In the past few years, the world economy has done very well. Almost every nation has grown richer. In the last six months, however, bad news has been pouring in.
- In the US, the housing bubble burst. The value of houses fell (by 9.1% just last December), triggering defaults in the sub-prime mortgage market and unfolding a financial turmoil. The banking system - uncertain about where, and how big, the risks are - put on the brakes, and got credit into a crunch. In simpler words, banks now lend very carefully, and getting a loan is not as-easy-as-it-was one year ago. To ease borrowing and kickstart a recovery, the Fed has intervened and drastically lowered interest rates to 3%. Meanwhile, the US dollar keeps depreciating vis-à-vis the other major currencies. The steady sell-off of dollars on the currency markets is triggered by grim expectations about the economic outlook and by the chronic twin deficit, that is: a) a deficit in the current account (i.e.: the country is importing more than it is exporting); and b) a deficit in the public budget (i.e.: the fiscal revenues don’t keep up with expenditures). The economy is in dire straits: inflation is skyrocketing (in January, prices jumped by 13.5% for producers and 6.4% for consumers). Jobs are being lost (January witnessed the first net loss in 4 years). Consumer confidence, income, and sales are distressed. Bottom line: for all the above reasons, a US recession is possible.
- In the high-income countries, economic growth is easing (except for Japan), due to lower internal demand (i.e.: consumers spend less, as they are worried about tomorrow), decelerating industrial production, and declining exports. For example, in Europe, a strong Euro and weaker US demand are taking a toll. Additionally, the US credit crunch is going global: sub-prime losses (up to $150 billion, for now) hit a few big international banks. As a consequence, credit conditions are getting tighter everywhere. Equity markets are increasingly volatile, and stocks tumbled badly in January, when $5.2 trillion were burned and emerging markets lost more than 10%. In Europe and in the US the risk of companies defaulting on their debt is now higher than ever. Finally, inflation is taking a painful toll everywhere (and limiting the action of fiscal and monetary policies), because of the rising prices of energy and food. The price of oil jumped to more than $100 a barrel. Coal prices are soaring. Food is becoming more and more expensive: while grain (corn, soybeans, and wheat) stocks are low, the cost of key farming inputs - energy and fertilizer - is high. The markets are rushing to secure assets - a safe hedge against inflation: the price of gold soared to more than $960 an ounce, a record high. The value of silver is the highest in thirty years.
- The developing economies will suffer the US turmoil, because they are interlinked – via economic and financial ties - with the high-income countries. Some commentators feel that for the developing world the key-word is “export”. For them, local growth comes - above all - from selling to the industrialized countries what they need: energy, commodities, and electronics (think of oil, coffee, and cheap computers, and you will get their point). In other words, the demand in rich countries is what drives production – and growth - in poor(er) nations. In the global economy these links are so deep, that the performance (i.e.: in terms of consumption) of the industrialized economies is crucial for global prosperity. Hence, a likely recession in the US (the world’s biggest consumer market) and mounting uncertainty in high-income countries should get us really worried about the developing countries and the global economy. A crisis is highly plausible. This is the view, for example, of the recent UN “World Economic Situation and Prospects 2008”, and of Martin Wolf, in recent Financial Times columns (see Article 1 and Article 2).
- The developing economies will get by, because they are well advanced in the process of de-linking from the industrialized economies. Other commentators feel that the developing economies have become resilient, i.e. able to operate and prosper despite the turmoil. The keyword here isn’t ‘export’, but “domestic demand”: the engine of local growth is a strong domestic spending – so strong that it could even offset a decline in exports to high-income countries. In other words, the emerging economies ‘are fine’. Over the years, they have grown vigorously, improved their macroeconomic stability, and accumulated large foreign exchange reserves. Also, they are increasingly trading amongst themselves: for example, China has replaced the US as India’s largest supplier of imports. In Russia, India and Brazil, imports are growing faster than in the US. In short, the emerging economies - driven by the rapid growth of China and India – are less tied to the industrialized world, and more interdependent. This is the view, for example, of the recent IMF “World Economic Outlook” (for the IMF, in 2008 developing countries will grow at 6.9%, and China at 10%), of the latest World Bank “East Asia Update”, and of a couple of recent posts in this blog (see Justin Lin Yifu, the new World Bank Chief Economist, and David Dollar on China).