Bloomberg News

Economies Prove Voters Aren’t Careful on What’s Wished For

September 06, 2011

(Updates with Zoellick comment in third paragraph.)

Sept. 6 (Bloomberg) -- The world economy is paying a price for democracy.

As recoveries from the U.S. to Europe lose momentum, policy makers are running into gridlock formed by the politicking and ideological preferences of governments that voters have chosen. Republicans and Democrats in the U.S. squabble about how to restrain the budget deficit and spur job growth, while officials throughout the euro zone differ over how best to safeguard the future of the single currency.

The result is what JPMorgan Chase & Co. economist Bruce Kasman brands a “crisis of competency” as investors question the ability of authorities to act fast enough to avoid repeat recessions. JPMorgan, UBS AG and Societe Generale SA all recently cited policy paralysis in downgrading estimates for global recovery. World Bank President Robert Zoellick today said Europe’s economic outlook is dependent on political decisions.

“There is a gap between market horizons and political horizons, and the markets don’t like that,” said Michala Marcussen, London-based head of economics at Societe Generale, who last month cut her forecast for growth worldwide in 2012 to 3.9 percent from 4.6 percent. “Political uncertainty is at one of its highest points in 20 years.”

G-7 Gathering

Fresh tests of leadership will come this week, when President Barack Obama speaks to a joint session of Congress Sept. 8 about his plans to increase employment and central bankers and finance ministers from the Group of Seven nations meet Sept. 9-10 in Marseille, France. The dithering shows how economies are still reeling from the aftershocks of the financial crisis and is a far cry from when policy makers united in late-2008 and 2009 to shore up the global banking system and arrest economic decline.

A surge in gold prices shows that investors don’t put much stock in officials, said Edward Yardeni, president of Yardeni Research Inc. in New York. He predicts the metal will climb to at least $2,500 an ounce, having risen about a third since the start of the year and exceeded $1,900 yesterday. Stocks slid as gold advanced, with the MSCI Asia Pacific index less than 1 percent from its lowest 2011 close at 1:31 p.m. in Tokyo.

“Gold is the asset of the last resort when investors have lost confidence in governments and fear they’re out of control,” he said. “Since I don’t see governments getting their act together and moving in the right direction, gold will go higher.”

Elections Loom

Elections in the next two years may prompt politicians to delay painful action such as budget cuts, said Tina Fordham, Citigroup Inc.’s senior global political analyst in London. France holds its presidential contest in May, the U.S. follows in November and Germany, Japan and Italy vote in 2013.

“The use of sticking-plaster policy measures to address deeper economic challenges is all but inevitable for the mature democracies,” Fordham said. “G-7 politicians’ willingness to undertake pre-emptive action to curtail risks is extremely limited and will remain so for an extended period.”

Financial markets nevertheless should benefit if officials are able to agree upon and implement strategies to address the world economy’s ills, said Jim O’Neill, chairman of Goldman Sachs Asset Management in London. Global equity markets lost about $4 trillion in August, and U.S. Treasuries posted their biggest monthly gain since December 2008, as political disputes, including protracted wrangling in the U.S. over the federal debt ceiling, fueled concerns about a relapse into recession.

Leadership Gap

“Many market dislocations have occurred” because investors are “worried about the lack of economic-policy leadership,” O’Neill said. “If the leadership comes, the opportunities created by this crisis will be snapped up.”

Policy makers now have less scope to act than they did during the credit crisis and subsequent recession, sharpening divisions about what to do next. Interest rates are at or near record lows, and budget-deficit pressures trigger calls to cut, not expand, spending.

“We don’t have as much policy weaponry,” said Charles Wyplosz, director of the Geneva-based International Center for Money and Banking Studies.

In the U.S., Obama and Congressional Republicans agreed to a plan that raises the debt ceiling only after months of negotiations. More than a quarter of Republicans in the House of Representatives still voted against the compromise, including Rep. Michele Bachmann of Minnesota, a favorite of the anti-big- government Tea Party and now a presidential candidate.

Europe Infighting

In Europe, officials still are fighting over the details of a plan they unveiled more than six weeks ago aimed at bailing out Greece and defusing the region’s nearly three-year-old crisis.

Central bankers, including Federal Reserve Chairman Ben S. Bernanke and European Central Bank President Jean-Claude Trichet, have said there are limits in what they can do and are urging elected officials to take more action. In addition to their loose monetary policy, authorities have pumped billions into financial markets.

Beyond central banks, “policy makers in both the U.S. and Europe have been distressingly missing in action,” said Mohamed El-Erian, chief executive officer of Pacific Investment Management Co. in Newport Beach, California. El-Erian, whose company manages the world’s biggest bond fund, puts the chances of recession at 50 percent in the euro zone and between one-in- three and one-in-two in the U.S.

Confidence Tumbles

Households have been spooked by the policy logjam, with confidence about the U.S. economy slumping to minus 49.1 in the week to Aug. 27, the second-lowest level in two years, according to the Bloomberg Consumer Comfort Index.

Consumers have “a sense of despair and pessimism about the role of the government,” Richard Curtin, director of a household survey for Thomson Reuters and the University of Michigan, said in an Aug. 26 statement.

In the euro area, confidence plunged last month by the most since December 2008, three months after the collapse of Lehman Brothers Holdings Inc., as the European Commission’s index of executive and consumer sentiment fell to 98.3 from 103.

