth rate since 2002. Forecasts for 2012 are worse, with most predicting further declines, and some suggesting growth could fall as low as 7.5%. Given that 8% has been considered the minimum needed to generate sufficient employment to avoid social unrest, this could be highly significant.

And it’s not just countries. After recent talk of a financial-sector led recovery, yesterday also saw Goldman Sachs announce sharply lower revenues, with earnings down 58% (article available by subscription only). This follows similar declines at JP Morgan and even worse results from Citigroup, where the investment banking division suffered a loss.

All the banks cited the problems in the Eurozone as central to their woes. The assumption appears to be that, once resolved, they can get back to ‘normal’. Lloyd Blankfein, CEO of Goldman Sachs, expressed this view in a statement yesterday: “This past year was dominated by global macro-economic concerns which significantly affected our clients’ risk tolerance and willingness to transact ... As economies and markets improve – and we see encouraging signs of this – Goldman Sachs is very well positioned to perform for our clients and our shareholders.”

I wonder... The profitability of banking has certainly been affected by problems in the Eurozone, but this does not make a return to the go-go years of bumper bonuses inevitable. Much of this was driven by investment – or ‘casino’ – banking’, where exotic financial instruments and absurd leverage levels combined to create and inflate bubbles from which traders profited hugely. Those days are gone, at least for now. In both the UK and US, regulators are moving to rein in these types of activities. In the Eurozone area, plans for a financial transaction tax continue. Whatever the new ‘normal’ in banking turns out to be, it is unlikely to deliver the astronomical – and largely illusory – returns that bankers have grown used to. It is noteworthy that the best performing US bank is Wells Fargo, which posted solid – if unspectacular – results based on ‘boring’ activities (article available by subscription only) such as taking deposits and lending to firms and individuals.

And I wonder about the prospects of China returning to double-digit growth rates too. While domestic factors are becoming more important for growth, exports remain key. At least in part, China’s success has been a function of the willingness of people in developed countries to buy their exports in ever larger quantities. With personal debt still at unprecedented levels, what appeared ‘normal’ may turn out to have been an historical anomaly.

Maybe banks and emerging markets will both have to get used to more modest returns, and develop different ‘business models’ that fit the new reality. Whatever the ‘new normal’ turns out to be, we can be sure of one thing – it won’t be the same as the last one. The World Bank is no doubt right to warn developing countries to ‘hope for the best but prepare for the worst’. The problem for policy-makers, however, is that no-one has much of an idea what either ‘the best’, or ‘the worst’ will actually look like; this makes ‘preparing’ for these outcomes even more difficult than it would normally be.

And that’s before we even consider the Eurozone...