Global Economy in 2012 - Pivotal Year, Pivotal Challenges

Our Themes For 2012 In many ways, our 2012 preview is a continuation of our 2011 outlook. At the end of 2010 we believed the upcoming year would be characterized by heightened political risk, a Chinese economic slowdown, and a culmination of the eurozone crisis. As it turns out, there remains much unfinished business. We expect 2012 to offer answers to some of the big questions, such as whether the Chinese growth model is doomed, and whether Europe can finally get its act together. Our growth forecasts are below-consensus, but not dramatically so. However, we are very concerned about the negative tail risks, with a deflationary scenario potentially arising from a combination of deleveraging and a reduction in global demand. No matter how we look at it, 2012 looks set to be as interesting – and as challenging – as 2011. 2012: The Year Of Political Risk (Redux) As we had expected, 2011 was among the most politically tumultuous years in a generation, with revolutions and public unrest reminiscent of the fall of the Berlin Wall and end of the Soviet Union two decades ago. The year 2012 promises to be another landmark year for political risk. The two biggest shocks of 2011 – the ‘Arab Spring’ and the eurozone crisis – remain unresolved, and we expect the fall-out from these two events to persist well into 2012. In fact, the outcomes of the ‘Arab Spring’ and eurozone crises will shape their respective regions for at least a generation. In addition, several politically or economically significant countries will hold general elections, which could result in changes of government, and thus policy. These include (in chronological order) Taiwan, Russia, Iran, France, Mexico, Venezuela, Ukraine, the United States, South Africa, and South Korea. Meanwhile, China will begin a five-yearly leadership transition in the autumn, which will continue into 2013. As regards risks stemming from international conflicts, we see a rising possibility of external intervention in Syria, growing tensions between the US and Israel vis-à-vis Iran over the latter's nuclear programme, and greater strains between Russia and the West over a host of security issues. The death of Kim Jong-Il also raises serious questions about the future of North Korea. China: From Miracle To Meltdown 2012 may be the year in which China’s economy goes from – as the title of our China Special Report in October put it – ‘Miracle To Meltdown’. We have warned for years about the imbalances inherent in the Chinese economic growth model, which are characterized by a major overemphasis on investment at the expense of consumption, underpinned by unsustainable credit expansion. Now, several indicators point to a Chinese hard landing. While the definition of hard landing is up for debate, we generally consider it to include the following characteristics: a contraction in manufacturing output as reported by the PMI surveys; a contraction in services sector PMI; a sustained fall in imports; doubledigit house price declines; elevated banking sector stress; and growing expectations of currency weakness. Each of these boxes was being ticked as 2011 made way for 2012, which is why, despite our 7.5% growth forecast for the year, the economic situation underneath the surface could be far worse than many are anticipating. Needless to say, a Chinese hard landing would be a crushing blow to countries hoping that China can – as it did in 2008-09 – sustain global demand in the face of a developed world downturn.