No need for market gloom on China — the eurozone is the real economic disaster to worry about

Regular readers would not normally turn to me like a source of optimism. Yet, in the middle of the current all-enveloping gloom concerning the world economic outlook, while not exactly optimistic, I’ve found myself nothing beats as pessimistic because the markets appear to be.

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Their gloom has begun to affect most commentators and may, I guess, result in a widespread fall in confidence in the real economy which could then produce, unnecessarily, the thing that the financial markets are worried about.

So, would be the markets right to be worried? Supposedly, they look in to the future inside a cold, calculating, rational way. Not on their behalf the swings of emotion affecting people within the rest of their life. Well, that’s exactly what the financial textbooks say.

Yet we all know that markets can occasionally succumb to euphoria. Former Fed chairman Alan Greenspan once known their “irrational exuberance”.

They were irrationally exuberant about tech stocks during the Internet boom and then these were irrationally exuberant about both American property market and also the ability of derivatives and various forms of financial engineering to magic risk out of the economic climate.

But when the markets are able to irrational exuberance, then they should surely also be able to irrational despair. I believe that is what is going on at the moment. Every item of news appears to be interpreted bearishly.

So, once the Swedish central bank last week cut rates of interest in an attempt to boost the economy, which was interpreted as a signal that things should be really bad. Ditto each fall in oil prices. Just like we thought i was clawing our way back after the disaster of 2008-09, we are now experiencing a succession of false dusks.

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What is the current gloom of market participants and commentators founded on? I suspect that it is partly a reaction to their failure to anticipate the financial crisis and the subsequent collapse of output. They are determined not to be caught out again.

But if we are searching for solid causes of pessimism rather than psychological analysis, I suppose most people’s answer will be the trouble in China. Yet everything has happened in China is really a slowdown within the rate of growth.

This slowdown has stopped well lacking a recession and doesn’t look as if it will develop into one. Indeed, several indicators claim that the Chinese economy has stabilised, albeit in a much lower rate of growth than the usual few years ago.

Over and above China, obviously, but partly associated with it, there has been a collapse in oil and commodity prices. This has brought severe pain to people companies and countries that leave these things. In principle, there should be offsetting gains for his or her consumers but, when i wrote before, these gains are small , widely dispersed.

Why aren’t more and more people banging on about eurozone weakness, rather than China, as the reason behind the world’s travails?

Consequently, even if they add up to exactly the same amount in total, they don’t make just as much impact.

And there is a clear asymmetry with regard to solvency and credit risk. Umpteen companies, as well as some countries, might be sent within the edge through the fall in oil prices but nowhere will a default or bankruptcy be averted because oil consumers’ real incomes happen to be boosted by a trivial amount. Nevertheless, low oil costs are providing a boost to many countries, including the U.K.



Recently, another ingredient has entered the mix – namely the apparent weakness of major banks. This seems to have its root within the supposed adverse consequences of negative interest rates for bank profitability, possible contact with those companies and countries that have lost as a result of the fall in oil and commodity prices, and general contact with the softness around the globe economy.

In fact, although the banking system remains weak in a number of countries, there’s been a good deal of progress because the crash. Moreover, the bank lending and money supply figures do not suggest that the machine as a whole is in crisis.

Moreover, the world economy keeps growing by between 2 percent and three percent per annum. Admittedly, this is slower than the rates of growth registered before the 2008-09 crash. Aggregate demand from customers has not grown strongly enough since then to return the world economy to normal. But the causes of this aren’t the same as what is commonly supposed. The Chinese slowdown is just one contributor, and indeed a minor one for us within the U.K. British exports to China, although growing, are small. Ireland is a bigger market for us than China.

An important supply of weakness in the world economy is the eurozone, which has still not returned towards the pre-crisis degree of output.

By contrast, the U.S. and U.K. are 10 % and 7 per cent respectively above their pre-crisis levels. Imagine just how much better the planet would now look if the eurozone had managed exactly the same increase in GDP because the U.S., or even the united kingdom.

Admittedly, it did manage development of about 1.5 per cent this past year – that was good by its low standards – but it now appears to be slipping back.

We are all aware why the eurozone has been so weak. It is a combination of the stranglehold on the weaker peripheral countries wrought by a loss of competitiveness, excessive debt levels and fiscal stringency; the persistent tendency to underspend in Germany and the Netherlands; and also the pronounced structural problems in France. The first two are a direct result of the euro.

It is now widely acknowledged that the euro continues to be an economic disaster for Europe. It’s still not widely perceived, though, that it’s also a leading factor behind the weakness from the global economy. The eurozone economy is larger than China’s. Moreover, its current account surplus is larger, too.

Why aren’t more and more people banging on about eurozone weakness, instead of China, as the reason behind the world’s travails?

Mind you, this specific area of the world’s problems don’t look likely to be fixed any time soon.

Perhaps I’ve talked myself into being a paid-up person in the pessimistic tendency after all.

Roger Bootle is executive chairman of Capital Economics.

The Daily Telegraph