As reports supportive of a rebounding world economy continue to grab headlines, crisis-stricken countries cannot wait to announce that a substantial recovery may be soon approaching. But is the so-called turnaround an established trend with a firm foundation and what are the potential risks that threaten to darken future prospect? Wang Zili, Vice Chairman of the Graduate School of the People's Bank of China, discussed these issues on his blog. Edited excerpts follow:
With globally coordinated fiscal and monetary stimulus gaining traction, the economic doldrums appear to be losing ground to an increasing feeling of optimism. Personally, I believe the anticipated upturn will last for no more than three to six months. If countries halt their stimulative measures within that time, the hard-won recovery will ultimately evaporate.
The reason for such a pessimistic stance is justified. Central banks in the developed world are pouring liquidity into their financial systems to thaw the credit freeze, which in turn has fuelled an upward trend on the capital markets. Once the liquidity finds its way into the real economy, acute global inflation will be inevitable. For a world economy that has yet to shake off the fallout from last year's downturn, the consequences of inflation prove devastating.
Bogged down by a faltering consumer market, the United States pins its economic hopes on exporters as a source of growth. As a result, the American policies are depressing the value of the dollar to make its exports more competitive.
One side effect of a weaker U.S. dollar is that international hot money has begun flooding emerging markets. Hong Kong, for instance, has reported a capital inflow of more than $73 billion. Learning from the painful lessons from the 1997 Asian financial crisis, countries in Asia have put reliable firewalls against financial risks in place.
The question for America is how it can breathe life into its export market amid the global downturn. Since Europe is still reeling from the recession, America turns its eyes to Asia. But sparking Asian consumption is a plan doomed to fail. Given the entrenched tradition of thrift and an insufficient social safety net, Asian consumers are less likely to replace their American counterparts as the engine of the global consumption recovery.
We must now come to terms with this simple truth—global demands will encounter sharp declines and any effort to reverse this unwelcome trend will be fruitless.
Even before the financial crisis, the fate of the U.S. economy had been sealed. Profligate U.S. consumption was financed by a pile of debt that defied the solvency of Americans. In addition, mounting toxic assets and paper losses sowed the seeds of disaster in the financial system, which in value was dozens of times greater than the real economy.
The bankruptcy of institutions like Fannie Mae and Freddie Mac should have been viewed as a viable solution to the financial ailment so that excessively large corporations that the government has no choice but to bail out in times of crisis are not allowed to proliferate. Similarly, instead of looking for an alternative driver for recovery, nations across the globe should accept the coming contraction in consumption and align their restructuring policies with unfolding situations. The world economy may be bound for a second decline sometime soon. That is when things will really start to bottom out.