Sunday, January 01, 2012
Chugging along: if we avoid the nightmare eurozone scenario
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

Harry S. Truman, or one of his speechwriters, came up with the famous “give me a one-handed economist” line, so exasperated was he with economists saying “on the one hand this, on the other hand the other”.

Hedging your bets rarely convinces anybody. As with those red and green forecasting fan charts produced by the Bank of England and others, which encompass a very wide range of possibilities, nobody applauds a fence-sitter.

So, with all that said, let me get 2012 off to a good start by offering a two-handed view, or at least two distinct scenarios. There are good reasons for doing so, as I shall explain, before saying at the end which I think is most likely.

It will not have escaped anybody’s attention that the eurozone crisis has not been resolved. The Brussels summit at which David Cameron made his stand was as noteworthy for the failure of EU leaders to deliver the deal they were aiming for.

True, the markets showed a spirit of goodwill over the festive period and the European Central Bank bunged nearly ¤500 billion of cheap funding into the coffers of European banks but the underlying uncertainty persists.

Will it be resolved in a disorderly manner, with the eurozone disintegrating, or will EU leaders, the European Central Bank and the International Monetary Fund find some way of muddling through? Or could the euro could survive but with not all its members staying the course? This is something I have long thought likely, if not now then at some stage.

Any of these things are possible but tucked in there somewhere is a very nasty outcome for the eurozone and Britain, what I shall call scenario one, which would see banking crisis and recession return with all the intensity of the autumn of 2008. It should not happen - it should not be allowed to happen - but that is no guarantee it will not.

It is also impossible to ignore. You can split the outlook for this year into one based on fundamentals, which I shall set out below, or you can think about what might happen if we get a re-run of the blind panic of three years ago. As happened then, that would sweep any fundamentals aside.

Before we get too depressed, however, is anybody actually predicting scenario one? They may be doing so in private but publicly available forecasts for the economy say not. According to the Treasury’s compilation of independent forecasts released just before Christmas, the gloomiest, from Standard Chartered, is for the economy to shrink by 1.3% in 2012.

That would be bad news, guaranteeing a substantial rise in unemployment, a worse outlook for the budget deficit and a huge political headache for the coalition.

It would, however, be a far cry from the recession of 2008-9, when gross domestic product (GDP) fell by a cumulative 7.1%. A new recession on the Standard Chartered scale would be more of an aftershock than a dangerous and damaging slide. And remember, they are currently the gloomiest.

Forecasters may be wrong, of course. But most are assuming that the eurozone will be more of a running sore, admittedly a very troublesome one, than a couple of broken legs.

That leaves us with scenario two. We will not know how the economy did in the final quarter of 2011 until January 25 but the assumption is not very much. Either GDP will be flat, or it will have dropped by a little bit, or it will have risen slightly.

And, it seems, we are due for a few more months of this, until roughly the middle of the year. There is nothing to suggest, barring euro armageddon, that the economy is about to fall off a cliff. There is nothing to suggest either that it is about to burst into life.

In scenario two, exports remain adversely affected by the eurozone crisis, even if it does not descend into outright chaos. Businesses are cautious about investing and government spending is being cut.

The economy in these circumstances needs the consumer - how can it not need the two-thirds of GDP contributed by consumer spending? Such spending has been unusually depressed; more so at this stage of the recovery than ever before.

The mechanism for lifting it, and the spirits of consumers, is the restoration of growth in real incomes. That will come, as I have noted before, only when inflation falls far enough. If the Bank of England is right that will come in the second half of the year. Standard Chartered, for all its short-term gloom, expects inflation to be down to 1.7% by the fourth quarter.

Falling inflation, and hence rising real incomes, will be the trigger for stronger growth in domestic demand. With luck, the same starting-gun that gets Usain Bolt away in the 2012 Olympics will fire consumers up too.

Growth is unlikely to be spectacular. The 2012 consensus lurched downwards between November and December, no doubt partly as a result of the Office for Budget Responsibility’s 0.7% forecast. Nobody likes to be above the official forecaster so the new consensus is 0.6%.

I would expect something a little stronger, but closer to 1% (as in 2011) than 2010’s 2.1% expansion. More importantly. however, if this view is right, the tone will be different.

So, while 2011 was a year that started with growth hopes high and then saw them fade, 2012 should be a mirror image. With luck we would be looking forward with optimism to the sunnier climes of 2013 and beyond.

So which scenario will it be? Both are possible but if I had a spare ten shillings I would put it on the second. I would give scenario two a 75% to 80% probability and euro armageddon 20% or 25%. That is too high for comfort, and puts the onus on eurozone leaders to maintain the pressure for a solution to the crisis that lasts beyond the next summit. But it may be as good as we are going to get.