x Abu Dhabi, UAEMonday 22 January 2018

How quickly did July's economic relief turn to dust

The global economy is clearly skating on very thin ice. So where did it all go wrong, and where do we go from here?

Back in July the sense was almost tangible that the world economy was slowly recovering from the impact of the March 11 Japanese earthquake on global supply chains, and from the effect of rising commodity prices, with oil prices starting to come off their second-quarter peak.

Most encouragingly it appeared that the US economy was finally beginning to turn a corner and pick up some momentum, with monthly jobs growth averaging 131,000 in the first six months of the year.

Markets were hopeful that a euro-zone default had finally been averted, with a second bailout for Greece having just been arranged.

Since returning from vacations, however, it has quickly become apparent that all was not as it seemed.

Global activity indicators over the summer drifted lower, not just in the developed world but in China and in other emerging market economies too, and US employment growth ground to a halt.

The financial markets skirted with a budget default in Washington, and having only just survived this the US was still unable to avoid a downgrading of its "AAA" sovereign credit rating. Most critically of course, the carefully crafted second bailout arranged for Greece in July began to unravel, almost before Europe's politicians arrived at their summer holiday homes.

Instead of looking at an improving economic landscape, the picture has been transformed to one in which we will now be lucky if the world avoids another recession.

The global economy is clearly skating on very thin ice, with the IMF, the Federal Reserve and the G20 group of developed and emerging economies all saying as much over the course of the last week. So where did it all go wrong, and where do we go from here?

The starting point is that by the middle of this year the world economy was still only partially on the road to recovery, three years on from the financial crisis of 2008.

Expectations and hopes were improving but the hard evidence of it was still very tentative, which is not really surprising given the still considerable levels of indebtedness prevailing, particularly in the developed world.

The US economy was advancing slowly, but what it could least afford was the eruption of a political stand-off in Washington over the extension of the debt ceiling.

Even though a deal was eventually secured, both consumer and business confidence were damaged by the political grandstanding.

With a presidential election next year, this gridlock on Capitol Hill is likely to continue, and unless progress is made soon the US will confront another year of economic headwinds stemming from an inappropriate fiscal policy.

China was not without its own policy issues either, despite the appearance of an enviable growth rate of above 9 per cent.

Inflation needed managing lower in a way that would not threaten a bursting of its property bubble, especially given the presence of worrisome debt problems of its own, although these are largely kept hidden from public view.

Both of these situations should be manageable, however, without a fallback into recession, but the political dimension complicates the matter in a way that makes the ultimate outcome much less certain and secure. Of course complicating the situation even further still is the problem posed by the euro zone's sovereign debt problems - the most critical issue the world faces. For the ramifications of the euro-zone debt crisis will stretch way beyond Europe's shores and have the potential to drag the rest of the world, already vulnerable, down with it.

Once again the economic risks stemming from the issue of Greece's insolvency have been amplified considerably by political mishandling of the situation.

Of course a Greek default now appears likely, but the management of that eventual outcome is what will make the difference between whether the world economy continues to grow, albeit slowly, or whether it faces another slump.

The lesson of the past few months, however, would appear to be that the world would be better served if the political dimension was more supportive of, and less disruptive to, the measures that need to be taken to nurture and sustain economic recovery and growth. That way, we may stand a chance of avoiding the fallback into a recession that should really have been avoidable.

Tim Fox is the head of research and chief economist at Emirates NBD