Jens Bastian and Vanessa Rossi
A new year always presents many risks and uncertainties - this is not unusual. However, the challenges that the global economy faces in 2011 include not only the normal threats posed by volatile background conditions, but also the possibility of a major structural break-up that might have far-reaching, possibly devastating, repercussions.
The 'normal' risks that the global economy faces include the challenge posed by global food prices and concerns over the US economy, the dollar and speculative capital. Rising food price inflation is damaging emerging markets' growth prospects: if this escalates, it could pull the rug from under the key driver of global growth. Yet tightening policy to curb increases in food price only works by weakening demand - not only posing a risk to global growth but also failing to address underlying food supply problems.
Improving growth in
Greater certainty about positive global growth prospects would also be the best cure for the waves of speculative capital roving the world - these must be anchored into real investments, enhancing real growth prospects and turning volatile capital into a stabilising ballast for the world economy.
In spite of these uncertainties, forecasts for global economic growth generally remain very robust indeed, in the 4-4.5 percent range for 2011, only slightly down from the rebound to almost five percent last year. The outlook for global economy is also relatively insensitive to the 'normal' variations in growth forecasts for Europe. Notably, whether the
However, in our view, Europe does pose a severe threat, not because of the importance of its GDP growth for the rest of the world under 'normal' conditions and risks but because of the potential for an eruption in the economic and financial system similar to, or perhaps worse than that of
Concerns about the integrity of the Eurozone and its financial sector have never been as widespread or as well founded as they are today. On whatever basis this is examined, the Eurozone debt crisis is still in intensive care. So 2011 will almost certainly be a watershed year for Europe and the euro.
After only a few months of relative calm, rumblings began again over the extent to which the Eurozone would continue to provide assistance and guarantees to member states in financial difficulty beyond the mechanism's current three-year time span. This coincided with news that the Greek economy was falling further into recession (GDP falling 4.2 percent in 2010), implying it may be unable to comply with the fiscal targets agreed agreed with the IMF and the
The Irish problem is therefore quite different to that of Greece and it raises deeper questions. Greece presided over runaway public finances for many years, illustrating the failure of fiscal discipline and enforcement capacity in the Eurozone in spite of the rules and regulations stipulated in the Growth and Stability Pact. Ireland more than met Maastricht rules but has been dramatically sunk by its aspirations to host European-scale banks while the ultimate responsibility remained at the national level. With its banks now struggling to survive or being fully nationalized, this is a responsibility Ireland should-but clearly cannot-bear on its own, given banking-sector liabilities over ten times its GDP.
The key concern going into 2011 rests on the following observation: two countries as economically and fiscally different as Greece and Ireland nevertheless ended up rowing in the same bailout boat. And others could follow. The essential question that follows is how much Eurozone member states are prepared to help?
When the Irish banks were forced to seek assistance for the second time in a year, Ireland had to look for help from the Eurozone and the IMF. The Irish government had already bailed out the banks once in 2010, to the tune of
However, European banks are also heavily involved, and the risk from contagion is much greater than for Greece. These banks hold more than
The political and financial-sector tremors in
These excessive debt levels limit the scope for providing assistance to the troubled Eurozone periphery, creating doubts about the sustainability of bailouts.
The 16-member euro zone must confront the risks posed by escalating sovereign debt and the politics of implementing austerity budgets. This spells trouble: austerity will not be popular even over a short time span, yet to bring the Eurozone's debt back in line with the sixty percent rule will require many years of fiscal stringency. Political capital will be consumed by this long grind and, with little scope for new initiatives, economic energy will also be sapped.
However, if countries ignore the sixty percent limit and continue with high debt levels, this may lead to a permanent European sovereign debt crisis and prolonged recession, which would also enfeeble the economy over the long run. Faced with unpleasant choices, and with no easy solutions, member states may fail to agree on a coordinated strategy, never mind on measures to enforce it. In this respect, 2010 did not represent a bumper year for successful crisis management capacity among Eurozonemember states.
United in Euro
This is truly a fight for survival for the Eurozone, and by extension the EU - and note the repeated mantra of German Chancellor
Given the scale of the debt built up in the major economies, and voter concerns in the more viable economies over the impossibility of taking on any burden but their own, there may be little option but to move to a debt divorce - effectively returning to the original Maastricht rule of 'no bailouts'. Continuing confidence, bad debt and liquidity problems in the banking sector may also force countries to make tough decisions over whether and under what conditions to back their banks. The restructuring of banks and sovereign debt in the weakest member states would be painful and could call into question their commitment to the euro. Some exits cannot be ruled out and might be facilitated by polarisation in holdings of debt if investors have already fled. We should also not forget that, back in spring of 2010, a political taboo was broken at the height of the Greek crisis when Chancellor Merkel and her Finance Minister
At the beginning of 2010, it was unthinkable that the euro, the world's second reserve currency, could fail. Monetary chaos would cause short-term disruption in the global economy and might prove difficult to control. A year later, the euro is in intensive care and two of its members are on life support with the IMF and the ECB. But we must seriously consider the possibility of change in terms of membership, enforcement and sanctions as well as conditionality. Impacts on the rest of the world depend on how the Eurozone handles this crisis and the changes to come - and Europe must hope that growth in the rest of the world continues to provide the stimulus necessary to help it through this crisis.
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