Economic sickness is spreading, but world leaders are at a loss to find cure

PUBLISHED : Saturday, 02 June, 2012, 12:00am
UPDATED : Saturday, 02 June, 2012, 12:00am


Wailings by Christine Lagarde, managing director of the International Monetary Fund, on the continuing Greek tragedy show how panicked the so-called leaders of the world are about the plight of the global economy, yet how clueless they are about how to get out of the mess.

The world is increasingly global, its economy globalising, but its politics is still driven by narrow national and nationalistic concerns. For all the endless summits of the G7, G8, G20, UN, IMF, World Bank and alphabet soup of organisations, not one has the imagination to devise a way out, nor is a leader courageous enough to offer a workable global plan.

Lagarde proclaimed in an interview with The Guardian that she had more sympathy for children deprived of decent schooling in sub-Saharan Africa than for those facing poverty in Greece. Greek parents are responsible if their children are affected by spending cuts. 'Parents have to pay their tax,' Lagarde declared.

'I think more of the little kids from a school in a little village in Niger who get teaching two hours a day ... and who are keen to get an education ... I think they need even more help than the people in Athens.'

It was an extraordinary performance, especially considering Lagarde is one of the leaders charged with finding a way out of the mess. Let's stick to Greece and leave aside what damage the IMF and its structural adjustment facility have caused to the desperately poor kids of Niger.

Perhaps the real surprise is that the euro has survived, given the inbuilt flaws in its manufacture. The question is what happens now. In spite of Lagarde's expostulations, there is a reluctance to let Greece go.

This may be because of fears of what will follow. Former IMF economics chief Simon Johnson and Peter Boone predict on the Baseline Scenario blog that, 'in Europe soon, millions of people will wake up to realise that the euro-as-we-know-it is gone. Economic chaos awaits them.'

They predict that a Greek exit will not be orderly but calamitous and will lead to a chaotic dissolution of the euro zone, as Greece defaults on Euro300 billion (HK$2.9 trillion) of external public debt and probably defaults on Euro155 billion owed to the euro system (the European Central Bank and national banks).

A Greek exit will lead, as some finance ministers have warned, to a flight from banks and sovereign debt across the euro periphery, not just in Spain, and put pressure on the ECB. The euro system's claims on troubled periphery countries are about Euro1.1 trillion or about 200 per cent of the broadly defined capital of the euro area, or 43 per cent of German gross domestic product.

Given the past behaviour of the euro authorities, the ECB will likely temporise and provide credit slowly and only when pressured. This will lead to spending cuts, a deeper recession and bubbling anger of electorates in a vicious cycle of capital flight, cuts, recession and popular anger.

Could this be avoided by letting Greece stay inside? It is hard to see a way - without some creative planning on all sides - to soften Greece's austerity and encourage Athens to be a better European player. This also depends on Germany being more generous, which also seems unlikely. Chancellor Angela Merkel evidently still believes in the magical confidence fairy coming to the rescue of good governments that practice austerity. But austerity all round only leads to deeper misery all round in these troubled times.

For former European commissioner Peter Sutherland, the euro saved Europe from the perils of devaluation, protectionism and economic nationalism, boosted trade and stability, and kept inflation low.

Others see the break-up of the euro as Europe's opportunity. Nassim Taleb, author of The Black Swan, says the break-up of the euro 'is not a big deal. When they break it up, there will be a lot of fun currencies.'

He is more concerned about the US where the budget deficit has reached 8.2 per cent of GDP, or twice the euro level. For him, Europe is sick, but is talking about it. 'In the United States we are ill, but don't know it.'

Economic sickness is spreading across the world, and is being made worse by political quack doctors fighting each other over nostrums and potions.

Problems are exacerbated where leaders see issues with global implications through nationalistic or, worse, party partisan, spectacles. This is marked in the US, but is also true in China, India and Japan.

This is where a euro break-up could have frightening implications. The European economy accounts for about 30 per cent of global GDP. Euro sovereign debt outstanding is about US$11 trillion, of which, Johnson and Boone calculate, at least US$4 trillion is a near-term risk for restructuring.

What will happen to the US$185 trillion in euro-denominated derivatives? Who has got a plan to handle capital fright on this scale?

Kevin Rafferty was managing editor at the World Bank, 1997-99