Sticky patch or meltdown?
How politicians could carelessly turn a temporary softening of the global recovery into something worse
Jun 16th 2011 | from the print edition
SUMMER is at hand in the world’s big financial centres, but the mood is hardly bright. Stock prices have been sliding for weeks in response to gloomy economic news. Factory output has slowed across the globe. Consumers have become more cautious. In America virtually every statistic, from house prices to job growth, has weakened. There was some respite earlier this week, but only because a few figures—on American retail sales and Chinese factory production—were not as dire as feared.
Globally, growth is at its weakest since the recovery began almost two years ago. Is today’s softness just a sticky patch, or is the global recovery beginning to melt away?
The great softening
The reasons for the lull suggest it should be temporary. First, the tsunami in Japan sent its GDP tumbling and disrupted supply chains, and thus industrial output, around the world, particularly in April. But just as that slump shows up in the economic statistics, more forward-looking evidence points to a rebound. The summer production schedules of American car firms, for instance, indicate that the pace of annualised GDP growth there will accelerate by at least a percentage point.
Second, demand was dented by a sudden surge in oil prices earlier this year. More income is being shifted from cash-strapped consumers in oil-importing countries to producers who tend to sit on their treasures. Costlier fuel has knocked consumer confidence, particularly in gas-guzzling America. And there is still an uncomfortable possibility that further instability in the Arab world will send prices soaring again. Nonetheless, at least for now, the pressure is waning. America’s average petrol price, though still 21% higher than at the beginning of the year, has started to fall. That should boost shoppers’ morale (and their spending).
Third, many emerging economies have tightened monetary policy in response to high inflation. China’s consumer-price inflation accelerated to 5.5% in the year to May. India’s wholesale prices leapt by 9.1%. Slower growth is, in part, a welcome sign that their central banks have taken action, and that those measures are beginning to work. There is no evidence that they have gone too far, even in China, where the worries about bringing the economy down with a bump are loudest. The bigger risk is that nervousness about a weakening world economy leads to a premature pause in the tightening. With monetary conditions still extraordinarily loose, such a loss of resolve would make higher inflation and an eventual crash far more likely.
A growth lull may be just what most emerging markets need, but it is the last thing that any advanced economy wants at the moment. The recovery in the rich world is weak and vulnerable, as recoveries tend to be after balance-sheet recessions. This lull is particularly dangerous because it coincides both with a move away from fiscal and monetary stimulus and with an outbreak of risky political brinkmanship on both sides of the Atlantic.
The shift from stimulus is well under way. Faced with a similar sluggishness last year, America’s Federal Reserve promised to jolt the economy with a second round of quantitative easing: printing money to buy government bonds. But the latest spell of quantitative easing comes to an end this month and the Fed has made clear it has no desire to add to it. The European Central Bank (ECB), meanwhile, is set to raise its policy rate again in July. The budget squeeze around Europe is intensifying, and even in America fiscal stimulus may give way to austerity (see article).
Some of these policy decisions are right. With America’s underlying inflation rate no longer uncomfortably low and declining, it makes sense for the Fed to refrain, for now, from another round of loosening; and, on the fiscal side, the country can probably get by without further stimulus. Some are not. In the euro area, where there is scant evidence of wage inflation and extreme weakness in the periphery economies, the ECB should not raise rates. In America, the big danger is that the row between the political parties over the country’s medium-term deficit leads to short-term spending cuts that are just what the country does not need right now.
Politicians playing poker
The current battle over raising the federal government’s debt ceiling is driven not by careful consideration of the economics but by ideology and brinkmanship. Democrats refuse to consider serious spending reform. Republicans reject higher taxes. Many tea-party types would rather see America’s government default than compromise on spending. The result is a perilous stand-off—and a growing danger that America will have to make drastic short-term spending cuts, or even find itself forced into a technical default.
A parallel dynamic is playing out in the euro zone, where the debate about how to deal with Greece’s debt crisis has descended into a high-stakes stand-off between Germany, which wants the maturities on Greek bonds to be extended, and the ECB, which resists any debt restructuring . The hope is still that Europe’s leaders will come up with a face-saving compromise at their summit on June 23rd-24th. But the longer the confrontation continues, the greater the risk of an accident: a chaotic Greek default and exit from the euro.
This dangerous political brinkmanship could also have a damaging effect by creating uncertainty. Companies are currently sitting on piles of cash because they are wondering how strong economic growth will be. Politics gives them more reason to sit on their hands rather than investing and hiring immediately, providing a boost the world economy sorely needs.
