Belfast Telegraph

Monday 22 September 2014

World economy on brink as quick fix fails to hide cracks

The US escaped defaulting by a whisker, but serious joined-up thinking will be needed after the holidays, says Hamish McRae

In the world of finance, August is not the cruellest month - it's July. Or at least that's the usual pattern, as financial crises tend to happen in the run-up to the holiday season rather than during it.

Why? Well, the not-totally- unfounded reason is that traders in the money markets want to get their books straight before they head off on hols.

So they make sure they have no open positions - and that has the effect of bringing any incipient market pressures to the surface. The eurozone crisis this summer has been a case in point.

Politicians don't want to hang around in August, either, as we have just seen in the US. Do you believe Washington suddenly ran out of money this week? Of course not. The deadline was set by politics, not economics.

But by any rational standards the political process by which both the US budget deal and the Greek bailout were reached are profoundly unsatisfactory.

The sight of US legislators clapping each other as though they had done something wonderful is really rather rum.

The balance of probability is still that the US will lose its AAA debt rating as this week's deal does not solve the country's medium-term fiscal problems. As for Europe, Greece may have been bailed out, but the way it was done highlighted the plight of the other weaker eurozone members.

Nor, let's be clear, have we anything to congratulate ourselves on here. We may have pulled ourselves back from the brink, but no government of a sophisticated Western economy should inherit a fiscal deficit of 10% of GDP, or have to carry through the sort of cutbacks this government faces.

So now it's holiday time.

The captains and the kings depart.

It is a moment to ponder quite what went wrong just about everywhere - and what is to be done about it.

In the months ahead, as the tumult of the markets resume and the world economy experiences a pause in the recovery, there will be an increasing realisation that the West can't go on like this.

Of course, our failure enables the Bric nations (Brazil, Russia, India and China) to sneer at us. Prime Minister Putin told a party youth camp: "They are living beyond their means and shifting a part of the weight of their problems to the world . . . They are living like parasites off the global economy."

We don't need to take any lessons from the Russians about fiscal management. In July 1998 (it had to be July), the IMF and World Bank lent Russia some $33bn in an effort to rescue the country's finances, but the rescue failed and Russia devalued the rouble and defaulted on its domestic debt.

Unsurprisingly, the rouble has not subsequently presented much of a challenge to the dollar as a haven for global savings.

The Chinese authorities have also been deeply critical of US policy, but while they continue to resist allowing their currency to be fully convertible, its global role is inevitably stunted.

While they continue to hold their currency below its equilibrium level by pegging to the dollar, they will assuredly find themselves accumulating dollar assets, thereby actually enhancing the dollar's global role.

Still, the events of the past few weeks will have undermined the dollar's position, just as the events in Europe have undermined that of the euro.

Britain's plight is nothing to be proud of. As this reality sinks in and as, in addition, the fiscal cutbacks everywhere take hold, we will have to confront our failure.

Some profound thinking will have to go on. I don't believe there will suddenly be agreement on a single developed world fiscal model - more likely we face a decade of experiment before established good practice gradually emerges.

But one thing is for sure: we can't go on like this.

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