Global fixes needed for global crisis

The adjustment process requires more than just stimulating the economy and involves a worldwide rebalancing

By JOERGEN OERSTROEM MOELLER


THE current financial and economic crisis seems to be moving into a phase where the deceleration is losing steam. But we are still in unknown territory, wondering how long it will take before a flat economy caught by stagnation will gain sufficient momentum to accelerate.

The global economy has encountered more serious problems than originally envisaged because deep and strong imbalances - especially in the US - have been allowed to persist. Therefore an adjustment process is not just about stimulating the economy, but the need to tackle the more agonising issue of rebalancing the global economy.

There are four basic challenges requiring the policymaker's attention.

The first one is the frightening similarity between this crisis and the start of the Great Depression in 1929. In both cases, the calamities began with a collapse of the financial system in the US spreading to the financial systems in other countries, triggering a decline in the real economy through rising unemployment and economic contraction.

All other recessions seen between these two events have started with a fall in demand, steering the economy into recession with the result that the financial sector ran into problems later because the lower growth or outright contraction pushed enterprises into lower profits or losses, turning normal bank loans into bad debt.

There is a frightening similarity between this crisis and the start of the Great Depression in 1929. In both cases, the calamities began with a collapse of the financial system in the US spreading to the financial systems in other countries, triggering a decline in the real economy through rising unemployment and economic contraction.

In 1929 and 2007, the financial sector dragged the economy into crisis, contrary to the normal pattern characterising recessions.

Is the worst over?

When people judge the performance of the financial sector in the current crisis and the policy measures applied by central banks and finance ministers, they - quite rightly - find it reassuring that the worst seems to be over.

That disregards the unhappy phenomenon waiting in the wings that over the next six to 12 months, financial institutions will report heavy losses as many enterprises cannot service their debts. Or in other words: what we have seen so far in the financial sector is the consequences of the original financial crisis emanating from sub-prime and related exuberance, but not yet the consequences from the economic downturn coming in with a time lag.

Unless we realise this, observers may be disappointed. They may be more than that when 2009 does not bring along improving but deteriorating profits for the financial institutions.

The second challenge is that the financial cycles have gone global. Work by the International Monetary Fund (IMF) shows unequivocally that the world is steered by a congruous financial cycle among industrialised countries and emerging economies. The curves reveal that as soon as one of these groups get into difficulties, another one is dragged into the quagmire immediately. There is no possibility of finding a refuge or opting out.

This also explains why global policymakers are so focused upon global or international steering instruments for the financial systems. If the cycles were national or regional, they might be dealt with in a national or regional context. But the plain fact is that as they are global, measures on a global scale are required. The other plain fact is that even if all political goodwill is taken into account, the world is far away from such measures.

The third point is that there is no global business cycle. There are two business cycles - one dominating the economies of the industrialised countries and another one for the economies of the emerging economies and developing countries. As the figures published by the IMF show, emerging Asia stopped fluctuating with the US business cycle around 1980 and emerging Latin America did the same around 1990 to follow the business cycle in emerging Asia instead of the US.

That makes global economic policy more difficult than if there was a global business cycle. When the major countries do not follow the same or congruous business cycle, measures required to turn the economy around differ and countries tend to diverge in their policy options instead of converging them.

The fourth point is that the US follows a course of strong stimulatory policies disregarding the deficits and imbalances. China is adopting a similar policy, but can better afford to do so, as the Chinese deficits and debts are manageable. The figures for the US are frightening, disclosing a deficit for the federal budget running close to 15 per cent of gross domestic product (GDP) plus a high debt, and deficits on the balance of payments despite a reduction of the growth differential between the US and several other industrialised nations including Europe. The main worry is that there are no signs that these deficits and imbalances gripping US economy are going away.
Japan is mired in a severe recession with a contraction of about 6 per cent this year. Britain falls more or less in the same category as the US, while continental Europe is reluctant to run up heavy deficits to stimulate their economies.

The discrepancy is illustrated by a closer look at the figures for G-20 countries. From 2008 to 2010, the budget deficit among industrialised G-20 countries is expected to grow from 4 per cent of GDP to about 7 per cent. For emerging G-20 countries, the corresponding figures are nil for 2008 and only 2 per cent expected for 2010. Government debt among industrialised G-20 countries is expected to rise from 80 per cent to 100 per cent, but at an almost stable fluctuation of around 35 per cent of GDP for emerging G-20 countries.

Politically, it reverberates around the globe that unsound and irresponsible policies are pursued by the industrialised world with the US in the forefront, while prudent policies have become the pride of emerging G-20 countries.

