At the beginning of 2011, plenty of people thought the worst was over. The US economy was on the mend, courtesy of the Federal Reserve's printing press. The UK's monetary independence – and, by implication, its exchange rate flexibility – suggested that fiscal austerity wouldn't completely derail the recovery.
Greece and Ireland had their difficulties but the eurozone seemed able to cope with its occasional little local difficulties. Few had high hopes for the Japanese economy, but Japan's economic influence had become marginal over the years. And, throughout the emerging world, the worry was not so much too little growth but, instead, too much inflation – in China in particular.
How times change. The main American theme through 2011 was disappointment. True, the US economy avoided the much-feared "double-dip" but the pace of recovery has been extraordinarily muted. Deleveraging by households, a housing market that's still on its knees and a jobless rate which remains remarkably high have all taken the shine off the US story. Weak growth has left Congress with difficult choices over what to do with the budget deficit.
The UK's independence from the eurozone has offered little help. A year ago, the Office for Budget Responsibility was projecting a return to 2.5-3.0 per cent growth by 2012 or 2013. That optimism has now completely gone: with hardly any growth this year and nothing much on the cards projected for next year either, the UK appears to have lost around 3.5-4.0 per cent of economic activity on a seemingly permanent basis.
The remarkable thing is that all this happened even before the eurozone crisis began to bubble over. Indeed, for much of 2011, even as the US and the UK disappointed, many countries in the eurozone did rather well. True, economic conditions for the Italians and Spanish were hardly pleasant but, for Germany and other northern European countries, life just got better and better: strong growth, high employment and low inflation. It is precisely their outperformance that has made the eurozone's systemic problems so difficult to deal with.
Yet even Germany is now showing signs of slippage. Recent readings suggest that even the healthiest of economic patients in the eurozone is in danger of needing the financial equivalent of intensive care. That might prove a good thing: the sooner Europe's creditor nations recognise they cannot emerge from this crisis unscathed, the quicker we are likely to see moves towards an all-encompassing solution. I only hope the European Central Bank is dusting off its printing press.
Japan provided the wild card this year. The earthquake and tsunami certainly devastated the Japanese economy but did these natural disasters also lead to economic disruption elsewhere in the world? Japanese-sourced electronic gizmos of one sort or another ended up in short supply, leaving production lines all over the world standing idle. Disappointing growth in the US and parts of Europe could, perhaps, be excused. Economists were happy to subscribe to this view because they had already persuaded themselves that policymakers knew how to deliver us from the financial crisis. They were, it now seems, too optimistic. Even as Japan bounced back over the summer, the rest of the world continued to disappoint.
Earlier in the year, Chinese inflation was surging ever higher and economists were warning that the Chinese authorities had no control whatsoever over domestic monetary conditions. A few months later and the talk is now all about economic collapse and a property market implosion. Yet the Chinese economy has persistently maintained its economic momentum, even when the rest of the world has been in deep trouble. There may be an occasional speed bump in the road but China is catching up for centuries of missed economic opportunity. We'd better get used to it.
As 2011 draws to a close, western economies look to be in even more trouble than they were at the beginning of the year. Debt is as big a problem as ever. Large companies are in perfectly good shape but households have borrowed too much, small- and medium-sized firms cannot borrow and governments now have debts of potentially nightmarish proportions. And still no political consensus on how to deal with the problem has emerged. That's hardly surprising. Nowadays debtors in one part of the world – the US, Italy, for example – owe money to creditors in other parts of the world – China, Germany. Resolving these international imbalances won't be easy.
All the while, the ratings agencies are breathing down the backs of sovereign issuers, so much so that we now have the remarkable spectacle of French policymakers demanding that, if any country in Europe should next be downgraded, it should be the UK, not France. The risks in the two countries are, however, quite different. The UK gilt market has a buyer of last resort: through its programme of quantitative easing, the Bank of England can keep gilt yields low even as government debt rises. The French bond market does not enjoy the same support so, even though the French budget deficit is smaller than the UK's, it is more vulnerable to a buyers' strike. For the French, the risk is higher yields. For the British, it's higher inflation (and a weaker exchange rate). Either way, there is no such thing as a free lunch.
The entente cordiale may be under strain but, in reality, no western country is in a particularly strong position currently. Blaming each other is perhaps inevitable but it will do little to dig any of us out of this mess.
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