I have refrained from any comment on economics recently, but I see worrying trends developing again. I really don’t want to go into details as this is a backpacking blog! However, there are a number of things that make me think that next year Western economies could suffer a relapse, perhaps even a recession:
- The ECRI (Economic Cycle Research Institute) leading indicator for the US has weakened markedly since the end of April. While this does not necessarily mean the US will go into recession (yet), it does suggest that the cyclical rebound in economic activity will wane next year.
- US M3 growth has collapsed. OK this is really technical and many economists will not agree with this, but ultimately money supply influences economic activity. The Fed doesn’t care about M3, but I think they are making a huge mistake. M3 heavily influences credit and economic activity over the long-term. I’ll leave it at that, as I could write a whole post on this!
- Austerity in Europe. All European countries are adopting ever more draconian budget deficit reduction plans. Individually these make sense but collectively they could drive Europe into another recession. As Europe is the UK’s main trading partner, the hope that an improving trade account might boost growth could be dashed.
- Deflationary spirals. I think that Southern Europe will go through a period of deflation, which will be extremely painful and destabilising. This is not really in economic forecasts yet, but it is almost certain as aggregate demand must fall as government spending is slashed. Without being able to adjust currency parities within the Eurozone, the general price level of these countries must fall to restore competitiveness. Given that German inflation is very low, this means serious deflation. Deflation is death for debtors and the banking system.
- Banks are struggling to fund. Banks in the weaker Eurozone countries are struggling to fund their lending in money markets. This means they will shrink lending and charge higher real interest rates. Given that the Eurozone tends to rely more on bank lending for financing, this will depress economic activity next year. This is the credit crunch part 2. While the UK is in a slightly better position, bank funding is still fragile.
- Inflationary pressures in Asia. India has an inflation rate of 10% and Chinese inflation is rising. Sure some currency appreciation would help but by next year, Asia could be facing an inflationary problem that requires some stiff monetary medicine.
I could give you more reasons to worry, but that’s enough for the moment. I’m almost certain that the Eurozone will suffer much weaker growth and probably a recession next year. It is highly likely that this will make growth weak in the UK, although a recession might be avoided as the UK is lagging in this economic cycle. If you want a simple guide to what’s going on at the moment, have a look at EconomicsHelp .