For
a world locked in a crisis, August 2011 was a particularly
bad month. Economic indicators relating to different
locations in its more developed regions suggested
that close to four years after the onset of the global
recession in December 2007, the world economy that
had not fully recovered was set to sink again.
Two developments-one in the financial realm and the
other relating to the real economy-were particularly
ominous. To start with, for the first time in history,
a rating agency (Standard and Poor's) had downgraded
US Treasury bonds from their hitherto unassailable
AAA (or risk free) status and even placed them on
watch for further downgrade. Official analysts and
some independent observers were quick to rubbish the
assessment from S&P, an agency with a poor record
of predicting fragility. The assessment was even shown
to be based on wrong numbers. But the fact that the
debt of world's most powerful country that was home
to its reserve currency was even considered to be
of suspect quality was telling.
The other disconcerting development was the release
of evidence that the strongest economy in the rich
nation's club-Germany-was losing all momentum, registering
a growth rate of just 0.1 per cent in the second quarter.
This came at a time when the news from elsewhere was
depressing. Recovery from the recession was known
to be sluggish in the US. Japan, that had been experiencing
long-term stagnation, had been devastated by a wholly
unexpected exogenous shock. And, France had announced
that it had experienced virtually no growth in that
quarter. The real economy crisis had penetrated Europe's
core, pointing to the possibility of a return to recession
in the Eurozone as a whole (with 0.2 per cent growth).
Even before the news from Europe had been officially
declared, the nasty standoff involving the Republicans
and Democrats over the debt ceiling in the US had
obviously unnerved markets. The week ending August
5 was the one of the worst since the onset of the
financial crisis, with the FTSE 100 falling by 10
per cent. Confidence has hardly reversed since then
with investors wanting to flee from the markets but
not knowing where to go other than into gold, prices
of which had already soared. Over the week ending
August 14, the collective outflow from equity funds
was $26.1 billion, while that from bond funds totalled
$10.4 billion.
Underlying this panic were four factors of particular
significance. The first was the evidence reported
above that the still-feeble recovery from the crisis
across the developed world was slowing. This was adversely
affecting growth in the more buoyant export-dependent
developed countries such as Germany and threatening
growth in developing countries such as China. Even
when growth was occurring in the emerging markets,
offering a counter to developed-country stagnation,
it was leading to inflation. This is necessitating
an increase in interest rates and the contraction
of government spending, with adverse implications
for future growth. With the resulting threat of a
global double dip, confidence was bound to wane, leading
to volatility in the financial markets that had just
been bailed out by governments and central banks from
the collapse induced by the crisis.
The second problem, at least from the point of view
of financial investors, was that this long drawn effort
to bail out a financial system that had speculated
its way to crisis had resulted in a substantial increase
in global debt. According to a calculation made by
the McKinsey Global Institute, as a result of a combination
of financial sector bail-outs and stimulus spending,
the total amount of debt incurred by governments across
the world rose by a staggering $25 trillion to $41.1
trillion over the decade ending 2010. What seemed
comforting was that on average it amounted to just
69 per cent of the global GDP. But in individual countries,
such as Greece and Italy, for example, debt-financed
spending had indeed taken the net debt-to-GDP ratio
to levels as high as 152 and 101 per cent respectively.
In some instances when slowing growth reduced revenues,
concerns about the ability of these countries to service
debt emerged. Till such time as there was confidence
that the stronger countries in the Eurozone would
back these economies with funding in the event of
any financial difficulties, banks and financial investors
ignored these concerns. But when it became clear that
such backing had its limits, bond prices fell, interest
rates rose and the willingness of financial agents
to roll over past debt waned. That made it even more
difficult for these countries to meet their commitments.
This was when the threat of sovereign default in the
developed world seemed real.
Consider, for example, the problem in Greece. The
government had indeed accumulated excess debt to sustain
growth and meet welfare expenditures. The private
sector that had financed that debt has suddenly turned
wary, and is willing to lend more, if at all, only
at exorbitant interest rates. When the IMF and some
European governments provided a modicum of support
more than a year ago, it was in return for severe
austerity measures that limited growth and reduced
revenues, making sovereign default a real possibility.
Not surprisingly, more than a year later, the Greek
crisis has intensified.
What is alarming is that the problem in Greece or
Portugal, in the Eurozone periphery, is not staying
there. Despite the fact that economic conditions or
the debt problem is nowhere as serious in countries
such as Italy and Spain, which happen to be the third
and fourth largest economies in the zone, Europe like
Southeast Asia at the end of the 1990 is overcome
by ''contagion''. The collapse of confidence and the
fear of a sovereign default has touched these countries
as well, resulting in a spike in the interest rates
their governments have to pay for additional borrowing.
In fact the problem has now afflicted France as well,
with Sarkozy having had to recall key ministers of
his cabinet from holiday, to find ways of assuaging
market fears that French debt would be downgraded
because of a large deficit. The value of shares in
French banks collapsed due to fears that the downgrade
would adversely affect their balance sheets.
