Three years ago, when the world economy was in mortal danger, a series of coordinated and unprecedented measures brought it back from the brink. Today, the patient, still sickly, must endure the sight of doctors arguing over what to do next.
For a brief period starting in the autumn of 2008, leaders of the world’s richest nations moved in lockstep to slash interest rates, rescue banks and pump billions of dollars of stimulus into their ailing economies. That was followed by a declaration by the Group of 20 nations in April 2009 that financial firms needed more regulation to prevent another global meltdown.
As 2011 dawns, there are arguments between nations — and even among domestic policy makers — about how to prevent further market turmoil while at the same time spur stronger growth, Bloomberg Markets magazine reports in its February issue.
At one extreme sit the austerity advocates led by the U.K. and German governments, who say the path back to prosperity starts with a retrenchment of the welfare state. On the other side is U.S. President Barack Obama, who ended 2010 striking a deal with congressional Republicans to extend George W. Bush’s income tax cuts as unemployment hovered near 10 percent — a move that boosted the stock market and led some economists to forecast stronger growth in America for 2011.
Central Bank Debate
Central bankers are also taking different tacks. In the U.S., Federal Reserve Chairman Ben S. Bernanke contends that more direct economic pump priming — known as quantitative easing — is necessary, while European Central Bank President Jean-Claude Trichet has inched his institution toward an exit from emergency measures.
While policy makers squabble over how to guide their economies, some analysts predict that most of the world’s future growth will be driven by emerging markets, meaning that the stasis in the West may hasten a profound and permanent shift of power to China and other developing nations. The question is whether the so-called BRIC nations — Brazil, Russia, India and China — can step up to claim a greater share of responsibility for the world economy and not act in their narrow national interests through institutionalized state intervention in markets and industries and capital controls.
‘Uncertainty and Volatility’
Trichet and other advocates for various factions will meet for the first time in 2011 in late January at the World Economic Forum’s annual meeting in the Swiss ski resort of Davos. That Alpine gathering of policy makers, business executives and economic theorists may help set the course that determines the short-term fate of the world economy.
In its annual survey of the risks facing the world, the Forum today said the financial crisis has sapped the ability of governments to address future shocks and that policy makers are increasingly divided over how to govern the international economy.
“There are disagreements within and across countries over monetary, fiscal, regulatory and currency policies,” says Nouriel Roubini, chairman of New York-based Roubini Global Economics LLC and a veteran WEF attendee. “We’re going to have a great deal of macro uncertainty and volatility.”
Roubini — who said at the 2007 Davos meeting that the world economy would face a hard landing — predicts 2011 will be another year of multispeed recoveries led by emerging markets, with richer nations remaining at risk of double-dip recessions. Roubini has had mixed success since. He incorrectly predicted the world economy would shrink throughout 2009 yet also told Davos delegates last year that excess sovereign debt would hurt the euro area.
If anyone needed evidence of the disparate state of economic policy making among Western nations, it could be found over a 33-hour period of decision making in the first week of November. First, the Fed announced it was planning to spend another $600 billion on U.S. Treasuries. Then a divided Bank of England, which had by that time already spent 200 billion pounds ($310 billion) on government bonds and bank debt, held back from doing more as some officials became concerned that further stimulus would trigger inflation.
Trichet remained focused on helping the euro region avoid runaway inflation and expressed concerns that Europe’s banks might grow dependent on aid. That’s a plan Trichet had to set aside in December when he delayed a withdrawal of support as the sovereign debt crisis overwhelmed Ireland.
The Bank of Japan rounded out the policy marathon that analysts at Copenhagen-based Danske Bank A/S called “hell week” by setting an earlier date for a meeting at which it outlined more details of its own stimulus program. Like low interest rates, quantitative easing is a crisis measure that policy makers including Bundesbank President Axel Weber have questioned as a suitable remedy for spurring economies.
