Jay Pelosky: Ominous Signs for the Global Recovery; U.S. growth may be ready to cool, Europe faces a serious deflation risk, and emerging markets are in disarray.
As the feel-good talk emanating from the World Economic Forum gathering at Davos last month fades and equity investors contemplate the possibility of a major market correction, a combination of factors suggests that something ominous may be afoot. Taken together, these three factors--simultaneous liquidity withdrawal by the Federal Reserve and China, a U.S. stock market on a knife's edge, and emerging markets in disarray--indicate that the global economy could be in danger of snatching defeat from the jaws of victory.</br></br>Some observers continue to predict a synchronized global recovery in 2014. The U.S. economy is accelerating, the story goes, Europe has bottomed and will return to growth, while Japan has turned the corner on deflation. China is stable at 7% GDP growth, and the rest of the emerging world is stronger than in prior crises, such as the one in 1998.</br></br>The counterargument suggests that the U.S. economy is ready to cool; that Europe faces a serious risk of deflation; and that Japan needs to do much more to ensure that growth and gradual inflation are entrenched. China is trying to deflate a credit bubble while the remainder of the emerging markets are divided among the mismanaged, the overly indebted and the unbalanced.</br></br>The current geo-economic framework may help to determine which of these visions is likely to play out. This framework suggests that the world economy has yet to find and implement new growth models to replace those broken in the past decade: the U.S. consumer engine, European vendor-financed growth and the emerging markets' export-driven model. Three additional factors are critical to understanding the global economic outlook.</br></br>First, the adjustment to the new post-crisis economics has been buffered by the Fed's unprecedented "quantitative easing" programs in the U.S. and record credit expansion in China. Now these two wellsprings of post-crisis liquidity and economic activity are drying up at the same time, with no growth-model replacement or policy at hand. This is a worrisome development, given the underlying realities of inadequate global demand and very low inflation.