Austerity measures in the US and Europe have the potential to create a two tier global economy, an analysis of the coming 12 months suggests

Written by Ray Clancy

Thursday, 16 September 2010 10:37

The current slowdown in US economic growth has lessons for Europe as it could be the start of a two tier global economy, experts are warning.

US economic growth is slowing faster than expected with confidence waning in the face of austerity measures. Spending cuts in Europe are also hitting investment confidence, according to Neil Dwane, chief investment officer Europe at RCM, a company of Allianz Global Investors.

‘We can still see a two tier global economy in place, with the over banked, overstressed developed world continuing to struggle to make headway, whilst the emerging markets likely to continue to deliver reasonably robust economic growth,’ he said.

‘It is quite clear inside the US that, apart from the activity being undertaken by President Obama and Ben Bernanke, the US states themselves have already entered quite a serious degree of austerity. We are reading about policemen losing their jobs, schools and hospitals being closed and in California they are now paying you with IOUs that are only worth 88% of the dollar bill written on the cheque when you take them to the bank,’ he pointed out.

‘We are seeing the US housing market relapsing badly in spite of the fantastic work that the bond market has done with its rally during the summer, reducing the yield on 10 year bonds to 2.5% and making mortgage renewal more affordable as a result.

‘But, clearly an awful lot of people cannot afford to refinance with the latest data from the US suggesting that one in four mortgages in the US exceeds the value of the property on which it was written. The US housing market, which is normally one of the cyclical parts of the economy that leads an economic recovery, is clearly now one of the anchors that is slowing this economy,’ he explained.

European countries need to expect a wave of austerity, he believes and although the summer in Europe has been more investor friendly as the sovereign debt crisis seems to have faded and the Euro has recovered, tough times are still ahead.

‘What we do see in Europe, whether it’s with the Greeks or the British, is that austerity is expected to arrive at the latest in 2011. We should therefore carefully monitor developments over the next six to 12 months, as the austerity wave which we see in the US at a state level could well spread to Europe too,’ he warned.

‘Worryingly, when one looks to the future, we see that the euro was not weak enough nor for a long enough period to either sustainably boost German exports or to improve the competitive position of the weaker Southern European countries,’ explained Dwane.

‘Countries like Ireland are beginning to show how hard it is, even if you are putting the most effective economic policy in place, to help the economy to recover. They are truly in a paradox of thrift at the moment where the more they save and implement sound economic policy, the more their economy continues to shrink. This may be a foretaste of what the future holds for Spain, Italy and for Greece,’ he added.

In terms of where attractive opportunities can be found in this current, uncertain climate, he believes that European equities offer investors good investment opportunities. ‘European companies with strong business models are well placed to benefit from strong market positions as well as exposure to emerging markets. Dividends are very attractive relative to other parts of the corporate structure, for example credit, and investors are well placed to benefit from both capital returns as well as a relatively high level of income, especially if there is no return to recession in the second half of 2010,’ said Dwane.