The EU Recession

Will the EU and China pull the US down into recession?

A couple of weeks ago the Chancellor of the Exchequer gave a great speech in Parliament (see link: The essence of it was: we cut government spending and the deficit and therefore retained our Triple A credit rating. Left unsaid was the comparison to those that did not cut the deficit and did not retain their Triple A rating.

It took some nerve for the Chancellor to say what he did at a time when there were already riots in the streets of London and other cities, even before the cutbacks became effective. More to the point here, the UK economy is barely growing and tightening fiscal policy can easily tip it into recession (see chart 1).
A recession in the UK is of course of limited significance for the global economy. Unfortunately, however, the UK was only following decisions taken by the EMU for its members. And some governments were forced by the sovereign debt market to take more painful cuts in spending (Italy is the latest, soon to be followed by Spain and France).
As a result of this tightening of fiscal policy, economic growth in the EMU came to a screeching halt (see charts 2-5). Against this background, the leaders of the largest economies in the EMU, Merkel and Sarkozy, had an emergency meeting last week. Their decisions included even more aggressive tightening of fiscal policy in the future and a tax on financial transactions (don’t worry about the latter decision – politicians periodically fall in love with the idea of taxing something they hate because it brings home the bad news. Eventually, they always retreat before causing the damage). What was glaringly absent from their decisions was any measure to boost the economy, even if only by monetary policy means.
This is not the first time Europeans have ignored the need for them to do something when their economy is falling into recession. In 2001, the US economy fell into recession but bounced back after 6 months. The recovery however wasn’t solid enough and Europe remained in a recession so that the Fed had to keep taking Interest Rates lower for the next couple of years. Eventually, rising house prices solidified the recovery in the US and the US in turn through its balance of trade deficit helped Europe out of the recession. This of course was a dangerous gambit in which the housing market in the US had to pull the world economy out of recession. I warned about those risks already in 2003 and the end result is well known. Unfortunately, the world cannot expect the US to pull it out of recession this time. On the contrary, Europe and China with a large and growing trade surplus – which of course means trade deficit for the rest of the world —can easily pull the US down (see charts 6-8). The only hope of avoiding this rests on the dollar continuing to go down sufficiently so the US balance of trade does not worsen significantly. This is also contingent on China continuing to let the yuan appreciate at a faster pace.

Chart 1

Chart 2

Chart 3

Chart 4

Chart 5

Chart 6

Chart 7

Chart 8

One Comment to 'The EU Recession'

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  1. I hope everyone has a great weekend! And how about some more contests? We usually only have the regular 10 favourites contest for the Pet of the Month. I like contests where you can win pets.

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