Don’t Dream It’s over

When will the global financial crisis be behind us? 


Listener: 13 June 2009. 


Keywords: Macroeconomics & Money;  


Hucksters trying to sell you something will tell you the global financial crisis will soon be over. But what do we mean by “over”? 


If we mean it’s when the world economy reaches the bottom of its abrupt dive, then that will happen at the end of the year, according to many observers. Unfortunately, even some of the best forecasters have already got the bottom point wrong – some were confident it would be reached a year ago. 


But will the crisis be over once the floor is reached? The world economy may just bump it along. The majority of forecasts suggest some growth will occur after the nadir, but expect it to be weak in most parts of the world. Is that the end of a recession? 


Another view is it all ends when the world gets back to where it was, say, a year ago. The forecasts for that level of production are some distance off, and getting back on the same world economic growth track as before 2008 (that is, allowing for both population and productivity growth) is not in the five-year forecasts I have seen. 


Another way of thinking about the end of the global crisis is when its causes are addressed. Here is a short list: 


The private overspending and insufficient savings – especially in the English-speaking countries – has to be reversed. Many economies also have to roll back their fiscal deficits. If they do this, those economies will have modest internal growth, because consumer and government spending will be restrained. 


Those economies – especially East Asian ones – whose savings financed the spending excesses of the rest of us need more public and private consumption growth. However, their capacity to grow is likely to be lower in the next decade than in the last, since their sources of big productivity gains are almost exhausted, although their growth will remain high by the standards of the rich (OECD) countries. 


The world’s big banks need to get their balance sheets in order, increasing their equity relative to their deposits. The US Government has actively helped its banks and the optimists hope these banks’ balance sheets will look good by the end of the year – although one might expect the banks will still lend only cautiously. European banks may be in a worse situation than their US counterparts. Yet the European authorities are doing less to remedy their imbalances. 


Bad debts have to be substantially reduced and the excessive prices of assets (houses) have to get back to normal. Slowly, slowly. 



The regulatory regimes that encouraged the financial instability need to be replaced. People are beavering away at this, but even when they come up with reform proposals, hurdles will be erected: by the financial sector, which does not want its freedom limited, even if it might cause future crashes; by the parliaments that have to enact the legislation; and by the international community that has to coordinate it. 


Somehow the excessive liquidity (money) injected to moderate the downswing has to be absorbed. If not, prices will rise. 


So the world economy may return to a sickly growth next year, but the crisis will not really be over and the danger of world inflation remains. 


When the crisis ends, the world economy will be different. The global-warming, peak-oil and water-shortage crises will be looming larger, and the distribution of production will be different. 


Most notably, the US economy will be relatively smaller. (It has already fallen from around 30% of the world’s production in 1950 to 20% today.) And it will be weaker, because debtor nations like the US – in this situation as a consequence of the Bush profligacy and the need to sustain a collapsing economy – have less authority than creditor nations. The US may still be the largest economy (or second largest if the European Union is treated as a unity) but it will not be the “hegemon” – the dominant leader – it has been. 


<>The details are for a future column. A separate column will look at when New Zealand‘s recession will be over.