As 2007 winds down and people begin to look ahead to what the new year might bring, it seems clear that there is little that can prevent what began as a sub-prime crisis in the US from ballooning into a significant global slowdown. This grim outlook was underlined last week by the wholly inadequate rescue package that the US government announced in a bid to contain the damage that will be done as interest rates on sub-prime mortgages get reset (ie raised) periodically. Most analysts are agreed that the rescue package will not benefit more than 15 per cent of the mortgages that are reckoned to be at risk. Some forecasts say that the monthly rate of re-possessions, already at record levels, will climb from half a million today to perhaps even double that rate, at some time in 2008. The consequent impact on consumer confidence and spending can easily be imagined, as also the fall-out on the rest of a shaken credit system. The Federal Reserve is therefore caught in a dilemma. The slowdown should be prompting it to drop interest rates further, when its open market committee meets this week, but lower rates could accentuate the fall of the dollar against other countries as money leaves the US. Whatever the Fed does, the chances of it preventing a serious downturn are slim. The stock market has so far been behaving as though there is no problem, but already there are signs of increasing volatility (usually a danger signal), even as spreads increase in bond markets -- another indicator of increased risk. So it is hard to see how the current levels of optimism -- on which the record valuations are founded -- can last beyond another quarter or two, because the bad news must start sinking in. | |
| Although the 'de-coupling' theory has gained ground in recent months, with its beguiling argument that non-US growth engines like China and India will make up for the loss of momentum in the US, it is not difficult to see that developments in the US will affect the rest of the world. The US accounts for a quarter of world GDP, and close to a third of global growth, whereas China and India between them account for about a sixth of total growth. It is therefore inconceivable that a sharp slowdown in the US will not be felt around the world, on top of which there is the fall in the dollar's exchange rate. The euro is now at more than $1.50, and some of the weaker economies in Europe are quite likely to feel the pinch of an appreciating currency. China's economic momentum comes significantly from exporting to the US, and it too should feel the backwash effect of a US slowdown. India may be more protected, since growth here is driven more by the domestic market. But the world as a whole must feel the impact of a dollar depreciation that is designed to re-balance America's foreign trade and reduce its deficit from the unsustainable level of 7 per cent of GDP. |
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| In short, there are two separate problems that the world must cope with: the financial fallout of the sub-prime crisis, and the readjustment of the world economy as the cheaper dollar encourages a shift of economic activity to the US. The first problem will be more in evidence in 2008, the second could come more into play after that. From that perspective, 2007 is the year that marks the transition from a booming global economy to one that has to atone for the excesses of the boom. |
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