There is a real risk that the politicians’ pig-headedness could lead to disaster. The odds of a catastrophe—harsh fiscal tightening in America, or a crash in the euro zone—may not be high, but neither are they negligible. Though economic logic suggests that the world economy is just going through a sticky patch, squabbling politicians could all too easily turn it into a meltdown.
Hardline IMF forced Germany to guarantee Greek bailout
Acting IMF chief threatened to trigger sovereign default if Berlin failed to come to rescue of Greece
Germany was forced to agree to bail out Greece for the second time in a year under strong pressure from the International Monetary Fund following the resignation last month of its head, Dominique Strauss-Kahn, the Guardian has learned.
Under its acting chief, the American John Lipsky, the IMF has taken a more hardline stance. The fund warned the Germans in recent weeks that it would withhold urgently needed funds and trigger a Greek sovereign default unless Berlin stopped delaying and pledged firmly that it would come to Greece’s rescue.
Senior officials and diplomats in Brussels confirmed that the IMF threat to pull the plug on its funding, in stark contrast to the more emollient line of Strauss-Kahn, had been defused because of a German climbdown.
As political turmoil continued in Greece on Thursday, with the prime minister, George Papandreou, scrambling to form a fresh government, the stage was being set for a political struggle between Europe’s powerbrokers over the fine print of the proposed new €100bn-plus rescue of Greece.
Berlin is deeply at odds with France and with the key EU institutions – the European Central Bank (ECB), the European commission, the presidency of the EU, and the head of the eurozone, Jean-Claude Juncker, prime minister of Luxembourg – over the terms of a deal.
While conceding the need for the fresh bailout, Berlin is insisting that the banks and other private creditors holding Greek debt take losses as part of the rescue plan, which is expected to amount to €125bn (£110bn), or about €90bn if the Germans succeed in forcing losses on holders of Greek bonds.
Although international stock markets enjoyed a calmer day on Thursday, Juncker believes that imposing losses on investors could trigger a European version of the Lehman Brothers bank collapse – a so-called “credit event”. Juncker said: “It’s a really ugly situation. The [German] idea is dangerous. It could provoke the gravest risk, that all three rating agencies declare a credit event and then there are big contagion risks for other countries.”
Nout Wellink, a member of the ECB’s governing council, warned that the EU bailout fund would have to double to €1.5tn if Greece does fail to pay its debts and spreads financial turmoil to other countries. French president Nicolas Sarkozy goes to Berlin on Friday for a summit with German chancellor Angela Merkel, with the aim of stitching up a compromise.
Under Greece’s first €110bn bailout, shared by the EU and the IMF, a fifth tranche of €12bn is to be disbursed next month. Publicly, the IMF had been threatening to withhold its share of the money unless Greece’s funding gap for 2012 is closed. But Olli Rehn, the European commissioner for monetary affairs, said on Thursday that the EU and the IMF had agreed to throw Greece the €12bn lifeline by next month to forestall a default.
Privately, sources said that Lipsky challenged the Germans on the fringes of a G8 summit in France almost three weeks ago, and demanded that Berlin guarantee Greece’s borrowing requirements and put a figure on the pledge. The IMF ultimatum came a week after Strauss-Kahn, a former French presidential contender, resigned as IMF chief following his New York arrest on charges he denies of attempted rape and sexual assault of a hotel chambermaid.
Berlin blinked, according to participants in the negotiations, and 10 days after the IMF challenge, the Merkel government admitted for the first time that Greece would need a new bailout. But it stoked further controversy by demanding that Greece’s private creditors take losses on their loans.
Before a series of crucial EU meetings starting this weekend, Berlin looks increasingly isolated in its demands, spelling trouble for Merkel at home, where the rescue of spendthrift eurozone countries is deeply unpopular. Merkel’s junior coalition partner, the liberal Free Democrats, on Thursday reiterated the need for the banks to take some of the pain in the Greek crisis.
The rescue scenario is also hostage to developments in Greece, with European leaders anxiously eyeing the political turmoil in Athens and questioning whether Papandreou would be able to deliver on his side of the bargain: savage spending cuts and tax increases aimed at raising €28bn, combined with a €50bn privatisation programme.
“We expect the Greek parliament to endorse the economic reform programme as agreed by the end of June,” said Rehn. “We will not let the euro area face any kind of catastrophe.”
The turmoil sent the euro tumbling to a record low versus the safe-haven Swiss franc, and intensified pressure on the region’s other lower-rated states, highlighted by weakening demand at a Spanish bond auction.
Senior officials in Brussels worried that time was running out. Papandreou’s attempt to form a government, win a vote of confidence and then drive the austerity package through parliament could take longer than scheduled, jeopardising the planning in European capitals.