If 2012 was the year of the "fiscal cliff" and unlimited bailouts in Europe, what will 2013 be? Making economic and financial forecasts is never easy -- and I usually stick to the long-term variety -- but here are some of the topics that may sway global markets in the coming year, for better or worse:
In the eurozone: The person who helped to calm markets most in 2012 was probably Mario Draghi, who became head of the European Central Bank only a year ago. With one short statement -- punctuated by the line "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough" -- he committed to keeping the euro area together essentially by printing as much money as necessary to buy up its bonds. The question is whether his credibility will last through another year. Even if the common currency is safe for now, it will not be stronger unless Draghi can force finance ministers to accept new rules about how countries enter, leave, and act in the euro area. Even then, setting a single monetary policy for a group of economies at different stages of boom and bust will be a thankless task. Their economies need to come into closer synch for the euro area to work as planned -- and that's unlikely in 2013.
In Britain: Meanwhile, the markets will be watching Mark Carney's first moves as governor of the bank of England. The former governor of Canada's central bank and Goldman Sachs alum has the respect of investors, but he's facing a much more difficult situation in Britain, which is currently hamstrung by a backwards fiscal policy, than he did in riding Canada's resource-fueled boom. In fact, he'll be working in an environment much closer to what Ben Bernanke, the chairman of the Federal Reserve, has had to deal with in the United States, where Republicans in Congress blocked fiscal stimulus even as the country struggled to recover. Bernanke was forced to take extraordinary measures to fulfill the Fed's mandate; Carney may also have to get creative in London, as he is surely in for a long slog.
At the Fed: Investors are already starting to wonder who will replace Bernanke when his term ends in January 2014. The Fed is undergoing something of a policy shift now, having decided to target an explicit level of unemployment as well as a maximum threshold for inflation. It's unlikely that the Fed's pledge to keep rates low through 2015 will change, unless the global economy should suddenly boom. But the new chairman (or chairwoman!) will determine whether the Fed cements the first major change to monetary policy since Paul Volcker took over in 1979.
Whether it happens before or after January 1, the United States will find a way to make sure taxes don't rise on most middle-class families, and also to avoid arbitrary spending cuts in some government departments. The fiscal cliff will turn into something like a fiscal ramp. Afterwards, the deficit will remain. As I and others have said, it is neither so big nor so difficult to control as some politicians might like the public to believe. Once the rhetorical fog clears, markets are likely to feel more comfortable with the nation's fiscal situation and respond accordingly.
Is it lucky that Japan's central bank is under the thumb of its politicians? Perhaps, since its once and future leader, Shinzo Abe, seems to be the only one with a plan to shock its economy back to life, à la Dr. Frankenstein. Markets welcomed his party's electoral victory earlier this month, but part of his platform was a tougher stance on China and territorial disputes in Japan's neighborhood. In terms of the health of the global economy, fueling conflict in East Asia could negate whatever gains Abe achieves at home. Here's hoping he leaves the nationalist rhetoric on the campaign trail and focuses on raising the living standards of his constituents.
China's new leaders have much more power than Japan's Abe to reshape their economy, but, unlike him, they haven't signaled any sudden changes. Nevertheless, they have big challenges ahead: curbing overinvestment, building demand for goods and services in the domestic market, turning the renminbi into a convertible currency, reducing civil unrest, and managing a pile of foreign reserves with highly uncertain exchange and interest rates. Many of these problems would go away, or at least be less pressing, if the new leaders could unleash a new source of economic growth. A thorough legal and regulatory reform that instituted more transparency, stronger property rights, and better protection of investors would do the trick.
THE MIDDLE EAST
What will happen in the Middle East, and how will it affect the global economy? I don't know, but I am pretty sure that something will happen in the Middle East and it will affect the global economy in 2013. Syria and Egypt still look volatile, and Israel, Lebanon, and Iran are always wild cards. The main interest of the major economic powers now is containment -- how to stop a conflagration from disrupting trade and growth. But there are upsides, too. As soon as Egypt can stabilize and restart its economy, it can become a regional powerhouse: a country of more than 80 million people growing by more than 6 percent per year. Egyptian stocks, which should be a leading indicator of economic growth, have already started to climb.
A return to faster growth will inevitably mean a return to higher prices for food, fuel, minerals, and metals. The global economy doesn't have to pick up much steam for prices to spike, since demand often increases more quickly than supply can respond. We've been seeing crop prices high enough to cause riots every couple of years now, and investors will likely seek out companies that can boost yields -- whether in harvests or extraction processes -- or come up with substitutes for resources in short supply, such as copper and rare earths. Those are long-term plays, though -- we can't count on innovation to solve shortages in the near term.
Every day, emerging economies are becoming more closely linked to the global financial system. These economies are some of the fastest growing in the world, but it's not always easy for foreigners to buy into them. Rising issuances of stocks and bonds are gradually opening up these markets, connecting money from around the world with profitable opportunities. Issuances of debt securities in developing countries have risen steadily for the past few years even as the global economy struggled to grow, and bond funds covering emerging markets have performed extremely well. This trend has plenty more room to run, and it's no accident: Giving the billions of workers in developing countries access to new capital -- in this case, by bringing in foreign money to buy it -- is one of the best ways to make them more productive, helping them to earn higher wages and increase their own spending. The more this happens in 2013, the better 2014, 2015, and every year thereafter will be.