World Economy: The Elusive Recovery

Published on political affairs pa, by C P Chandrasekhar, November 3 2010. /

Original source: People’s Democracy (India): The optimism that overcame global governments when growth figures for the last quarter of 2009 were released is fast receding. Growth has slowed sharply in the subsequent two quarters and unemployment rates are in danger of rising further. In the United States for example, growth in the last quarter of 2009 which was placed at 5 percent relative to the corresponding quarter of 2008, is estimated to have fallen to 3.7 and 1.6 percent in the subsequent two quarters. Unfortunately, this occurs at a time when the resolve to address the crisis has considerably weakened.

Not surprisingly, on September 9, the OECD which had, like many other organizations, been upbeat about the recovery of the world economy from the Great Recession, issued an interim assessment that reflected a new skepticism. “The world economic recovery may be slowing faster than previously anticipated”, it argued, with growth in the Group of Seven countries in the second half of 2010 projected at around 1½ percent on an annualized basis compared with its earlier estimate of around 2½ percent in the Economic Outlook released in May … //

… WRONG BELIEF:

This would imply that a major stimulus is in order. But when talk of the stimulus arises it takes the form only of a monetary stimulus or “quantitative easing”. This involves large doses or several billions of dollars of asset purchases by the Federal Reserve aimed at injecting liquidity into the economy and driving down interest rates. The problem with this approach is the belief that the desire or inducement to spend or invest exists and the problem is the lack of credit to fuel such spending. That is a belief that has been proved wrong many times over in recent history. Yet there are myriad ways in which liquidity is sought to be injected into the system. For example, the Treasury department has announced a $1.5 billion program aimed at small businesses and designed to trigger $15 billion in additional private lending.

What the quantitative easing does is that it lowers UN interest rates, widens the differential between interest rates in that country and elsewhere in the world and encourages, therefore, the carry trade. When additional liquidity is injected, financial investors (rather than industrial firms) borrow dollars at low interest rates, convert those dollars to currencies of countries where interest rates or financial returns are high or just higher and make an investment to benefit from the differential in returns.

The consequence of encouraging movements of this kind is that there is a surge of capital flows into emerging markets in Asia and Latin America that is strengthening their currencies and inviting intervention on their part to prevent currency appreciation that worsens their competitiveness. The fall outs are the much talked about “currency wars” that are mistakenly presented as the cause of rather than, partly, the result of uneven development. It is not that the faster growth of these emerging economies is the result of undervalued currencies. To the extent that in some cases that faster growth is the result of export success, the success is due to cost competitiveness which in substantial measure stems from the availability of cheap surplus labour in a context where capital and technology are mobile but labour is not. Best-practice technologies are combined with cheap labour in these locations for production for world markets. Overall, it is better performance resulting from cost competitiveness which delivers a trade surplus and encourages the capital inflow surge that tends to appreciate the currencies of these countries and undermine their competitiveness.

It is in this light that we must view the IMF’s optimism that comes from the fact that the emerging markets are doing well enough to lift “global growth.” That unevenness is not the basis for combined growth but for conflict that demands responses that could undermine the competitiveness of the emerging market economies. Moreover, the capital inflow surge into some of these emerging markets results in real estate and stock market bubbles that are likely to burst and therefore render such growth fragile. What is needed is a return to an effort at having a globally synchronized fiscal push with measures to distribute the benefits of that push across continents and countries. It is that option that the IMF foregoes when it emphasizes the need to “stabilize and subsequently reduce high public debt” and calls for  “a strengthening of private demand in advanced economies” without explaining how that is to be ensured. (full text).

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