Businesses are starting to react. H. J Heinz Co., the world’s largest maker of ketchup, is eliminating unprofitable promotions as customers use coupons more often and pay greater attention to what they buy, Art Winkleblack, chief financial officer for the Pittsburgh-based firm, told analysts Aug. 23.

Reason to Worry

Consumers, companies and investors have reason to worry as the world economy shows signs of losing momentum, says Mark Vitner, a senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina.

“There’s not a lot of room for policy error, and inaction can be as bad as doing something wrong,” Vitner said. “There’s a certain level of denial among officials as to how bad the problem is.”

Economists at UBS cited “few signs that policy makers are able to effectively address sovereign-debt and growth challenges” as a reason for trimming their forecast for 2012 global expansion on Aug. 24 to 3.3 percent from 3.8 percent.

The same day, Citigroup economists cut their prediction to 4 percent from 4.4 percent, noting “escalating policy-rated uncertainties, which will likely deter risk-taking and lead firms to continue to emphasize balance-sheet improvement over expansion.”

Growth Rate

The world economy grew 5 percent last year on a purchasing- power-parity basis, which attempts to take account of currency- value differences in measuring output, according to the International Monetary Fund in Washington.

The clashes among officials have “driven home the point that there is no cavalry to ride to the rescue,” JPMorgan’s Kasman and his team wrote in an Aug. 26 report. The New York- based bank now sees global growth of 3.5 percent this year and 3.4 percent in 2012, down from its early July forecast of 4 percent and 4.4 percent.

Obama acknowledged on Aug. 30 that more must be done to bring down unemployment, which has stalled near or above 9 percent since April 2009, and reduce the deficit, which the Congressional Budget Office estimates will reach about $1.3 trillion this year.

“Even though we’ve taken some steps in the right direction, we have to do more,” he said at the American Legion’s 93rd National Convention in Minneapolis. “We’ve got to break the gridlock in Washington.”

Obama’s Plans

The president previewed parts of his Sept. 8 speech at an Aug. 29 White House ceremony, saying he will lay out proposals “to put more money in the pockets of working families and middle-class families, to make it easier for small businesses to hire people, to put construction crews to work rebuilding our nation’s railways and airports,” and other measures to spur growth.

House Republicans are taking a different tack. They plan a series of votes in the next few weeks on legislation to limit regulations, including environmental and labor rules they say burden businesses and discourage hiring. The two sides also are at odds over how to reduce the deficit, with the Republicans rejecting Obama’s call to couple spending cuts that both sides agree are needed with higher taxes.

“The markets are pretty uncertain because they don’t know what’s going to happen with the fiscal situation,” said Nicholas Bloom, an associate professor at Stanford University in California who studies the effect uncertainty has on economies. “The solutions being offered by the Republicans and the Democrats are really pretty different and political power is so evenly balanced. A small thing could flip it either way.”

Eye on Voters

Policy differences also plague Europe, with Finland’s demand for collateral on new loans for Greece only the latest obstacle governments have thrown in their own way as they fight the debt turmoil. Fearful of a voter backlash, legislatures are taking their time ratifying a plan to increase the size of a regional rescue fund and let it buy bonds in markets and aid banks. The delay has left the ECB -- whose policy makers convene this week -- propping up markets by purchasing Spanish and Italian debt for the first time.

“One cannot deny there is a certain amount of uncertainty emanating from the political sphere, so we hope these problems can be sorted out,” ECB Governing Council member Ewald Nowotny said in an Aug. 26 interview.

Rescue Fund

Even when the latest round of negotiations is resolved, doubt will persist over whether the European Financial Stability Facility’s firepower is big enough, at 440 billion euros ($619 billion), and sufficiently nimble, given it must await a request from a debt-hit government before buying bonds and counterparts need to endorse the assistance. Also still in question is what exact role investors will play in the second bailout of Greece.

There also is disagreement about how to manage the euro area, leading to speculation its composition may change over time. Having initially resisted bailouts, German Chancellor Angela Merkel now is pushing back against calls for governments to issue joint bonds. Her opposition reflects voter anger over Germany signing the biggest checks of any country for Greece, Portugal and Ireland. Merkel’s party this week lost an election in her home state, its fifth defeat this year.

In Japan, Yoshihiko Noda last week became the country’s sixth prime minister in five years. He faces a debate about raising taxes to pay for reconstruction from the March earthquake and tsunami, and whether this would hinder efforts to revive an economy that’s shrunk for the past three quarters and is beset by deflationary trends.

Japan Rebuilding

“It’s not clear how fast Noda can pass the third extra budget,” said Takuji Okubo, chief Japan economist at Societe Generale in Tokyo. “We may end up having a new prime minister next year.”

Failure to get a grip risks leaders repeating the mistakes of Japan in the 1990s that led to rolling recessions and deflation, said Stephen King, chief economist at HSBC Holdings Plc in London.

“Our political leaders are in denial,” said King, a former U.K. Treasury official. “The longer they leave the hard decisions, the worse things will become.”

--With assistance from Sophie Leung in Hong Kong and Toru Fujioka in Tokyo. Editors: Melinda Grenier, James Hertling

To contact the reporters on this story: Richard Miller in Washington at rmiller28@bloomberg.net; Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editors responsible for this story: Chris Wellisz at cwellisz@bloomberg.net; Craig Stirling at cstirling1@bloomberg.net


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