The world economy is improving

According to a recent report in The Economist, the “global economy looking less fragile than it did just six months ago.” A global purchasing managers’ index compiled by J.P. Morgan has says that and if recent patterns prevail, “industrial production should soon follow. Don’t get carried away; this is no runaway rebound. Nonetheless, it’s encouraging given the uncertainties that still hang over the global economy. See, “A Gentle Wind at the Worlds’ Back.

According to the report, “three serious worries had been hanging over investors and business: a euro breakup, a hard landing in China, and America heading over its fiscal cliff. I also noted that while the odds of avoiding any one of these were good, the the odds of avoiding all three were pretty low, about one-in-three. How can the economy be healing given that all these uncertainties remain? At the margin, the most serious threats have receded.

◦    “The risk of a hard landing in China may have passed. Purchasing managers’ indexes compiled by both HSBC and the National Bureau of Statistics rose in October, and the new orders components of both are above the all-important 50 level for the first time in 12 and six months, respectively.

◦    “Europe remains in recession but the crisis is not getting worse. The Spanish government bond yield, for example, is still comfortably below 6%. This suggests that while the region’s economy will remain under pressure for many more months, the risk of a disorderly breakup of the euro is off the table, at least for now.

“That brings us to America, where the fiscal cliff remains unresolved, and will be at least until tomorrow, and probably longer. Yet the American economy is getting better. October payrolls grew more than expected. A striking divergence has opened up between indicators of business sentiment such as capital spending, which are weakening, and consumers, which are strengthening; consumer confidence, for example, is at its highest since February, 2008, according to the Conference Board. Businesses seem much more attuned to the threat of the cliff and are delaying capital spending and posting fewer job openings whereas consumers are responding to better current news on hiring, higher prices for homes and stocks, and lower prices for petrol. (Hurricane Sandy will significantly distort the data in coming months, masking the underlying trend.)

“None of the uncertainties have fully receded. China, for example, begins its own leadership transition this week and while the outcome of this tightly scripted affair is not in doubt, the economic policy consequences are: will there be more fiscal or monetary stimulus, or greater liberalization of the economy? It will take months to find out. The euro zone is far from out of the woods. Spain continues to dither on applying for a bailout. This week Greece’s parliament must pass a tough austerity package to qualify for another tranche of its own bailout. Even if it does, the bailout is no longer big enough. For Greece to avoid reneging on its commitments and remain in the euro, the official sector will either have to pony up more money, or restructure its holdings of Greek debt.

“And in America, any one thinking the election will resolve the deep divisions over the role and size of government and thus the direction of fiscal policy is dreaming. Absent one party taking the  House, Senate and White House by large margins, the resolution to the cliff will remain up in the air for weeks and perhaps months more. Some of the latest rhetoric has not been terribly encouraging about the odds of a compromise. Obama seems intent on vetoing any extension of the Bush tax cuts for the wealthy, and John Boehner seems equally intent on not agreeing to any tax increase. For a while the conventional wisdom was that if Mitt Romney won, the Republicans would take the senate. No longer: the senate seems likely to stay Democratic even if Romney wins. Andy Laperriere at ISI Group labels such an outcome “among the worst outcomes for financial markets of any plausible election scenario.” That’s because any budget deal would require agreement of the Senate leadership. Yet Democrats won’t agree to repeal or significantly water down Obamacare, a priority of Mr Romney and the Republican house. Such a combination, Mr Laperriere concludes, would produce “a protracted period where both parties test out whether their position can prevail among the public and uncertainty reins. The grand bargain will be less likely and would very likely be preceded by months of political combat.”

“The fact things are getting better in spite of the lingering risks can be attributed in good part to central banks, whose latest actions appear to have been quite effective. The containment of stress in Europe is primarily thanks to the ECB’s announcement of Outright Monetary Transactions, i.e. purchases of as much sovereign debt as needed to keep the euro together.”

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