Some like to read the US FED’s Beige Book (published July 29) as confirming that the US has started to leave the recession. The Financial Times applauds “the slowing down of negative growth”, the Neue Zürcher Zeitung, however sees little reason for premature hope. In China, of whom many expect the salvation of the global economy, the government has asked the banks to slow down credit to enterprises – which resulted in a confidence loss of stock exchange investors. In Europe, negative reports outweigh positive ones. The growth outlook remains dismal, every day new record lows are reported from the Baltics, Ukraine, Russia. The contraction in the Baltic countries is reminiscent of those after the breakdown of the Soviet Union. Q2 GDP reductions of more than -20% year-on-year are truly catastrophic and give rise to severe doubts about the ability of government to maintain social peace.
Household incomes are falling in the rich countries, private consumption restricted to necessities (viz. the reductions in tourism expenditures) and even the US Americans have started to save.
Can the surprisingly robust (preliminary) return of double-digit growth of the Chinese economy compensate for the U.S. sudden parsimoniousness? I doubt it. Look at the quantities involved: in 2008 the U.S. economy produced 14.8 trillion $ in GDP, the Chinese economy, the third-largest in the world, 4.4 trillion $, less than a third. U.S. consumption is approximately ¾ of GDP, while the Chinese save and invest a lot and consume only 2/5 of their product. Thus, Chinese consumption amounts to roughly 1/6 of U.S. consumption. This implies that there is no way that Chinese private consumption, even if it ballooned, could compensate for the fall in U.S. consumption – but, of course, stimulating Chinese domestic consumption could help global demand. But let us not kid ourselves.
But what about the recent boom in stockmarkets, what about the recent jubilations by our banks, boasting billions of profits in Q2 – and with it billions in bonuses? Yes, some institutions and some people are making a lot of money once more; yes, some act as if there had not been a yesterday and carry on as before; yes, many banks try to pay back the rescue funds they got from their taxpayers , in order to avoid this unpleasant meddling in “their” affairs; yes, some CEOs of large bankers publicly question the “too big to fail”-doctrine (see J. Ackermann on July 30); yes, unemployment is rising everywhere; yes, public budgets are stretched to the limits; yes, the financial markets are awash with liquidity – which the banks do not lend out; yes, suddenly every real business venture is too risky to lend – driving enterprises to issue bonds with the help of (right!!) investment banks helping them (against a small fee) place their bonds; yes, investment banks are mopping up cheap distressed assets; yes, some of them are buying up previously vilified CDOs, repackaging them, securitizing them, selling them……. Does that not ring a bell?
The dismal truth is: the crisis is far from over. Banks are in continuous negotiations with customers, adding up non-performing loans, increasing loss provisions, increasing their risk-bearing capital base, scrambling to get their balance sheets in order for year-end, in order to look good for the rating agencies, the financial analysts, the markets.
Politicians and supervisors are tugging here and there, making (more or less) brave efforts to rein in some of the previous excesses, but right now it seems that the financial entrepreneurs have the upper hand once again. Feeble attempts to coordinate better supervisory activities, to work out home-host country rescue (financial) responsibilities, to create macro-systemic watchdogs – all these are under way, but feeble they are relative to the requirements and the near-disaster the world economy was facing only months ago.
The hardest-hit region is Eastern Europe and beyond, the previous COMECON countries and Soviet Republics, which up to a year ago was the fastest growing region in the world – relying heavily on foreign capital flows, integration into the European economy (for 10 of them the European Union proper). In many of these countries most of the financial system (up to 100% for some countries) is owned by West-European banks which built up impressive balance sheets in the region – even though financial intermediation there is still far below Western standards. This ownership has saved these countries’ financial systems from collapse, since all Western parent banks have committed to stay in the region, to save their affiliates, to resume lending soon. The Western banking packages, the joint efforts by International Financial Institutions together with the IMF and the liquidity measures of the European Central Bank – all these have helped to avoid systemic collapse.
There is consensus that because of the high export exposure with Europe of many of these countries, a resumption of growth will only come after that of the European Union – which is still not in sight. Questions need to be asked about the way forward. Reliance on foreign capital flows will need to be lessened, more domestic capital needs to be generated for investment; the debt burden of the private sector, mainly consisting of hard-currency-denominated debt, will be staggering, especially for the countries with floating exchange rates, or those that could not maintain their peg to the dollar or Euro. Is Euroization the answer? It seems very unlikely that many of these countries will join the Eurozone any time soon, even if – as seems to be justified from a substantive point of view – the Eurozone countries will not loosen the entry requirements for new entrants. Thus, the future choice of an appropriate exchange rate regime will be paramount – which both gives flexibility and stability. It will be a question of trade-off for each country, which of the two conflicting objectives gains priority.
Most Western states, let alone the developing and emerging ones, will eventually come out of the crisis with significantly higher debt levels. Taxpayers and other citizens will pay for these debts for a long time to come. This will imply lower growth rates in the medium term – and even less enhancement of welfare for citizens. It is mainly for this reason that distributional issues will require much more attention than during the boom years. The prospects for further world growth are there. In order to be more sustainable, they need to be managed more carefully, the proceeds of growth be distributed more evenly over income and social groups, age cohorts, between material needs and mitigation of climate change – and between the “real” economy and the financial sector.