In fall 2008, the global financial crisis swept through the markets. It has not been contained. In the absence of decisive, credible and internationally coordinated actions, the worst is still ahead.
In the second half of the year 2011, growth will slow because the debt and default problems in the leading advanced economies (Eurozone, the United States, and Japan), and overheating in the large emerging economies (China, India, Brazil, Russia).
But there is more to the story. The fragile, multispeed recovery of the world economy is threatened by the converging trends of the Eurozone crisis, U.S. stagnation, trade disruption from Japan’s massive triple crisis, continued instability in North Africa and the Middle East, a secular trend in oil and food prices, and rising interest rates in Asia.
In April, stock markets worldwide soared to $59.2 trillion; since then, markets have lost almost $2.9 trillion. In the coming weeks, the world economy will be overshadowed by new, converging risks. As a result, markets will reflect increasing uncertainty.
The Greek Crisis Has Only Begun
In Brussels, crisis management has failed since spring 2010. Hundreds of billions of euros have been committed to the bailouts of Greece (EUR110 billion), Ireland (EUR115 billion), and Portugal (EUR78 billion).
Since each of these economies each represents less than 2% of the total Eurozone GDP, the European leaders have been able to defuse the crises, until recently. The new EUR12 billion emergency aid package for Greece bought a few weeks of time, but it will prolong the pain.
Greece is basically insolvent. Debt has soared to more than 160% of the GDP. Private consumption has collapsed. The public sector accounts for more than 40% of the Greek economy (10% more than in Sweden).
Escalating protests reflect the Greeks’ sizzling anger. The ruling PASOK party’s approval rating is rapidly declining. Over 90% of the public are dissatisfied with Greece’s governance. Another 90% say the country is “on the wrong path.” About 80% are unhappy with their lives, and 70% are concerned that conditions will keep deteriorating.
The EUR50 billion privatization program is vital. But it is difficult, if not impossible, to implement in 2-3 years the kind of changes that usually require a decade or more.
Such austerity measures will not resolve the Greek crisis; they are more likely to turn the Syntagma Square in Athens to Tahrir Square in Cairo.
As political expediencies replaced economic viabilities, Greece, along with certain other Eurozone crisis economies, was allowed to join the Eurozone too early.
The moment of truth will follow as Brussels begins to finalize details of a second bailout, estimated to amount up to EUR120 billion and designed to help Greece remain afloat until 2014.
As social turmoil will re-escalate again in Greece, it will split the fragile political consensus behind austerity measures. That, in turn, will magnify the potential for contagion in the Eurozone as risks climb in major economies.
Dominoes from Athens to Rome and Madrid – and Tokyo
In the past few days, the spotlight has shifted to Rome. In Italy, the debt amounts to EUR1.8 trillion. The government is obliged to pay $253 billion (US) of maturing bonds and bills in the second half of 2011 and $352 billion (US) next year; that is, 26% of Italy’s total debt burden.
In contrast, the UK also has $1.8 trillion in total debt, but it has to refinance 13% of the total in the same period.
And from Italy, the spotlight will shift to Spain, where more than 20% of the work force is unemployed (and youth unemployment is over 40%), while the debt is already EUR640 billion.
Unlike Greece or Portugal, these two nations are among the top-12 largest economies in the world. Furthermore, Italy and Spain represents 16.9% and 11.5%, respectively, of the Eurozone GDP.
In the Eurozone, time is simply running out. What makes things worse is the time bomb in the balance sheet of the European Central Bank (ECB).
During the crisis, Brussels saved the financial sectors in the key economies by transferring losses and risks to the public sector. In the process, the ECB, through the system of European central banks, assumed responsibility for hundreds of billions of euros worth of risky securities and equally risky collaterals, in order to boost up the banks in the struggling Eurozone.
This is why Jean-Claude Trichet, the ECB head who will retire on November 1, continues to fight the inevitable debt restructuring – and why Alex Weber, former chief of Deutsche Bundesbank and only a few months ago Trichet’s most likely successor, resigned from the race.
