Lets assume that the IMF, the World
Bank and the financial markets are all wrong when they say the US is now set
for a period of robust growth, that Europe is on the mend and that China can
make the transition to a less centrally planned economy without a hard landing.
In those circumstances, three questions need to be asked. The first is
where the crisis is likely to originate, and here the dollar is on the emerging
markets. China's economic data is not always very reliable, but it is clear the
curbs on credit are having an impact. The world's second biggest economy is slowing
down and probably faster than we thought. Other
emerging markets – India, Brazil, Turkey – if anything look even more
vulnerable if markets respond negatively to policy moves in the US. The speed
at which the Federal Reserve tapers away its monthly stimulus will depend on
conditions in the US, not the rest of the world, and the potential for capital
flight from countries with big current account deficits is real.
The second question is how policy would respond if a second shock
occurred well before the global economy had recovered from the first.
Traditionally, central banks and finance ministries use upswings to restock
their arsenals. They raise interest rates so that they can be lowered when
times get tough, and they reduce budget deficits so that they can support
demand through tax cuts or public spending increases.
A renewed bout of turbulence would start with interest rates already at
historically low levels, budget deficits high and central banks stuffed full of
the bonds they have bought in their quantitative easing programmes.
Conventional monetary policy is pretty much maxed out, and there seems little
appetite for a co-ordinated fiscal expansion, so the choice would be
unconventional monetary policy in the form either of more QE or helicopter
drops of cash.
The final question, highlighted recently, is what sort of impact a
second recession would have on already stretched social fabrics. Unemployment
is rising, insufficient jobs are being created to cope with the demands of a
rising world population, and the improvement in working poverty has stalled.
All the ingredients are there for social unrest, which is why maybe it’s
best to call on businesses to use rising profits for productive investment
rather than share buy-backs.
