2012 Preview: Coupling and Economic Growth

Happy New Year for 2012 to all my blog readers.  Having just returned from spending the festive season in South Africa (St. Francis Bay and Cape Town to be exact), with a stop in Dubai on the way out, I wanted to reflect on the global economy and its prospects in 2012.

While on the plane, I was reading the Xmas/NY edition of The Economist, and it struck me that the notion of "coupling" and "decoupling" has really not gone away, but at the same time has not been properly explored in academic circles in economics.  And whether we like it or not, when we talk about prospects for different parts of the globe it is all within the context of some kind of international business cycle, which is mostly determined by what goes on in the US.  So as I am doing more research which looks at economic cycles right now, I have also been interested in trying to characterize how different the US cycle is from cycles elsewhere, not in terms of the size of it's ups and downs ( - it's amplitude to a physicist) but more in terms of its shape, compared to other economies.  The first place though to start should be within the US itself though and here the dynamic graphic above comes into play.  This is an Oldham coupling mechanism (taken from this Wikipedia page) where the cycles are clearly not in sync and amplitudes are quite different.as well, but all three wheels have the same cycle periodicity.  This is something like what we see in economics, except of course that there isn't the regularity that we see here because economies are not "pinned" together like these wheels are.  Nevertheless, the fact that there is cycle dependency is what interests me in terms of my research and this is one of the research themes I will be exploring in more detail this year.

If this type of coupling is one of the processes that is at work then it (partially?) explains why certain economies (like India's and China's) have much more growth volatility than does the US and other developed economies. Given that you accept the idea of a loose international synchronization of growth rates, then the good news is that 2012 will likely be markedly better for economic growth than most of the pundits expect - and I think we're already seeing that in the US employment numbers released in the first week of the year.

So what does this mean in terms of finance and investment?  Apart from following the general advice about keeping quite a lot of funds in US stocks and avoiding European stocks given the problems with implementing the austerity measures in the euro area, the Standard and Poor's downgrades, together with the cuts to public expenditure in the UK, there seems to be little consensus on what else to do with your money in 2012.

So where else is promising? I think Africa has still a lot of unfilled potential, and particularly those corporations based in South Africa or US corporations or European corporations that operate in Africa.  Parts of East Asia, in my view, are also still interesting - India, Malaysia, Indonesia and Taiwan in particular, but China is worrying, given the large property bubble that still exists there.  South America also still has potential, but is largely dependent on central banks being able to restrain inflation while ensuring growth.

But my main point in this posting is that prospects everywhere are extremely dependent on the international business cycle, which in turn is determined largely by what happens in the US and Europe.  While the US increasingly looks to be doing better, Europe still has large clouds hanging over its prospects in 2012.

Japan + the markets + higher oil prices = another (mild) recession?

OK, I know it's been a considerable amount of time since my last posting, but I've been busy interviewing and doing conference presentations, but also a little blown over by world events in the last 6 weeks.  Each time I've sat down to write about one event, another seems to happen!  The events in the Middle East, and particularly the fall of Mubarak in Egypt and the uprising in Libya, have been astonishing, while the earthquake, Tsunami and nuclear fallout in Japan have been heartwrenching to watch unfurl, and the market reaction has been knee-jerk to say the least. All these bits of the jigsaw might be relatively easy to analyze by themselves, but the interactions between them all have been difficult to piece together and understand in the context of the world economy. 

So let's start with the fallout (literally) from Japan's tsunami, earthquake and tsunami.  Japan's economy was beginning to show some feeble signs of recovery prior to the earthquake, tsunami and nuclear fallout, but this disaster changes everything.  The fall in Japanese stock prices, as Warren E. Buffett, the billionaire investor recently stated, thinks the disaster in Japan doesn’t change the economic future of the country, but with the market turmoil creates a buying opportunity for investors (see http://www.businessworld.in/bw/2011_03_21_Buffett_Japan_A_Buying_Opportunity.html).  I would go one step further, and say that it does substantially change the economic future of the country, and for one simple reason - the stimulus that the rebuilding must bring to the Japanese economy.  As any undergraduate principles of economics student knows, a disaster, as long as it happens in a country, region or state that has the resources to rebuild ( - and despite it's massive public debt, Japan certainly has the capacity to rebuild through issue of either savings bonds to the thrifty Japanese general public or by special financing bonds for public infrastructure), will lead to higher GDP than before and often higher sustainable growth rates than before if this better quality infrastructure.  Think New Orleans and contrast this with Haiti and hopefully you'll get my point.  The key here is that this rebuilding effort may begin to utilize resources that have been idle, or largely idle over the past 18 years, allowing Japan to break out of it's deflationary liquidity trap.  In economics jargon, I see the disaster in Japan as a shock that might allow Japanese GDP to start growing in a more normal way again.  That can only be good news for the rest of the world.

What about the impact on other countries and therefore the global stockmarket reaction to this?  Well Japan had a housing meltdown in the early 1990s with no apparent impact on the rest of the world, so why would the destruction of wealth this time around have a sizeable economic impact on the rest of the world?  Hence my reaction to the skittishness in the stockmarkets about the Japanese situation is that myopia will soon overcome any nervousness about the global fallout from the Japanese situation.

Now to the situation in the Middle East.  The main threat here is continuing instability and that clearly affects the oil price.  There are 2 possible scenarios that I see playing out - either a) the "low-hanging" fruit has already been picked (i.e. countries that could have a relatively stable transition of power) and populist uprisings in the "high-hanging" fruit will cause massive instability if (and that's a big "if") this wave of popular protest continues or b) the action over the Libyan situation causes a "domino" effect to occur i.e.the wave of popular protest against unpopular autocracies gathers steam and becomes unstoppable.  Clearly scenario a) is the most worrisome for the rest of the World, and would entail much higher oil prices than where we're at, whereas presumably scenario b) would imply only temporary disruptions and a much better long term future for the region.

So if much higher oil prices occur, would this give us a "double-dip" recession?  I think the risks are certainly there in certain countries, and it would be a similar set of recessions to those that occurred in the 1970s with oil prices the catalyst, but I don't think the natural international business cycle points in this direction right now.  I think though on balance this has a much lower risk than continued growth, particularly in the developed world, as countries that have significant long term stimulus efforts in place (such as the US) will not be completely knocked off course by significantly higher oil prices. The major risks are to countries such as the UK and clearly higher oil prices would cause a further slowdown in countries such as China and India.  Countries like Brazil and Canada could benefit from such a scenario though, although obviously the benefits would not be evenly spread throughout the economy.
 
Certainly, once again, we live in interesting times!!