Deflating hopes of a global recovery

The global economy will see significant deflation through 2012, but it will take time for investors to realise the extent of the problem, Gluskin Sheff chief economist David Rosenberg warns.

Western economies face the triple-D menace of debt, deflation and deleveraging next year, as consumers and governments are finally forced to rein in their spending, according to Gluskin Sheff chief economist David Rosenberg.

In a recent report, Rosenberg warns that Western economies are now in a precarious position. The European debt crisis, he notes, "has taken the global debt crisis to a new and potentially more dangerous level than we experienced in the aftermath of the 2008 Lehman collapse.”

As for governments, he says, "they hit the debt wall at various stages in the past year and the list of countries either being downgraded or shut out of global capital markets is growing by the week, if not the day.”

One thing, he says, seems reasonably certain. "The global economy is going to endure a significant deleveraging cycle as we move through 2012 – one that will affect most, if not all parts, of the developed world. It will be accomplished by some combination of default and writedowns, debt repayment and rising savings rates. All this promises to be very deflationary.”

Rosenberg predicts that over the next 12 months, we’ll witness some major behavioural shifts on the part of consumers and governments.

In the first place, the global consumer will have no choice but to become much more frugal. As Rosenberg notes, "for those who were betting on elevated portfolio returns to deliver adequate retirement savings, time has run out. They will have to save the old fashioned way at some point.” And well-off consumers will also tighten their purses as treacherous equity markets crimp their wealth.

Governments will also be embracing a new austerity, introducing spending cuts and tax reforms. As he notes, each government faces its own particular circumstances and challenges, but what they have in common "is a relatively high degree of chaos.”

With global growth slowing sharply, Rosenberg predicts that we’ll also see a surge in nationalism, which will provide an umbrella for increased protectionism and isolationism.

There’ll also be some major shifts in political ideology. The United States, along with most developed countries, have to work out how they’ll pay down their accumulated debts. "Inevitably, 'taxing the rich' and/or wealth confiscation cannot be ruled out, especially if social stability is threatened by lingering high rates of unemployment.”

Not surprisingly, Rosenberg believes that we’ll likely see major geopolitical upheavals – such as wars, and regime changes over the next 12 months. As he points out, the eurozone debt crisis has already toppled seven European governments, Greece and Italy are now being run by technocrats, and there is a political crisis brewing in Belgium.

The problem is that policymakers have now run out of 'bazookas' to ward off the looming recession. As a result, Rosenberg believes that deflationary pressures will intensify, while equities and real estate head into a new bear market.

However, he says, it will take some time for investors to realise the extent of the problems facing the global economy. "We will be watching for evidence that consensus expectations gravitate toward acceptance that we are deeply entrenched in recession before we expect to see the next low in the equity markets, and conversely, the next (and possibly last) low watermark in bond yields.”

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