World Economy
On Wednesday, July 8, 2009 14:35 by Sudip BandyopadhyayWorld Markets have calmed down since the chaos of last autumn, when it seemed any institution, no matter how grand, could disappear overnight. Appetites for risk have retuned. But investors are seized by a new uncertainty: how confident should they be about the prospects for recovery? Since March, the stampede to safety has been slowly reversing. The dollar is 9 per cent cheaper than four months ago and sovereign bond yields have risen. The oil price has been picking up, last week touching $ 73 a barrel.
Certainly, these are good portents. Forecasters, who once raced to slash outlooks, are now daring to upgrade them. The Organisation for Economic Co-operation and Development’s latest research now foresees output for its member nations growing by 0.7 per cent in 2010, rather than falling by 0.5 per cent, as it expected back at the March nadir for confidence. Yet, beyond the belief that the world has avoided a second Great Depression, there is little new information out there. So, although investors are still skittish – equity price volatility indices remain high mature stock markets have been treading water, indecisively bouncing up and down within ranges over the past month. The markets cannot make up their minds. Investors will be cheered by the continuing good news from China. Shanghai index has risen by 9 per cent, and the country has enjoyed a series of growth forecast upgrades. China’s large stimulus, along with its financial policies, seem to be working.
What is the long-run prognosis for the global economy and why might it be misleading? In the long term, the desperate measures that appear to have averted the “nightmare scenarios” of a banking collapse followed by a second Great Depression will have an impact. That impact will not be positive. By pumping money into the economy and artificially lowering the price of credit, UK and US governments are deliberately stoking inflation. Mild inflation would reduce the cost of the debt that got the world into trouble in the first place. But accelerating inflation would be something entirely different. Central banks’ task will be to judge when that risk has become predominant and then slam on the brakes by raising rates. Tellingly, the US Federal Reserve did this too soon during the Great Depression, forcing the second recession of the 1930s.
It looks like the typical case of a patient running on steroids. The real health will be only be known when the stimulants are withdrawn. This process needs to be handled with extreme caution & the true test of the world economic health will be when this application of brakes happen.
