• Global economy continues to face significant challenges.
  • U.S .fiscal cliff disaster likely to be avoided.
  • Chinese economy will slow down but recession is unlikely.
  • Eurozone breakdown remains an unfortunate possibility.

Clouds remain on the horizon of the global economy, Andrea Boltho said in his keynote address at the ULI Fall Meeting in Denver. The Oxford University economics professor sees challenges facing all three of the world’s major economies—the United States, Europe, and China—with the most serious being posed by the continuing problems in the Eurozone.

Boltho was relatively upbeat on the world’s largest economy, arguing that “the U.S. is doing infinitely better than Europe and much better than many other countries around the world.” In global terms, the United States remains in a strong position, with rising consumer confidence and economic growth stronger than all other countries except Germany and Sweden, both of which it is expected to eventually overtake.

However, even the U.S. economy is not without significant challenges, with the most pressing being the prospect of the fiscal cliff. Boltho said he believes that common sense will prevail and a political consensus will be reached after the election to avoid disaster.

In contrast with the U.S. recovery, the issue facing China is the speed and magnitude of its slowdown following the recent boom. Evidence suggests that China is not in for the hard landing that many commentators fear, and Boltho said he believes the country is heading for “a slowdown, but recession is unlikely.” He argues that China’s debt remains comparatively low at about 20 percent of its gross domestic product (GDP), compared with the U.S. debt, which is approaching 100 percent of GDP. In addition, there are signs that the country’s housing prices have stopped falling and are starting to show early signs of turning positive.

Boltho said the picture in Europe is less certain and that the breakdown of the euro monetary union remains an “unfortunate possibility.” In his opinion, Europe faces three major problems: too much debt, insufficient competitiveness, and a divergence in governance standards between the northern and southern countries in the Eurozone.

The immediate problem facing the Eurozone remains sovereign debt. To date, the standard solution provided by Europe’s political leaders has been the introduction of austerity packages. However, the problem with this approach is that, though it starts to erode deficits, it also results in a corresponding reduction in GDP. Despite austerity measures, Greece’s national debt is heading toward 200 percent of its GDP, and economic recovery still remains a distant prospect.

Boltho said he believes that Greece leaving the euro and defaulting on its sovereign debt remains a distinct possibility. If a so-called “Grexit” does occur, Boltho believes the risk of contagion in genuine. If what has been promoted by European leaders as an irreversible monetary union were to be broken, it is likely that other southern European countries would follow suit. The European Central Bank could help prevent this domino effect by printing money and using it to buy bonds issued by struggling nations. However, this move is likely to be resisted by Germany, which fears the joint specters of inflation and a future lack of discipline in these countries as they tackle their budget deficits.

The results of contagion are hard to predict, but the crisis is likely to lead to a European recession deeper than that seen in 2009, as well as a less-encompassing euro used by northern European nations and a range of new currencies replacing it across southern Europe. The impact of a breakdown in the euro on the U.S. economy would be far less significant because exports to Europe only account for about 1.5 percent of GDP.

Even if a breakup is avoided, the Eurozone still faces significant challenges. In the medium term, the European economy suffers from insufficient competitiveness, which has been driven by strong wage inflation in Spain, Italy, and France since the establishment of the euro, Boltho said. In time, wages in these economies either will have to decline in real terms or will recover at a much slower rate.

Over the longer term, European countries need to address the issue of governance, and more specifically the divergence in standards between the northern and southern countries. There is a perception of increased corruption and reduced confidence in the rule of law in the Mediterranean countries that could damage potential trade and investment in those nations.