The world economy once again stands on a precipice. Finance ministers might want to look straight ahead, but investors are forcing them to peer down to the abyss.
As advanced economies slow sharply and emerging economies wonder whether inflation or recession is the greater threat, the need for finance ministers to find a way to achieve their ambition of “strong, stable and balanced” global growth has rarely been more urgent.
A world expansion must be strong enough to allow adjustment to the stresses that have built in the past decade. It must be stable because any hitches risk an intensification of the crisis. And it must be balanced, because simply putting off the necessary restructuring will only increase the strains causing angst among investors and politicians.
The alternative is another financial and economic crisis, worse perhaps than that of 2008-09.
Those in positions of authority are worried. Christine Lagarde, the new managing director of the International Monetary Fund, has urged countries make necessary adjustments to restore confidence.
“I believe there is a path to recovery, much narrower than before, and getting narrower. To navigate it, we need strong political will across the world―leadership over brinkmanship, co-operation over competition, action over reaction,” she said in a speech this month.
Tim Geithner, the US treasury secretary, flew to Poland this month with the same message to European finance ministers that the time has come for political will to solve the eurozone crisis and help put the world economy on a stronger footing.
“Governments and central banks have to take out the catastrophic risks from markets …[and avoid] loose talk about dismantling the institutions of the euro,” he said.
The scene is set for the discussions at the Group of 20 and the International Monetary Fund this weekend to be as tense as those in 2008.
Then, the post-Lehman economic crisis and deep recession were stemmed by a huge show of force from global policymaking. Governments underwrote their banking systems. Interest rates across the advanced world were cut to negligible levels. Central banks turned to unorthodox measures both to pump newly created money into their economies and ease strains in markets that had frozen.
Governments allowed tax revenues to plummet without offsetting action and implemented some stimulus. Commodity prices plunged, raising real incomes in oil-consuming nations. Emerging economies, particularly China, gave a huge boost to domestic investment with direct spending and looser restrictions on lending. And very few nations erected trade barriers to impede the recovery when it came in spring 2009.
The policies worked in stemming the crisis, but some have fallen into reverse. Commodity prices have risen to levels similar to those in 2008, the equivalent of a tax on oil-consuming countries. Fiscal policy is being tightened across the advanced world. But the greatest problem in advanced economies is that companies and households remain cautious about spending.
Companies are hoarding cash. Households are reducing liabilities and governments, particularly in the eurozone, are realising the limits of being the consumer of last resort. For them, the adjustment is far from complete.
Willem Buiter, chief economist of Citi, says: “The advanced economy slowdown is across the board and countries reinforce each other. We don’t expect a recession yet – although we are close to it – but there is not enough growth likely to stop unemployment rising in the US.”
Having revised their global economic forecasts higher as the recovery initially seemed better than expected, international organisations have become much more gloomy.
The Organisation for Economic Co-operation and Development expects almost no growth in advanced economies for the rest of 2011 and the latest figures from the International Monetary Fund this week mark down global economic growth in 2011 from 4.3 to 4 per cent, and from 4.5 to 4 per cent in 2012, with advanced economies facing the bulk of the forecast downgrade.
Rich countries no longer dominate the world economy. At market exchange rates some 40 per cent of global output comes from emerging economies and a much greater share of growth. On the basis of the IMF’s spring forecasts, the combined size of emerging economies would expand 30 per cent between 2007 and 2012, an average annual growth rate of 6 per cent. For advanced economies the growth rate over the same period is likely to be close to zero.
But becoming the dominant force in global growth has not helped emerging economies ride out the storm. Faced with twin threats of global downturn and inflation, policymakers have not known where to turn.
Some countries, Turkey and Brazil in particular, feel the time has come when they should worry less about inflation and cut interest rates to underpin expansion. Others, including China, are playing a waiting game. And India is so concerned about inflation that its central bank raised interest rates in September.
Two things are creating the turbulence in the global economy. First is the eurozone, which is struggling with a conflict between its relatively healthy economic fundamentals if it were a unified country and the fact that it is a combination of 17 economies with often divergent interests.
Given that the eurozone’s aggregate fiscal position is better than all other large advanced economies – the US, Japan and the UK – the euro crisis could be solved with greater pooling of tax receipts and policy.
Replacing national sovereign debts with eurobonds would solve the immediate crisis. But the more solvent north – Germany, the Netherlands and Finland – would have to accept to a degree the liabilities of the south – Greece, Ireland, Portugal, Spain and Italy. That would be an enormous political step, as would the periphery’s resultant loss of sovereign policymaking.
Without a shift in this direction, the euro might not be able to survive, especially if the public begin to believe a split is possible.
As Professor Larry Summers of Harvard University and former chief economic adviser to Barack Obama, said this week: “Now, when these problems have the potential to disrupt growth around the world, all nations have an obligation to insist that Europe find a viable way forward.”
The eurozone woes are replicated at a global level. Huge trade surpluses in oil producers, in China, Germany and Japan are financing deficits, predominantly in the US. With US politicians unable to agree on a stimulus to keep these trade patterns going, the alternative is that the global economy rebalances at a lower level of output, the depression everyone has worked so hard to avoid.
The stakes could not be higher as the G20 meets in Washington. A solution to the numerous contradictions in the world economy is not needed immediately.
But time is running out.
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