The inevitable repercussion of this is an unbalanced effect on the global economy of national stimulatory measures. Some of the US stimulatory measures will benefit Europe or Japan or China, which will give rise to questions in the US on why such countries do not adopt similar stimulatory policies instead of getting a free ride on the US measures.

So far, these voices have been kept under control, but unless the US economy starts to reflate in early autumn, there is considerable risk that the US discontent about the lack of coordination will spill over into strong words and maybe even policy actions to preserve the positive effects of stimulatory measures for the US economy.

Time is running out for the global economy to mastermind a better coordinated global response addressing the underlying imbalances. We know that the crisis is deeper than we thought. Unless we introduce global measures to address the imbalances, it will also be longer.

The writer is a visiting senior research fellow at the Institute of Southeast Asian Studies, Singapore and an adjunct professor at Copenhagen Business School and Singapore Management University

Green shoots and dud forecasts

By Samuel Brittan
Published: May 14 2009 22:13 Last updated: May 14 2009 22:13

We have been told by that usual bringer of bad tidings, George Soros, that the “economic freefall” has stopped. The normally cautious president of the European Central Bank, Jean-Claude Trichet, has identified a slowing down of the rate of decrease in gross domestic product and, in some cases, “already a picking up”. The Organisation for Economic Co-operation and Development composite leading indicator shows at least a slight uptick. The admittedly highly erratic Easter UK retail sales figures show an actual increase and surveyors report more property inquiries. Financial commentators talk of “green shoots” and one of them has even suggested that the recession came to an end in April. So – Bank of England dissenting – everything is all right and we can get back to normal life.

Except that it isn’t. It is perhaps unfair to cite the continuing horrifying rise in unemployment in so many countries. For that is admittedly a lagging indicator. A better reason for being suspicious is that so much of the new optimism is associated with a very recent recovery in equities. These lost up to half their value in the key US and UK markets, but have come less than a third of the way back since early March. Paul Samuelson once said that the stock market had predicted eight of the last five recessions. The same might be said of recoveries.
There is also a little matter of arithmetic. UK GDP is estimated to have fallen at an annualised rate of 7.4 per cent in the first quarter of 2009. So it is as well that the rate of decline is itself declining. A more specific factor is that a drop in stocks much amplifies any recession. As the Bank of England inflation bulletin explains: “De-stocking only reduces GDP growth if the fall in stock levels is larger than the fall in the previous period.” When this no longer happens the recession looks less draconian; but it does not mean that it is over.

In fact, I have never shared the gloom-and-doom, end-of-capitalism attitude to the credit crunch. Injecting public funds into failing banks was not the best way to bolster demand and credit, especially as governments have relied upon these very same bankers to advise them. Critics on the left and right agree on this matter and are largely right. Nevertheless, governments and central banks have probably injected enough cash into the world economy to prevent the worst from occurring. Sound money commentators fret about the difficulties of withdrawing the stimuli in time. They should equally worry about the danger of withdrawing them too soon. One reason why US unemployment remained so high in the New Deal period is that a premature monetary tightening and attempt to balance the budget aggravated a new recession in 1937.

There has been much discussion about whether the present recession will be V-shaped, which is what national authorities would like; W-shaped, in which a modest recovery would be followed by a further downturn; or L-shaped, in which output stops falling but we crawl along at the bottom without getting back to normal trend growth. Having exhausted suitable letters of the alphabet, commentators talk of bath-shaped and hook-shaped recessions as well.
The truth is that we do not know. To me the most dispiriting aspect of current discussion is the way in which both governments and their critics still cling to national income forecasts, known in the trade as “NIF”. The value of such forecasts is not to be judged by their average record over several years, but by whether they signal problems and opportunities in advance of turning points. Here their record is abysmal. At the beginning of 2007 both national and international mainstream forecasters looked ahead to a golden period of good growth with low inflation, oblivious to the credit crunch that was to hit us later the same year. This should have been the coup de grâce, but it was not. There is no solution in putting wide ranges of error on the predictions – what one economist called “giving them wings”. New Bank of England charts show a range of between minus 2 per cent and plus 6 per cent for output growth in 2011 and 2012, which is honest but useless.

I recently heard a well-known forecaster say that the only valid question is which forecasters to go by and what methods they should use. Not so. New mathematical theories of chaos and complexity provide insights into why forecasting is so problematic but do not provide alternatives. We just have to accept that the future cannot be foreseen in the way many governments and businessmen would like.