“Quantitative easing is like morphine for the global economy, and when you take that away, the pain is going to come back in some measure,” says Jitesh Gadhia, senior managing director at Blackstone Group LP in London, who will be in Davos. “That could take consumption power out of the system, and so appropriate exit strategies are important for the world economy.”
As North America and Western Europe debate when and how to end emergency measures, emerging markets have been chugging along, delivering higher growth rates. Their expansion has been so unremitting that it’s actually driving a new economic cycle that will last at least 30 years from 2000, says Gerard Lyons, London-based chief economist at Standard Chartered Plc.
“The world economy may now be experiencing its third super cycle,” he says, with historically high growth being propelled by trade, investment and stepped-up urbanization of populations.
The previous generation-long periods of similar prosperity ran from 1870 to 1913 and from the end of World War II to the early 1970s, when the U.S. and then the rebuilt economies of Germany and Japan drove growth.
The difference this time, Lyons says, is the role of emerging markets. He estimates that developing economies accounted for 20 percent of growth in the first super cycle and 28 percent in the second wave. In this round, they will deliver 68 percent of the world economy’s advance by 2030, he predicts.
By then, the global economy will total $308 trillion, up from $32 trillion at the start of the millennium in nominal terms.
Lyons says the transfer of wealth will eventually be reflected in China’s wielding greater influence over global policy and coming under pressure from the U.S. and European Union to act in less-self-interested ways. In turn, Western nations will have to learn to cooperate more with countries that were once bit players, such as China.
“The shift in economic and financial power is under way, and that will inevitably lead to a shift in policy power,” Lyons says. China enters 2011 as the world’s second-largest economy, having leapfrogged Japan in the second quarter of 2010.
Lyons’s view is backed by current levels of growth. According to the International Monetary Fund, the global economy will grow 4.2 percent in 2011 compared with 4.8 percent in 2010. Yet emerging markets will power much of 2011’s expansion: China is forecast to grow 9.6 percent, and India, 8.4 percent. In contrast, the U.S. will grow 2.3 percent and the euro zone 1.5 percent.
“We’re really witnessing a transformation of the world economy and society that is very exciting,” says Jim O’Neill, London-based chairman of Goldman Sachs Asset Management and creator of the BRIC acronym. “Nobody knows their place in the new economy, and it’s going to be a challenge for everyone.”
The game of musical chairs is already taking place. The G-20, of which the BRIC countries are all members, has now replaced the Group of Seven as the main body for steering global economic policy. China is also now set to become a more powerful member of the IMF after richer nations agreed to shift more than 6 percent of voting rights to developing countries.
IMF Managing Director Dominique Strauss-Kahn, who wants China to let its yuan appreciate, says the country’s elevation may be the spur it needs to act more multilaterally.
“Countries like China becoming bigger players in the game will take more into account that they have some responsibilities,” Strauss-Kahn said at a press conference in Frankfurt in November.
Recovery Versus Crisis
O’Neill says the next challenge for international policy makers is to encourage China to let the yuan rise more to prompt the country’s consumers to spend more. That may be the goal of French President Nicolas Sarkozy, who says he will use his country’s 2011 presidency of the G-20 to promote a “new monetary order” that modernizes economic relations between the emerging markets and the West.
“This recognizes China’s importance but also leaves it to think more about the rest of the world,” O’Neill says. He estimates that consumer spending in the BRIC nations will surpass U.S. purchases in 15 years.
The sense of policy in flux shows it’s perhaps easier for countries to manage a crisis than a recovery. Back in 2008, the Fed, the ECB and other central banks executed an unprecedented coordinated interest rate cut that China soon joined. Within a year, G-20 nations had pledged more than $2 trillion in stimulus and plucked banks from the brink of collapse.
Nations also united around a promise to toughen regulation of their financial systems. China, which promised $40 billion to an emergency fund at the time, also secured a G-20 pledge that the IMF and World Bank would no longer be dominated by Western leadership.
The birth pains of that new world financial order were on display at a November summit of G-20 leaders in Seoul that ended without agreement on a solution for the trade and investment distortion that’s often partly blamed for triggering the credit crisis.
