With global financial woes abating, the world economy appears to have found its footing. Emerging Asian economies have steered a steady course toward recovery while Western countries leave the worst times behind. But the road ahead may be a bumpy one given the fact that an array of underlying risks still loom large. Tao Dong, a senior economist with Credit Suisse, shared his opinions on these issues in an article recently published on his blog. Edited excerpts follow:
One year after the demise of Lehman Brothers, the financial situation seems to have come full circle, coming back to where it began a year ago. Global stock markets have more or less recovered their lost ground, and investment banks have restored a level of leveraged credit, if only slowly. The bleak job market and exploding government deficits still serve as a reminder of what the economy has undergone.
The government stimulus package set the stage for a prolonged rally, but given a hangover of uncertainties, how well the world economy fares remains to be seen. Will it be a V-, U-, or W-shaped trajectory? Perhaps the "plucking model" of the renowned U.S. economist Milton Friedman could give some clue concerning what to expect—the deeper the economy recedes, the stronger it rebounds.
The Lehman Brothers bankruptcy shocked the world. Defaulting on their highest-rated bond obligations and money market funds caused overnight turmoil to unfurl, creating panic among investors and putting a freeze on credit flows in the financial system. Slowly but surely, the financial woes found their way into the real economy as investments stalled and inventories began to pile up. The devastating consequence was that manufacturing and trade industries were sent into a free-fall decline.
Even at its worst, the financial crisis was not a doomsday-like event for the world economy. When global central banks pumped liquidity into capital markets, things started to take a turn for the better. With cheap credit filtering into the banking system, the financial woes faded as abruptly as they had arisen. Meanwhile, government subsidies provided a catalyst for consumption and enterprises restarted their idled machines. Given the magnitude of the financial turmoil, even the slightest improvement was seen as a solid step toward recovery. The third quarter this year will see a robust rebound, powering the world economy as it rises out of the recession.
Looking ahead, there will be three major bottlenecks that threaten to curtail the growth momentum.
First, the credit recovery has yet to gain a sustainable footing. The quantitative easing policy is a big help for large companies as the central banks finance their corporate bonds. But commercial banks remain reluctant to lend, leaving a number of small and medium-sized enterprises wringing their hands over the desperate need for funds. That is why the employment landscape appears to be so bleak.
Second, the private consumer market displayed signs of life, but a substantial turnaround is still some way off. Massive government subsidies for car and house purchases have brought some buyers off the sideline, providing a cushion against the downturn. Yet, the question is the government simply cannot keep the consumption afloat on an endless supply of subsidies. A weakening government balance sheet has prompted worries over the long-term prospects of the global economy.
Third, with liquidity flooding the economy, asset price inflation is taking hold. The consumer price index may linger at a low level in the coming months, but the asset bubble will put policymakers in the crossfire over fighting inflation and maintaining growth.