The Year Ahead: Martin Walker’s Outlook for 2012

By Martin Walker
Senior Fellow, Global Business Policy Council
January 2012

A great deal—but not everything—about the prospects for the global economy in 2012 will depend on China’s ability to handle two transitions at once.

The first is China’s political transition in the leadership to the new so-called “fifth generation,” all born in the decade after 1945. The second is the increasingly urgent transition from an investment-driven to a consumption-driven economy. This will be made all the harder by the near certainty that global growth will be constrained in 2012.

The main reason for this is that Europe, China’s biggest export market, is still rocked by the euro’s troubles and the unresolved sovereign debt crisis. Europe is facing a year of severe austerity as Germany pursues its quixotic attempt to impose fiscal orthodoxy on Southern Europe. On top of those burdens, Europe will face a sharp credit crunch as its banks hoard cash to meet new capital requirements.

This is not to predict that the euro will collapse; there is too much political capital invested in its survival. But unemployment and bad debts will rise, consumption will stagnate or even fall, and the streets of Italy, Spain, Portugal, and Greece will see angry and increasingly organized opposition.

China’s second biggest export market, the United States, is likely to continue its anemic and sub-par recovery in 2012. It will be surprising if either political party seeks a full-blown confrontation over the national debt ceiling in an election year, but there will be no attempt to stimulate the economy, so unemployment will remain high and housing prices will continue to drift downward.

Growth is unlikely to get much above 2 percent for the year, and if a Republican wins the White House in November, then the United States is likely to follow Europe into a dismal austerity. And an election year is likely to sharpen the trade tensions with China, which have already reached worrying proportions after China imposed duties of up to 22 percent on large cars and SUVs made in the United States, in what appears to be retaliation for American complaints over Chinese dumping in wind and solar power exports.

After Europe, the United States, and China, the next biggest economy is Japan. With a very strong yen and falling exports to Europe, Japan’s trade balance went into the red in November for the second month in a row. With by far the highest level of sovereign debt of any leading economy, Japan could face a debt crisis. Standard & Poor’s and Moody’s each downgraded their ratings for Japanese government bonds last year and have announced that they are waiting for a credible plan for fiscal reform in 2012. With the government predicting 2.2 percent growth based on the hope of a domestic consumer boom, the ratings agencies are unlikely to be satisfied.

Looking at the other big economies, the United Kingdom is locked into stagnant austerity and Brazil’s boom has stalled. India has seen falling industrial production and faces a budget deficit of 9 percent, so it is likely to see growth slow sharply. Russia will benefit from high energy prices, but it will continue to suffer capital flight as nervous investors watch the political crisis that is undermining Vladimir Putin’s regime. Canada is likely to outdo Germany and deliver the best performance of the traditional G7 countries.

The politics of the Middle East and the coming embargo on Iranian oil are likely to keep oil prices high, while the U.S. shale gas revolution should keep natural gas prices from rising to match. Renewable energy prospects will continue to disappoint, with what looks to be a costly and embarrassing problem about to hit Germany’s booming wind sector. Two large new wind farms in the North Sea are ready to start work but the transmission lines aren’t ready to feed their power into the grid. Since giant windmills have to move to face the wind, the Germans may have to power them with dirty diesel until the transmission lines are in place.

Surprises like this can be expected to recur throughout the coming year. We now know that Spain’s budget deficit is going to be much larger than anyone expected and Spain’s regional governments are far more indebted than they previously admitted. So Spain will be high on the eurozone watch list this year.

Then there are the vagaries of the vote, with presidential elections in the United States, France, and Russia to add to the unpredictable nature of the year. One wild card to watch will be the performance of the anti-immigrant Front National candidate Marine Le Pen in the French elections. Ten years ago, her even-further-right-wing father Jean-Marie Le Pen stunned Europe by forcing the incumbent Socialist prime minister into third place. Now she is also running on a pledge to take France out of the euro, and a December poll by Ipsos/Logica found 45 percent saying the euro was bad for the French economy and 36 percent wanting a return to the franc.

In the end, the prospects for 2012 will depend on China’s ability to avoid a hard landing brought on by the combination of a property crash, a banking crisis, and the need to rescue some bankrupt local authorities. The odds of this happening before 2014 are about one in three, according to analysts at Japan’s Nomura group. Since China alone accounted for almost half of global growth last year, that risk looks uncomfortably high.

One thing is certain: Governments around the world are out of fiscal ammunition. If Europe’s likely double dip slows both China and the United States, there is little politicians can do. That is why the extraordinary measures to create liquidity by all the big central banks have become so crucial, and why economists are wondering at what point all that extra liquidity translates into new inflation. This will be a year of living dangerously.

Martin Walker is a senior fellow of A.T. Kearney’s Global Business Policy Council. He is based in Washington, D.C.

The views expressed in this commentary are those of the author and do not necessarily represent the views of A.T. Kearney or the Global Business Policy Council. The views are not meant to suggest specific inducement to make a particular investment or follow a particular strategy, but only as an expression of opinion.