“The key message is that America is recovering faster than Europe and that’s because American policy has been much more aggressive in supporting the economy after the crash,” said Ian Shepherdson, chief economist of High Frequency Economics, in a session called “Making Sense of the Global Economy in 2011” that took place at ULI Europe’s Paris 2011 annual conference in February.
Europe also has the enormous problem of the sovereign debt crisis. “So far, the major catastrophe has been confined to Ireland, Greece, and Portugal, although there are also concerns about Spain, Belgium, Italy, and the Netherlands,” he explained.
This is a huge drag on Europe for two reasons: first of all, it forces those countries to impose enormous austerity policies on themselves, such as increasing taxes and cutting spending as a condition of getting money from the International Monetary Fund and from the European rescue fund, slowing the European economy as a whole.
Secondly, European banks are being “kept awake at night” by the huge amounts of money owed to them by Portugal, Ireland, Greece, and Spain—the “PIGS.” Already fragile, these institutions are reluctant to increase their lending to private businesses because they have unknown potential losses from their exposure to the PIGS—somewhere in the order of 14 to 15 percent of gross domestic product (GDP), estimated Shepherdson. In comparison, U.S. banks’ exposure to the PIGS is much lower.
“The American banks are starting to lend to businesses again—that’s why the American economy is accelerating, but in Europe that’s just not the case and it’s unlikely to happen anytime soon until there is some real clarity about the losses from the PIGS.”
There is likely to be some sort of restructuring of the PIGS’ debt, reckoned Shepherdson. However, the problem is they owe a lot of money over a short space of time: “It needs to be stretched out over a much longer time frame,” he said.
Nonetheless, any kind of restructuring would impose losses. “If you’re owed, say, $1 billion by the PIGS, you might get it back—but over the course of the next 30 years, instead of the next five years like you expected. That constitutes a loss because having to wait for the same amount of money over a longer time is just the same as being paid less than you thought you were going to get paid in the original time.”
European banks are very concerned about this, stressed Shepherdson, so the PIGS’ hit on the European economy extends beyond the direct slowing effect that exposure to these countries has on the individual economies. It is also serving to engender fear about the state of the entire European banking system.
“As a result, the gap between the U.S. and Europe—particularly the U.K.—will widen substantially over the next year,” he said.
In addition, there is the issue of inflation and the attendant concern that it might result in interest rates going up. “My guess is that it won’t, but you can’t rule it out.” In the United States, however, Shepherdson believes there is no chance of rates going up “so that fear of higher rates is not there in the same way it is in Europe and the U.K. It’s another reason for American businesses to be more aggressive in expanding.”
Elsewhere in the world, emerging markets are growing strongly and there is no reason to expect that to change. Despite an inflation problem linked to food prices, “I think you’d have to be very brave to bet against strong growth in Brazil, India, and China for the foreseeable future,” concluded Shepherdson.