What looked like a cyclical upswing from a short, sharp shock proved a mirage. The game has changedby Nick Carn / January 25, 2012 / Leave a comment
A year ago, the world economy was growing steadily. The consensus was that after the credit crunch it had undergone a short-lived and wrenching trauma and survived it. After a stressful 2011 for Euroland, it is the European debt crisis that now dominates concerns. As much of southern Europe plunged deeper into recession and sovereign credits were downgraded to junk, investors were forced to reconsider the definition of a “risk free” investment. By the end of the year, the future of the monetary union, or at least of its membership, was openly called into question. The US, Japanese and British economies, on the other hand, were merely disappointing.
Emerging economies also hit trouble. Many had felt that they could be a haven from the problems of the rich world but, while economic growth initially held up better, stock markets had heavy falls. By the end of the year, growth had started to ebb with leading indicators pointing to further weakness ahead.
With conventional wisdom confounded, it was an altogether wretched year for most investors. Double-digit losses for stock markets were commonplace, with China hit particularly hard. Commodities, notwithstanding the supposed existence of a “commodity supercycle,” fell heavily. For bond investors the so-called “European convergence trade,” the strategy of investing in higher-yielding government debt to reap the excess return, came spectacularly unstuck. As Italy and Ireland both struggled, the old adage of “never lend money to a country with green in its flag,” looked poised for a comeback. The winning investments were long-dated government bonds in the US, Britain, Germany and Japan. British inflation-linked gilts (bonds that pay a return adjusted to include inflation) led the pack, rising more than 20 per cent and now offer a return below the rate of inflation. It’s safe to say that this was not a widely-recommended investment.
Three years on from the start of the financial crisis, much of the developed world’s banking system still depends on the kindness of governments, not least in Euroland, while the single biggest engine for global growth over the past decade, China, remains largely a command economy. Politics looks firmly reinstated as the master science, but even for politicians the debt crisis is a game changer. For decades, the ability to borrow meant that governments could distribute net largesse to their electorates. Increasingly this is not the case. Partly due to the European Monetary Union’s brutal strictures, Greece,…