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Claude Smadja: Look at Europe, and worry

As long as stringent austerity is enforced on countries in crisis, economic stagnation will endure

Claude Smadja 

Claude Smadja

Since 2010, the world economy has looked like a patient who whenever his condition shows signs of improvement is suddenly instead in danger of regressing immediately to a more alarming status. The optimistic chorus at the beginning of 2014, according to which the global economy would strengthen in the course of the year, with Europe gradually coming out of its crisis, has now been muted. The International Monetary Fund (IMF) is expected to revise downward its global growth forecast for 2014, and it is more obvious by the day that the euro zone is stuck in - at best - an infinitesimal growth mode, with deflation looming larger and larger.

When surveying different economic regions of the world, prospects fluctuate from one part to the other; but one reality emerges very starkly: Europe represents today the greatest risk for the global economy, and developments there need to be watched very closely in the months ahead, as they could well create another drag on the global economy.

Starting with the United States, it is now clear that the country is on the road to a sustained recovery and that the conditions are met for the United States Federal Reserve to end its quantitative-easing/economic-stimulus programme next month, as it planned. United States gross domestic product (GDP) growth increased to 4.2 per cent annualised for the second quarter of the year with all economic indicators moving upward. The United States banking system is in a sound situation, having now cleansed itself from the impact of the 2008 crisis, and American corporations are awash with cash to the tune of an aggregate amount of more than $3 trillion. However, the United States recovery is not strong enough for the country to once again play the role of the economic locomotive of the world, or the market of last resort for other economies.

Turning to China, every indicator provides the evidence of a slowdown as the process of economic restructuring is getting under way. The leadership in Beijing has come to terms with single-digit growth as the new normal for China's economy and recognises that growth in the second part of the decade might be around five to six per cent. However, it will do what is necessary to achieve its stated objective of 7.4 per cent of growth for 2014, because it cannot afford a precipitous decline of economic activity.

So while there will not be any new grand stimulus programme, the recent injection by the People's Bank of China of $80 billion into the banking system to increase the supply of credit shows that the government has a number of instruments available to ensure that growth does not decline below a certain level deemed necessary. The picture that emerges from China is, thus, one of an economy that should be able to stay a moderate course - barring some unforeseen developments that could unleash a negative turn of events - but will be much less of the stimulus factor than it has been in the last 10 years for other economies in Asia or in Latin America.

The world's third largest economy, Japan, is in a different situation: Abenomics - the economic-revival programme launched by Prime Minister Shinzo Abe at the beginning of 2013 - offers the first real opportunity to get the Japanese economy back on a growth path after 20 years of deflation. The first two "arrows" of Abenomics - with quantitative easing, or QE, launched by the Bank of Japan and measures to move towards restoring fiscal sustainability - have played their role. The Nikkei index is now at around 16,000 compared to 8,600 when the Abe Cabinet took office, and the Consumer Price Index has moved from -0.5 per cent in 2013 to 1.5 per cent now. The Bank of Japan will not exit from its ultra-loose monetary policy before achieving the two per cent inflation target, even if this takes longer than expected.

However, it is the third arrow of Abenomics - measures to spur overall productivity, strengthen the services sector, revitalise agriculture and reform unsustainable social systems - that is the most crucial in remaking Japan an active contributor to world economic growth. While corporate Japan has begun recovering some of its animal spirits, the decline of GDP in the second quarter, due to an increase in the consumption tax from five to eight per cent, shows that there is still a long way to go before Abenomics can be declared a success. One reason for cautious optimism is that Mr Abe and his Cabinet are moving ahead - albeit with more caution than some would like to see - with the realisation that this might be the last chance to get Japan out of irreversible decline.

Unfortunately, this cautious optimism would sound like fanciful wishful thinking if applied to the euro zone. It is now obvious that the very nature of the European crisis makes it impossible to solve it by relying only on an easing of monetary policy while forcing the countries in crisis to keep a growth-adverse fiscal policy. Yes, a number of structural reforms are acutely needed in all the countries involved. But forcing the bitter medicine of painful reforms down the throat of an already weak patient while keeping him on absolute diet might end up killing him. At least, this is inflicting tremendous suffering, in terms of stubbornly high joblessness rates, and very serious damages to the social and political cohesion of the countries concerned with long-term consequences.

The poor results of the European Central Bank's last episode of QE lite, when European banks took only euro 80 billion of the euro 170 billion of loans offered to them at a fire-sale rate, have shown that it is not just a question of having more money floating in the euro zone. It is a matter of confidence and growth prospects - those are needed to give banks and companies a reason to take loans and invest. As long as stringent austerity is enforced on countries in crisis, economic stagnation will endure with ever higher joblessness rates (look at the latest figures in France and Italy, and the minimal improvement in Spain) and ratios of debt-to-GDP that are, in many cases, continuing to deteriorate. Improvement in the Greek or Irish economies is just gloss, irrelevant in the larger euro-zone picture.

In other words, an easing of too-stringent fiscal policies - allowing for more time to reduce the fiscal deficits of the countries in crisis - is a sine qua non. This is what the exasperated Americans are asking from their European friends; this is what Paris and Rome are quasi-begging for. This is what even the IMF recommends. Unfortunately, this is not what Berlin wants to hear. Chancellor Angela Merkel and her finance minister continue to rely on export-led growth and huge current-account surpluses and refuse to boost domestic consumption, for instance, with projects that would revamp Germany's ailing infrastructure and support economic activity in other euro-zone countries. The only question is whether, and when, the financial markets will realise the risks involved in this absurd obduracy, and will again get into some jittery mode that will create new tremors for the global economy.

The writer is president of Smadja & Smadja, a strategic advisory firm

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First Published: Wed, September 24 2014. 21:50 IST