This has led to the third of the difficulties confronting
the global economy. This is that government bonds
are now not an automatic safe haven to which investors
can retreat without blinking. An ideological backlash
against public debt had send out (wrong) signals that
had made investors in sovereign bonds of countries
with even reasonable public debt to GDP ratios jittery.
Consider for example government bonds issued by the
US, which is home to the dollar, the world's reserve
currency that is still nearly as good as gold. Even
for those infused with an unthinking dislike for government
borrowing, US public debt is by no means too high
relative to its GDP to warrant excessive concern.
There are at least 10 advanced economies, from debt-strapped
Greece to conservative Germany, that record a higher
net debt-to-GDP ratio.
There is no real fear of US default. The stand-off
between the Republicans and the Democratic administration
over a routine decision to raise the Congress-mandated
ceiling on public debt stemmed from another source.
It resulted from the Republican objective of extracting
a cut in the fiscal deficit and ensuring that it was
realized through spending cuts that hurt the poor
and middle classes rather than tax increases that
touched the rich. In the last-minute ''deal'' that
was struck, President Obama was authorised to increase
the debt limit by at least $2.1 trillion, on the conditions
that there would be an immediate cut in spending so
as to reduce the deficit by $1 trillion and that a
bipartisan committee would identify ways of further
cutting expenditures so as to realise an additional
$1.5 trillion reduction in the deficit. Despite this,
Standard and Poor's decided to go in for an irresponsible
downgrade supported with wrong calculations, only
because it had decided that a $4 trillion reduction
in the US fiscal deficit was needed for debt sustainability.
The Republicans had managed to extract ''only'' the
promise of a $2.5 trillion reduction. S&P was
not acting on its own. It was merely reflecting the
opposition of finance capital to a proactive state
financing expenditures with borrowing.
Finally, because of the propaganda behind this blind
fiscal conservatism, there is political opposition
to increased public debt across the developed world
leading to a withdrawal of stimulus measures and a
turn to expenditure reduction rather than expansion.
The result was not just slower growth. It was also
the erosion of an instrument that since the Great
Depression was seen as the main remedy for recession:
enhanced public expenditure. Governments voluntarily
gave up their right to resort to fiscal means to reverse
the deceleration in growth, even in countries that
were not recording large fiscal deficits and faced
no threat of a public debt crisis. This not only directly
affected growth in individual countries and across
the globe. It also meant that countries that were
dependent on exports to global markets to sustain
much of their dynamism, whether it be Germany in Europe
or China in Asia, are facing the danger of a slow
down in growth. This is already visible in Germany,
as noted above. It is likely to afflict China as well,
especially if other countries choose to partially
close their economic border in response to the crisis.
Governments now respond only when finance (not the
real economy) is under threat. As happened in 2008,
they are intervening today because of the threat to
the banking system, which is quite heavily exposed
to public debt, especially in Europe. But since fiscal
conservatism has gripped most developed country governments
and fiscal policy is not seen as an alternative, monetary
policy or the infusion of liquidity into the system
by having central banks purchase government bonds
held by the banks has become the main tool to combat
fragility. The European Central Bank that was adopting
a conservative stance has gone shopping for government
bonds including Greek paper to support the banks,
while the US Federal Reserve has tied its hands by
committing not to increase interest rates from their
near zero per cent level in the foreseeable future.
The latter would be fine if the global downturn keeps
oil and commodity prices low. But if geopolitical
and structural factors keep these prices, especially
those of oil buoyant, the loss of the interest rate
lever may necessitate further fiscal contraction and
even lower growth as happened after the second oil
shock of the late 1970s.
In sum, while the reliance on monetary easing may
stave off a banking crisis for some time, the evidence
increasingly shows it is likely to do little to stall
the downturn in growth and trigger a recovery. If
the downturn persists, confidence is likely to erode
including confidence in government bonds.
There seem to be two messages coming out of the global
economy right now. The first is that a second ''dip''
or recession, potentially steeper than the first,
is upon us and is likely to be of longer duration
than the first. The danger this time around is greater
because, for ideological and other reasons the fiscal
weapon that governments had deployed in the first
recession is now being abjured by them. On the other
hand, there is no evidence of the emergence of alternatives
that can serve as effective substitutes.
The second message is that after a long time the crisis
that capitalism faces is centred on its metropolitan
core and not the less developed periphery. Mere talk
of decoupling cannot prevent this crisis from spreading
to the export dependent economies in the successful
periphery. The crisis it appears is bound to be global.
Economically speaking capitalism is under siege. Its
strength is that politically the attack on it is largely
spontaneous, sporadic and fragmented. Till that consolidates
and gains political momentum, chaos and anarchy seem
to be the promise.
August
30, 2011.
|