Ironically, the euro, which was created to strengthen European integration, is now about to threaten the very basis of this integration, especially as the ECB is signaling rising interest rates amidst the deteriorating Eurozone and beyond.
Under excessive and too-rapidly enforced austerity measures, growth is already slowing down in the UK. At the same time, the stagnation in the leading Euro economies is reminiscent of a “Japan lite” syndrome.
In Japan, GDP growth for fiscal 2011 has been revised to about 0%. The triple crisis is likely to increase the gross public debt, which has already soared to over 210% of the GDP. In the medium-term, larger fiscal deficits and decreasing household saving rate could move Japan toward a savings crisis.
U.S. Debt Crisis
On May 16, 2011, the U.S. debt exceeded $14.3 billion, the legal debt limit. This burden originates from the 1980s, the Reagan administration, low interest rates and the laissez-faire mantra of deregulation, privatization and liberalization.
With the global financial crisis in 2008-2009, private sector losses were shifted to the public sector, and U.S. debt soared again. When Barack Obama arrived in the White House, it was already 84% of GDP. By the end of the year, it is expected to exceed 100% of U.S. GDP.
In 2009-2019, the U.S. debt will amount to some $20 trillion. The Bush tax cuts and the wars in Iraq, Afghanistan and Libya account for almost 50% of the total. As the costs of the medical services are soaring, the retirement of the large boomer cohorts in the mid-2010s will make the situation much worse.
Through “extraordinary measures,” U.S. Treasury Secretary Timothy F. Geithner has been able to extend the technical debt limit until August 2. So far deep political polarization has made it difficult for the two dominant parties to agree on a new debt limit.
And even when the two will agree on the new limit, they must urgently develop, launch and execute a credible long-term fiscal adjustment program.
Winston Churchill once said that “you can always count on Americans to do the right thing – but only after they have tried everything else.” That, however, was amidst World War II, when the U.S. still spearheaded the world economy and the public debate in Washington was led by the likes of Roosevelt, Truman and Eisenhower.
Extreme political polarization between and within the two leading parties will complicate any potential for actionable compromises.
From Inflation to Rising Food and Energy Prices
During the past decade, the high growth of the large emerging economies (China, India, Brazil, and Russia) has served as the most powerful growth engine for the world economy. Over time, this secular trend will only strengthen.
In the near-term, however, some growth engines must cope with overheating, inflation, asset bubbles, and soaring food and energy prices.
In China, growth can remain strong for years to come, as long as the central government can contain inflation and cope with local government debt. In all other large emerging economies, the economic environment is growing more challenging.
In India, inflation and high-profile corruption cases have added to tumult. In Brazil, the appreciation of the real is taxing growth, while political turmoil has contributed to uncertainty.
In one way or another, the instability in North Africa and the Middle East has already spread to Algeria, Bahrain, Djibouti, Iran, Iraq, Jordan, Oman, Syria and Yemen, while minor incidents have occurred in Kuwait, Lebanon, Mauritania, Morocco, Saudi Arabia, Sudan and Western Sahara.
In the aftermath of political reforms, expectations have risen across the region. But a crisis of rising expectations is almost inevitable because economic development requires time. For all practical purposes, that will contribute to rising food and energy prices.
In the U.S., the Eurozone, and Japan, efforts to muddle through the aftermath of the global crisis have now failed.
Coupled with turmoil in North Africa and the Middle East and overheating in large emerging economies, challenges are increasing in several regions. The net effect is no longer probabilistic and quantifiable, but accumulating, and unmeasurable uncertainty.
In the absence of decisive, credible and internationally coordinated actions in Brussels, Washington, and Tokyo, in cooperation and consensus with the large emerging economies, advanced economies are now contributing a challenging outcome worldwide.
As each region hopes to bumble through the aftermath of the global crisis, all add to small differences in initial conditions, which are, in effect, laying a potential for a new global storm.
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