Let me end with a simple illustration. The weather in summer in north-west Europe is known to be highly variable. Somebody going away for a fortnight in that part of the world would find it helpful to have a day-by-day prognosis of temperature, rainfall, sunshine, wind conditions and so on. But apart from the first day or two it cannot really be done. Rather then rely on long-term weather bureau predictions, it is safer to take an umbrella or raincoat and a warm pullover as well as sunglasses and a sunshade, even at the cost of slightly heavier luggage. Now apply this homely little story to economic policy.

More columns at www.ft.com/brittanwww.samuelbrittan.co.uk

EU-CHINA RELATIONS: A chess game with 28 players

By Jonathan Eyal

EUROPEAN governments may disagree about how to tackle the current financial crisis, but they all agree on one issue: China is crucial to global economic recovery.

Yet, as a recent report from the European Council on Foreign Relations (ECFR) - a leading think-tank - points out, the Chinese have a very different perception about Europe's importance. They regard the European Union (EU) as a political dwarf - a rich but dysfunctional player which very often can simply be ignored.

China 'treats its relationship with the EU as a game of chess, with 27 opponents crowding the other side of the table and squabbling about which piece to move', the ECFR report claims. And unless the Europeans act in unison, matters are only likely to get worse.

Europe has long felt sidelined by China. Trade disputes between America and China preoccupy all international financial negotiations. Europe, which is actually China's biggest export market, hardly gets a hearing. And the whopping $332 billion surplus in China's trade with Europe last year alone elicits no expressions of concern from Beijing.

More importantly, the Europeans feel politically humiliated. If the Chinese cancelled a summit at the level of heads of state with the US, this would have been headline news. But when China cancelled a scheduled summit with the EU last December because it did not like Europe's policies over Tibet, nobody noticed.

One reason why China does not take the EU seriously is that, despite its name, Europe is hardly a proper 'union'. It is a confederation of nation-states, pursuing different agendas. It did not take the Chinese long to conclude that, while there was no point in offending the stream of EU bureaucrats who visit Beijing, the real business is still conducted in Berlin, Paris and London.
True, the Chinese are paying a price for this policy. China's relations with the European Parliament are poor: the EU legislature frequently passes resolutions criticising Beijing's human rights record.

But, on the whole, China still gets its way by 'running rings around the EU', as the ECFR report puts it.

Beijing's chief tactic is to forge a close relationship with one important European country at any given time. For years, Britain was Beijing's bogeyman. Now, it is the turn of France to be excluded, while Britain is lavished diplomatic attention.

In theory, there is an answer to this tactic: the Europeans can stick together. As the authors of the ECFR report argue, the EU could refuse to make trade concessions unless Beijing opens up its own markets. Also, it could refuse to lift the current arms embargo on China until Beijing promises to cooperate over European security concerns in Iran or Africa.

But this confrontational approach, although beguilingly simple, is also guaranteed to fail. Europe is the victim of wider historic trends that can neither be ignored nor wished away.

Paradoxically, the Chinese used to be the EU's most fervent supporters. During the long decades of the Cold War, China hoped that the EU could provide a counter-balance to the US and the then Soviet Union, a third force in international relations. That was the moment when Europe could have forged a special relationship with Beijing. Unfortunately, that was also the moment when Europe preferred to examine its own navel.

That historic opportunity is unlikely to return. The Chinese have now reached a stage in their development when they no longer need the EU to counter-balance America: Beijing can do this on its own. And the rise of other powers has further diminished Europe's importance. So the Europeans are proposing to get serious about China just when Beijing no longer needs them.
And despite all their pretences, the Europeans still do not understand what makes China tick. Although all EU member-states have embassies in Beijing, only a handful have any serious presence throughout Asia. Very few European foreign ministries employ Chinese speakers or experts. And only a tiny minority have either the capacity or interest to think in global terms.
The result is that Europeans often make decisions without even sparing a thought as to how they could affect China.

At the last G-20 summit in London, for example, the Europeans wanted to isolate offshore financial centres - the so-called 'tax havens' - oblivious to the fact that China, with its interests in Hong Kong and Macau, was never likely to accept this. It took US President Barack Obama to broker a deal, leaving the Europeans to fume on the sidelines.

The same applies to Europe's grandstanding on human rights. Not one EU official believes that the 'dialogue' with Beijing on such matters can produce any results. But talks continue, because nobody agrees what should replace them.

As the report from the ECFR correctly points out, 'Europe's approach to China is stuck in the past'.

Yet the future still does not lie in confronting Beijing. Rather, it has to start with the Europeans understanding that they never had the slightest hope of 'changing' China, and they no longer have the luxury to choose how or when to engage with Beijing.

This may not be a pleasant conclusion for the 'old continent'. But it remains a necessary one.

ST May 7, 2009