Sunday 28 December 2014

Constantin Gurdgiev: 'Recovery' does not mean it's all sunshine and light in 2013

Constantin Gurdgiev

Published 06/01/2013 | 05:00

The US experience shows that 'green shoots' do not necessarily lead to a widespread economic improvement

Basking in West Florida's sunshine, downtown Venice is a sleepy affair – quaint and quiet boulevards full of historic trees (if not historic buildings), beaches free of crowds and full of sea birds.

An unlikely mirror to the US economy in many ways, it nonetheless shares in the dynamics of the country's leading economic indicators.

According to the majority of the forecasters, 2013 is going to be the year when the US economy is set to take off onto a new growth trajectory, pushing inflation-adjusted GDP by some 3 to 3.5 per cent. Pent-up economic capacity, capital investment and job creation, held in check since the end of 2007, should act as the major drivers for the world's largest economic engine. Meanwhile, four years of relatively robust deleveraging of American households will be an economic lubricant, facilitating expansion of private sector credit.

In reality, these forecasts are not new. Year after year, since the end of the last official recession in June 2009, the US and international analysts have predicted that over the next 12 months the economy will post a real recovery, comparable to the exits from all previous recessions. Year after year their forecasts were proven to be overly optimistic. Instead of escaping the near-zero growth dynamics, the US economy continues to struggle with finding a solid ground.

In the likes of Venice, this translates into a strange split in the overall economic activity, best exemplified by the local property market. Robust sales of new construction homes are offset by the stagnant secondary market, reflecting the bifurcation of American fortunes. Those who accumulated debts in the 1997-2007 bubble are still fighting for survival. Meanwhile those who entered either jobs or retirement since 2008 are enjoying robust savings on new, high quality, lower priced dwellings.

Much the same applies to the rest of the US. Headlines suggest that house prices are on the rebound, and mortgage lending is up. Mortgage rates are near historic lows, despite the fact that bank lending margins are near historic highs. Corporate debt issuance is up and unemployment rolls are slowly inching down.

The US markets had a blast of a year in 2012. Despite the still unresolved fiscal deficit overhang, the breaching of the debt ceiling, and ballooning Federal debt, the US government borrowing costs were sustained at superficially low levels. Helped by high risk aversion amongst the global investors and the aggressive monetary easing by the Federal Reserve, the US 10-year Treasury bonds yields came down from 1.88 per cent to 1.76 per cent, while five-year Treasuries yields compressed from 0.83 per cent to 0.72 per cent. US 10-year bonds gained 1.86 per cent in return terms in 2012, while 30-year Treasuries rose 1.5 per cent.

US gains in economic competitiveness have been spectacular in 2012. On top of an historically weaker dollar boosting exports and lowering demand for imports, the "shale revolution" saw energy costs plummet. Manufacturing is now experiencing a new on-shoring trend, with corporates bringing back manufacturing capacity previously located outside the US. The most recent example of this is Ford's plan to build a new $773m factory in Michigan. Ford has now committed $6.2bn for investment in the US manufacturing over 2013-15.

The WTI-Brent spread (the differential in the cost of oil between the US and Europe) has declined $18.39 per barrel (some 20 per cent of the overall price) compared to the 2001-2010 average as the US ramped up production from shale deposits to 6.99 million barrels per day – the highest level of crude output since 1993.

However, as in Ireland's case, improved US competitiveness is yet to translate into a broader economic recovery.

According to the Current Population Survey data, American median annual household income remained stagnant between January and November 2012. The November 2012 median household income was 4.4 per cent lower than at the end of 2008-2009 recession and the start of the current "economic recovery". 2012 incomes are some 6.9 per cent below those reached at the end of 2007 and 7.6 per cent lower than in January 2000. On top of this, the fiscal cliff compromise raised taxes on virtually all working Americans, reducing disposable household incomes by some 2 per cent, according to some estimates. The deal is estimated to cost the US economy 1 per cent of GDP annually, starting in 2013.

Weak and narrowly focused on specific subsets of the economy (financials, ICT, export-oriented sectors) economic growth in the US has been unable to lift the real economy out of the L-shaped "recovery". In other words, the main lessons to be learned by Ireland's policymakers from the US "recovery" of 2012 are unpleasant ones.

Firstly, gains in competitiveness and exports growth are not capable of propelling the economy onto a growth path.

Secondly, even with fully deployed monetary and fiscal policies tools, the debt crises are unlikely to lead to a J-shaped or even a U-shaped recovery any time soon.

Thirdly, green shoots in various pockets of the economy are not necessarily going to lead to a widespread recovery.

Even when these sources of stabilisation are supported by expansionary monetary policies, debasement of the domestic currency and massive accumulation of debt (policies not available to Ireland), they are simply not enough.

In the case of Ireland, these lessons mean that in 2013 we will most likely remain stuck in a near-zero growth scenario, with continued contraction in domestic consumption and investment. Even if Ireland delivers on GDP growth of 1.1 per cent in 2013, as forecast by the IMF, the associated uplift in our economic fortunes will be negligible, as all growth will remain concentrated in the MNCs-dominated export sectors.

Real GNP – a much better measure of our economic activity – is more likely to post a 0.1-0.3 per cent rise, while Gross National Income (GNI) per capita is likely to stay at the levels some 22-23 per cent below those attained in 2007. In fact, current inflation-adjusted GNI per capita in Ireland stands below 2000-2001 levels, implying that, in real terms, the Irish economy is now marking its 12th year of the so-called "lost decade".

With zero employment growth, unemployment here will stay static at around 14.6 per cent only thanks to rampant emigration and the expiry of unemployment assistance supports for long-term jobless.

In other words, like Western Florida's economy, the Irish economy will continue bifurcating into the pockets of continued stability, underpinned by the multinationals, amidst the general landscape of continued economic stagnation.

Subtract Florida's beaches and sunshine, and the 2013 economic outlook for Ireland is more pain, punctuated by delirious government announcements of turnarounds and recoveries that the rest of us will struggle to connect to the everyday reality on the ground.

Dr Constantin Gurdgiev is adjunct professor of finance with Trinity College, Dublin and an adjunct lecturer in finance with the UCD Michael Smurfit Graduate Business School

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