COLUMN-Economic optimism now official

Fri Nov 23, 2012 10:10am EST

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By Anatole Kaletsky

Nov 23 (Reuters) - Economic optimism is now official. The year ahead could be "a very good one for the American economy," Ben Bernanke, the chairman of the Federal Reserve, declared on Tuesday. If he turns out to be right, these words could probably be applied to the world economy as a whole.

Since Bernanke, even more than other central bankers, has spent the past four years warning of perils such as the "fiscal cliff" and the dismal condition of the U.S. labor market, this statement, delivered in the carefully worded peroration of a speech to the prestigious Economic Club of New York, marks an important turning point.

Not because Bernanke has a crystal ball that offers him economic clairvoyance. But because his views have an enormous impact on business and financial sentiment around the world. And sentiment - especially about government policies - is the biggest problem for the world economy today.

In terms of objective economic and financial conditions, the end of this year looks like a turning point in the slow recovery from the global financial crisis. Outside the euro zone, which now accounts for just 17 percent of global output and will shrink to just 9 percent by 2060 according to the Organization of Economic Co-operation and Development, economic statistics are clearly improving.

Unemployment, though still high, is steadily falling. Banks are now adequately capitalized. Property prices have stabilized, stock markets are rising and credit conditions have returned more or less to normal. For much of this year, the main obstacle to hiring and investment decisions, according to many business surveys, has been uncertainty about politics and monetary policy. That uncertainty is almost over.

This may sound preposterous. After all, businesses and financiers have been obsessed all year with the euro crisis or speculation about Fed monetary policy or the U.S. presidential election or China's surprisingly chaotic leadership transition - and now the prospect that the United States will fall off a fiscal cliff, dragging down the whole world economy.

But that is the point. Political uncertainties have been resolved or dramatically improved in all the most important economies. Yet business sentiment is so negative that almost nobody believes this.

Consider what is happening around the world - with the glaring exception of the Middle East, where war and political chaos is unfortunately quite normal. China has belatedly anointed its new leadership, which should end the paralysis in economic policy and ensure that the country's gradual adjustment to a slower growth does not deteriorate into an economic collapse. In Europe, the crisis has certainly not ended, but German Chancellor Angela Merkel's decision to back unlimited ECB bailouts and to keep Greece within the euro, essentially guarantees that the euro will not disintegrate, nor the banking system suffer a Lehman-style meltdown. At least until next October's German elections.

Best of all, the uncertainty about U.S. politics and monetary policy, which have preoccupied businesses and investors this year to the exclusion of almost all other issues, is about to disappear.

Bernanke made clear on Tuesday that his optimism about the economic outlook depended entirely on the assumption that Congress would ultimately back away from suicidal legislation that would deliberately push the U.S. economy over a fiscal cliff on January 1. The bad news is that a plausible deal to avert this self-inflicted catastrophe has not yet been outlined. Fear of another Lehman-style financial crisis therefore quite reasonably restrains business decisions around the world.

But the good news is that this uncertainty is almost over. By New Year's Day, 2013, Congress and President Barack Obama will have chosen one of two options. The first is to deliberately sabotage their nation - in which case the world will be back to economic Armageddon. The second will be to tear up the fiscal suicide pact.

As long as Washington decides to avoid fiscal suicide, it hardly matters how. The best outcome would be to agree on broad outlines of long-term fiscal consolidation, while avoiding any spending cuts or tax hikes in 2013. The alternative would be merely to "kick the can down the road" by extending today's fiscal legislation and increasing the Treasury's borrowing powers. This is not ideal, but investors and business leaders could live with it.

The Fed would then continue financing Washington's deficits at near-zero interest rates for another two or three years, as explained last week in this column - and as Bernanke has now promised again. The long-term problems of demographics and healthcare costs would then have to be addressed in the next election cycle, after 2016.

Whichever option Washington chooses, the current uncertainty about U.S. fiscal policy will, for better or worse, be resolved by January 1. Assuming the fiscal cliff is averted, investors and businesses around the globe will have lost their main excuses for avoiding decisions.

When they look at Europe, they will see a continental economy in recession, but no longer close to a Lehman-style financial shock. In China, the new leadership is now in a position to act, if necessary, against risks of the economic slowdown getting out of hand. In the United States, monetary policy is now fixed until 2014 and the presidential election is out of the way.

Business leaders may like Obama or hate him. They may agree with Fed policy or disapprove. But there is no longer any point in delaying business decisions until after the next Fed meeting, or until healthcare reform is abandoned or until a new president with new policies is inaugurated next year.

That leaves the fiscal cliff as the only serious policy uncertainty to fret about.

Assuming that Washington decides not to commit economic suicide on January 1, the business obsession with politics will then have nothing left to feed on. Business leaders and investors will be forced to redirect their attention to economics and the financial fundamentals of their businesses. They may be pleasantly surprised. Once this political uncertainty is neutralized, prospects for most of the world economy look pretty good.

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