There is an unseasonable as well as an unreasonable burst of confidence in the financial markets. Junk bonds are in great demand, and equity markets have crossed their previous best level in many cases. There is talk of the global economy having turned the corner. No one is talking yet about the Ďgreen shoots of recoveryí as Norman Lamont claimed prematurely in his days as the British Chancellor of the Exchequer. But there is a feeling that the worst is over. At Davos, they are experiencing much joy.
What is going on? Are we just tired of feeling miserable and have collectively decided to cheer ourselves up? Or is it that finally after two years plus of QE stuffing money down our throats, there is now a tendency to gamble that any piece of paper that offers more than the near-zero yield is better than nothing? The eurozone countries are saying that the worst is past; the euro did not collapse and there was no Grexit. Ireland is even talking about moderate growth and is past its worst financial state. Spain has not recovered but it didnít collapse nor did it have to resort to ECBís emergency help. Portugal has just floated some debt for which it has paid under 5%. Italy is facing its election with some equanimity that whichever way it goes, Monti may be back as Prime Minister at the head of some coalition.
The uncertainty, if there is any, is with the stronger Northern eurozone economies. The most recent regional election in Germany has seen a defeat for Angela Merkelís CDU and their Free Democrats partners. A Left-Green government will take power. As the federal elections take place later this year, it may yet be that the SPD-Green combination may defeat Merkel. In that case, we may have a slightly more reflationary policy than before but only very marginally so. The major effect will be on the longer running project of creating a fiscal union in the eurozone. The Left may agree more with FranÁois Hollande about the need for growth. The ECB will not like this and may not relax policy. It will add uncertainty to the resolution of the eurozone integration timetable.
In the midst of this, David Cameron has come out with a clear statement that, if re-elected in 2015 as the governing party, the Conservatives will offer a referendum over EU in or out by 2018. The idea is that since eurozone integration will require a new treaty, this will give the British, who are outside the euro, to renegotiate some competences back to themselves. Of course, if the British get away with it, so can other countries demand repatriation of competences for themselves. This is what is called variable geometry in EU jargon. At this point, even finalising the treaty will become very difficult. The Tory eurosceptics are happy and they can breath easier as their main opponents are the UK Independence Party which wants to withdraw totally, no questions asked. Cameron came out with his speech to unite his fragmented party and to gain strength in the forthcoming negotiations. But this means that, until 2018, the issue of the UK in or out will haunt investors. The markets, however, did not move after the speech and euro/sterling rates remained unchanged. Maybe the markets have seen through this ruse as a device for putting off decision and killing discussion of the topic. I think the markets will wake up soon enough.
The US has better news with the debt-ceiling saga postponed until May. Even so, the battle between the Republican House and the President will not die down. The US, in the meantime, has the legally-binding sequestration which is the only way the US politicians will bite the bullet on budget cuts. Obama won the first round on the fiscal cliff but he may not win much more. In any other country, a simple tax like VAT would be agreed upon and stave off the threat of debt explosion, but not in the US.
The macroeconomic picture in the US is looking better in terms of unemployment and there are even some signs of growth. The UK is expecting a triple-dip recession and yet unemployment was down in the last quarter. Real wages are going down; this is a classic market-led recovery. It will take its own time to perk up. There is no such movement in the eurozone. The IMF has just revised its growth forecast for 2013 and 2014 downwards by 0.1% ( as if any economic statistics is accurate within such a small margin!). The emerging economies are also on a similar track, though with a higher growth rate. China seems to have come out with a near-8% growth rate for 2012 and chances are of the same again. India has to do better in 2013 than it did in 2012, but that depends crucially on the Budget being able to cut the deficit.
It may all happen but somehow I doubt it.
The author is a prominent economist and Labour peer