The global economy in 2012: feast, or famine?

NEW YORK — The world’s financial markets are on the brink, and 2012 could result in the global economy turning a corner — or crumbling, experts said on Saturday.

During a panel discussion at The Economist’s World in 2012 festival, former U.S. Treasury secretary Robert Rubin, Morgan Stanley CFO Ruth Porat and Brookings Institute fellow Eswar Prasad agreed that 2012 would be the year that defines the path that the U.S., European Union and emerging economies for the next decade.

What they disagreed on was the likelihood of each option.

First, the United States. Rubin said he believes that there is “a material likelihood” of major government action on fiscal matters in the short period of time after the U.S. presidential election.

“If major action does occur, it is more than likely that it will be reasonably constructive in terms of mainstream agenda,” he said. “Though it is certainly possible it could be otherwise.”

The direct relationship between the success of business, citizens and politicians suggests that it’s more than likely that common ground for “fiscal rectitude” can be found, Rubin said.

Why? Rubin offered four reasons:

1. A bevy of events scheduled to occur at the end of 2012 and in early 2013 will be a major political and financial problem unless addressed, including the expiration of middle class tax cuts, sequestration, a possible payroll tax holiday and the reaching of the U.S. debt ceiling. If they all occur, the estimated fiscal demand will be reduced by four to five percent.
2. Continued economic duress could increase political pressure to act.
3. The 2012 election itself will produce impacts, “whatever they may be.”
4. A post-election period will increase political will to address the issues.

Still, “there is still a very real possibility that there will be continued dysfunction and a contrived reaction” and nothing will happen, Rubin said. In which case there are two options: a divided government that works together to find a solution “near the mainstream,” or government controlled by a single party, which could lead to more lopsided fiscal strategy.

“At some point, I think it is likely, not certain but likely, that our country will address our fiscal issue,” Rubin said.

The other panelists were more concerned about Europe’s effect on the global economy.

Porat said that she was optimistic about 2012 only because conditions can’t possibly get much worse. In other words, we’re so close to the bottom that capitulation by resistant parties is inevitable.

“Global markets are more stressed than they have been since the bottom of 2008,” she said. “The gravity of the threat to global markets remains until there are precise, [definite] steps. These economies have minimal ability to withstand further pain and shocks.”

Bond levels and the spread between industrial cash bonds and financial bonds — worse today than after the collapse of Lehman Brothers — are two indicators showing how difficult the situation is, she said.

“European financials have approximately €1.7 trillion [in maturing bonds] next year, which makes it very hard to finance in the coming year.” That means a de-leveraging of €2 trillion or more.

“The two most relevant factors affecting GDP growth in 2012 are action by Congress and the path forward in Europe,” she said.

Even with positive steps, Morgan Stanley predicts that the U.S. GDP will only grow by 2 percent in 2012 — “which does not begin to make a dent in 9 percent unemployment,” she said — and a slight decline in Europe’s GDP.

“Muddle through is logical,” she said. “The choice is right in front of us now: either the derailment of the Euro zone or tighter fiscal integration.”

“Structural solutions are there if the will to act is there.”

Prasad offered an even bleaker outlook, listing four major trends he expects in 2012.

Those are:

1. “2012 is going to be a much tougher year for Europe than 2011. If you think 2011 was tough, you ain’t seen nothing yet.” Why? Structural defaults will be more difficult to take on than fiscal defaults.
2. “The IMF is going to become a lot bigger and stronger” because it will take on responsibilities of technocrats who can’t get it done without political support. “Europe and emerging markets will channel their resources through the IMF,” he said.
3. Emerging markets will undergo stress but come out OK. “The advanced economies are really squeezing themselves into a box where productivity gains will be much harder to get in the future” — this is not the case for emerging economies, he said.
4. “Currency wars are going to heat up” because unemployment figures are still high, globally. Exports generate a lot of jobs, but money is cheap in U.S. and other developing nations, and emerging markets want to play ball — so they will continue to buy more debt from U.S. and others, who have plenty of desire to keep taking it.

However, he offered a glimmer of home, at least in North America: “The U.S. does have this fundamental resilience about it,” Prasad acknowledged, saying he would bet on the country if he could.

Porat said that once the pain is found to be over, recovery could be swifter than expected.

“There is so much cash on the sidelines,” she said. “When there’s any sort of sense that we’re turning a corner, you’ll see a lot of cash come in.”

The Economist economics editor and panel moderator Zanny Minton Beddoes asked Rubin if he thought Greece’s potential departure from the European Union would be harmful or helpful to economic stability.

He looked out at audience, shook his head and groaned.

“If Greece leaves — voluntarily or pushed out — the leaders of Europe better be sure that they have very strong firewalls [so that it doesn't go out of control],” he said. “That’s what this whole thing is about: firewalls.”

And what of the American middle class? Rubin said the U.S. needs to focus on growth and the declining wages of this demographic. “It has to be an extremely high priority for our policymakers, but it’s an extremely complicated topic,” he said.

Prasad agreed and said that the same wealth disparity is also rearing its head in emerging economies.

Porat said growth can’t happen without innovation. Quoting New York City mayor Michael Bloomberg, she said that sacred economic cows need not be slaughtered but each milked a little bit more.

“It’s about expenses and revenues,” she said. “We cannot cut our way to greatness in the near-term.”

More coverage from The Economist’s World in 2012:

• China’s economic role in 2012: four views
• The future of tech: wireless, frictionless, cautious