Guyana and the wider world Optimism
The current state of the global economic crisis, one year after the financial meltdown of last September (2008), provides a crucial backdrop for consideration of the third, and final lesson to be learnt from global and national efforts to cope with economic recession, financial crisis and the credit squeeze. The first lesson, which I have already covered is the role of stimulus packages as a response mechanism. This was followed by an assessment of conditional cash transfers to the poor, as an innovative and successful way to tackle the economic misery, which much of the world has been enduring for the past year.
The third G20 Summit since the crisis began a year ago took place in Pittsburg USA last week. Many economic analysts and governments are quite optimistic that for most countries recovery is already taking place and that the crisis will turn the corner in the next quarter of this year. And, that further, 2010 will see the resumption of widespread growth. For some countries this will occur early in 2010 and for others much later. However, already, it is being confidently asserted that 17 out of the G20 countries will be definitely out of the woods by the end of this year.
Such optimism at the recent G20 Summit contrasts with the dour expectations at the time of the summit in November last year and the April one earlier this year. Readers, however, should be reminded that there are several downside risks attached to this optimistic outlook. And, as I shall argue one of them (trade policy) is the subject of the third lesson to be learnt from the crisis that I shall be considering.
Downside risks
What are the downside risks to the expectation of economic recovery? The first downside risk is that the recession may take a ‘double-dip.’ That is, the global economy as a whole or some major economies including the US will slide back into economic recession despite the early signs of recovery at this stage. The question we need to ask is whether there is a real risk of this happening?
In my opinion there is. The basic reason for this is that leading the early signs of recovery is the massive stimulus spending of governments. If this is curtailed because of signs of recovery, there is a real risk that if alternative spending from consumers, investors or foreigners on exports, does not take up the slack caused by the decline in stimulus spending, then reduced aggregate demand could re-introduce a recession-type situation.
The second downside risk is also directly related to this. As we have seen, in the United States where the global recession is centred, the decline in consumer demand is a major contributory factor. The same is true for other rich developed economies. It remains true that US consumer spending alone accounts for about one-sixth of total global aggregate expenditure! This is indeed a whopping amount and so it must be a matter of great concern that US consumption expenditure still remains flat and shows no real signs of rebounding.
The third downside risk is that in the US unemployment continues to rise, even though at a reduced rate. As readers know, job growth tends to lag economic growth in the economic recovery phase. Despite this there remains a real concern because the unemployment situation is largely responsible for reduced consumption spending. As I have pointed out several times in these Sunday columns, consumer spending is highly correlated with employment and wage income.
Allied to this is the source of the fourth downside risk. For must consumers (and particularly those in the US) their homes account for the vast proportion of the wealth they possess. As I have shown previously, at the core of the global financial crisis and credit crunch is the bursting of the private housing market bubble in the United States. The securitization and leveraging of these household mortgages are at the heart of the global financial crisis, credit crunch, and financial panics over the past year. Until this market fully recovers, no one can be sure that the global financial system is stable and would not be prey to repeated episodes of financial contagion.
Stock markets, stress tests and inflation
The well publicised recovery of stock markets world-wide, and in particular stocks in the financial services sectors should not lead us to believe that all is well. Already for this year 94 banks have been closed in the US, as compared to 25 last year. And, for the four preceding years (2004-2007) only seven bank closures took place. This is a stunning statistic, not widely appreciated in our region.
Indeed it is because of such happenings that the stress tests I previously wrote about were conducted for the 19 largest banks in the United States, all of them considered as too big to fail. The report card on these called for further capital injections to cope with the risk of systemic collapse. Of note, similar tests have not been conducted for other huge global banks in Europe or Asia. As such, we do not know what surprises they might have in store for us.
Another important downside risk is that the financing of stimulus packages will see an increase in government indebtedness. In some instances this will be huge as not only did governments borrow to finance stimulus spending, but they also created debt to shore up financial institutions on the brink of collapse. Examples of these are the infamous financial bailouts introduced by President Bush in the USA and continued (and perhaps even championed) by his elected successor, President Obama. At the time of these bailouts it was widely assumed by governments and financial/economic experts that if this did not happen, the global financial system would suffer a catastrophic systemic collapse.
The concern about all this government debt is that it could lead to global inflation. History has repeatedly shown that when government debt becomes very large it feeds an inflationary outcome. Readers should also note, because it is not widely acknowledged, that such a financial outcome is of benefit to governments. Why? The answer is that inflation always reduces the burden of government indebtedness.
The final major downside risk is growing protectionism and the collapse of world trade. Indeed this was the unfortunate result of the Great Depression of the 1930s, from which lessons learnt then remain very valid today.
Next week, in the context of this assessment of the state of the global economic crisis, I shall discuss what we should learn about trade policy.