The U.S. accused China of keeping its currency undervalued to protect exports, while China returned fire by blaming the easier U.S. monetary policy for devaluing the dollar and flooding other markets with capital. Caught in the middle, South Korea, Brazil and other emerging markets are resorting to capital controls or exchange-rate intervention to stay competitive.
Those arguments are taking place as the euro region struggles to contain a debt crisis. In 2010 through mid-December, the European lawmakers arranged over 195 billion euros ($259 billion) of bailouts for Greece and Ireland. Now the turmoil may spread to Portugal and perhaps the much larger economies of Spain and Italy. Portugal’s borrowing costs fell at a sale of 10-year bonds today, indicating that investor concern about a possible rescue was easing.
Economists at Morgan Stanley now estimate that while emerging markets are responsible for half of the global economy, they’re delivering three-quarters of its growth. At the same time, they’re starting to take steps to prevent their economies from overheating with China raising its key one-year lending and deposit rates by a quarter point on Christmas Day.
Now, governments are taking divergent routes on fiscal policy. Obama’s tax cut package, which included a 2 percent reduction in payroll taxes, may already be having a positive effect. Economists at JPMorgan Chase & Co. estimate that it may boost GDP in 2011 by about half a percentage point in an economy they now say will grow 3.3 percent this year. The downside to the deal is that the U.S. budget deficit will swell to a record $1.5 trillion in the current fiscal year, those analysts say.
Meanwhile, German Chancellor Angela Merkel and U.K. Prime Minister David Cameron said failure to retrench deficit spending would lead markets to impose higher interest rates.
“There’s an enormous cloud of uncertainty about the effects of fiscal policy,” says Kenneth Rogoff, a Harvard University economics professor and former chief economist at the IMF. “It therefore makes sense to be gradualist, so we’ll see incrementalism in whatever direction is taken.”
The slow pace of fiscal policy puts more pressure on central bankers to spur economies even as they argue among themselves. At the Fed, policy makers disagreed in November about the decision to expand monetary stimulus — with the minutes of their meeting showing a majority sought a boost to growth and employment while a minority expressed concerns about inflation and dollar risks.
Bank of England officials have meantime split three ways since October over whether its stimulus policies should be maintained, withdrawn or expanded. Weber, a potential candidate to succeed Trichet as ECB president in 2012, has also lobbied for an end to the bank’s bond purchases and for his colleagues to show how they would cut other aid.
Inflation now running above both the U.K. and euro area central banks’ targets “will lead to deeper divergences within the boards,” says Cyril Beuzit, head of interest rate strategy at BNP Paribas SA in London.
For now, the major central banks are holding to crisis- level interest rates, with Morgan Stanley calculating the overall global interest rate to be 2.9 percent in December and minus 0.4 percent if inflation is accounted for. Rates are set to stay low because central bankers have greater success historically in fighting inflation than deflation, so they will err on the side of caution even if delay comes with potential costs, says Spyros Andreopoulos, a global economist at Morgan Stanley in London.
“They know what to do with inflation,” Andreopoulos says. “They’ll be inclined to exit too late rather than too early, and the risks of that could be both asset bubbles and inflation.”
In addition to the debate about macroeconomic policy, there’s dithering on the crafting of new regulation to prevent the next banking crisis. Bank of England Governor Mervyn King said in October that new Basel III banking rules to increase capital reserves at lenders, negotiated over a decade, aren’t enough to prevent another meltdown.
“What we cannot countenance is a continuation of the system in which bank executives trade and take risks on their own account, and yet those who finance them are protected from loss by the implicit taxpayer guarantees,” King said in a New York speech.
King’s words make clear that even as the U.S. works to spur greater growth, large stretches of the developed world still haven’t figured out how to ease out of this crisis — or prevent the next one. As Western policy makers spend another year trying to find a prescription for prosperity, their faster-growing, debt-free rivals are busy transforming the global economy.
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