New shocks cast cloud over world economy recovery

World Economy: 

New shocks cast cloud over recovery

THE RECOVERY in the world economy continues to assume an
anaemic character. While most attention is currently fixed on the debacle in
Iraq, serious commentators fret that accumulated economic imbalances could
yet derail the fragile and contradictory growth signs in the US over recent
months.

Robin Clapp

Just last week, oil prices climbed above $40 per barrel
for the first time in 13 years, prompting panic on the world’s stock
exchanges. The FTSE 100 suffered its steepest one-day fall in a year. It is
generally agreed that every $5 increase in oil shaves a quarter of a percent
off GDP (GDP – the total wealth of goods and services produced by a national
economy). So the oil hike will have immediate impacts, economically and
politically.

The rising cost of oil which will lead to British pump
prices heading towards £4 per gallon, is both a response to fears about the
disruption to supplies caused by the continual instability in the Middle
East and concerns that US interest rates might have to double by the end of
2004 as a result of worries about inflationary pressures.

Industry experts even predict that oil could go on
rising, especially as China’s overheating economy is guzzling 15% more than
a year ago.

The US economy is still the key to whether the recovery
can be sustained, but excessive reliance on America is also the biggest
problem facing the global economy. Since 1995 almost 60% of growth in world
output has come from the US.

This reflects an extraordinary rise in American
spending, with US domestic demand rising on average, by 3.7% a year since
1995, twice the pace of the rest of the rich world.

During the 1990s boom, it was American firms that
powered the global economy with a huge debt-financed investment spree.
Global prosperity continues to depend overwhelmingly on US demand. If it
were to drop significantly, the world would tumble into recession. Yet, for
years the US has been spending far beyond its means.

The stock market crash in 2000 may have exposed the
stupidity of those who believed the 1990s boom had created a "new
economic paradigm". But Bush’s trillion dollar tax cuts and the
rock-bottom interest rates introduced to stave off a deeper recession and
avoid a downturn have allowed new bubbles to form in the bond and housing
markets.

Investors have been coaxed into gambling on borrowed
money, often using housing wealth to underwrite it. If interest rates rise
unexpectedly, or too quickly, the unwinding of these investment bets could
cause meltdown in financial markets. American consumers’ indebtedness is
currently growing twice as fast as their incomes and since 2001 has
accounted for a staggering 92% of GDP growth.

Growing US debts

AS RECENTLY as 1980, the US was the world’s biggest
creditor. Now though it is the world’s biggest debtor country, having to
borrow more than a billion dollars a day in order to finance its engorged
economic appetite. The current account deficit – the amount it must borrow
annually from outside the USA – has been rising fast and is running at a
historic high of over 5% of GDP.

It has been mainly Japanese and Chinese central banks
that have underwritten Bush’s spending spree by buying huge quantities of US
government bonds. This has meant that those countries have been able to keep
their currencies low against the dollar, which has aided their export drive
to the USA.

The US is trying to engineer a controlled fall in the
dollar so as to reduce its deficits and has warned China that protectionist
measures will be instigated if "unfair" trade continues.

The other traditional powerhouses of the world economy
continue to stutter. Former US Treasury secretary Lawrence Summers warned
that "the world economy is flying on one engine."

The once mighty German economy is now a candidate for
the sick man of Europe tag. German GDP per head is below that of Britain and
France and only marginally ahead of Italy, while unemployment festers at
over 10% of the population.

Japan has commonly been referred to as a basket case
economy over the last decade. The poison cocktail of bad debts, plunging
stock markets and political paralysis have mired the country in recession
and deflation.

Recent growth in real GDP is mainly attributable to the
export of huge quantities of steel and manufactured and capital goods to
China. But with general government debt equivalent to 160% of GDP, the state
of public finances remains a dark cloud hanging over the economy.

The world economy still looks likely to face a lengthy
period of stagnation, punctuated by feverish and short-lived spurts of
growth. Workers will continue to pay the price for capitalism’s failures.
Globalisation, far from being a miracle cure for the ailing world economy,
has instead matured the conditions for even deeper crises.