Over-optimism raises risk of global recession

Over-optimism raises risk of global recession

In April 2010, the International Monetary Fund’s World Economic Outlook offered an optimistic assessment of the global economy, describing a multi-speed recovery strong enough to support roughly 4.5 per cent annual GDP growth for the foreseeable future — a higher pace than during the bubble years of 2000-2007.

27 MAY

In April 2010, the International Monetary Fund’s World Economic Outlook offered an optimistic assessment of the global economy, describing a multi-speed recovery strong enough to support roughly 4.5 per cent annual GDP growth for the foreseeable future — a higher pace than during the bubble years of 2000-2007.

But, since then, the IMF has steadily pared its economic projections. Indeed, this year’s expected GDP growth rate of 3.3 per cent — which was revised downward in the most recent WEO — will probably not be met.

Persistent optimism reflects a serious misdiagnosis of the global economy’s troubles. Most notably, economic projections have vastly underestimated the severity of the eurozone crisis, as well as its impact on the rest of the world. And recovery prospects continue to depend on the emerging economies, even as they experience a sharp slowdown. The WEO’s prediction of a strengthening recovery this year continues the misdiagnosis.EUROZONE’S PRETENCE

European Central Bank President Mario Draghi’s announcement last summer that the ECB would do “whatever it takes” to preserve the euro reassured financial markets. But, as pressure from financial markets has eased, so has European leaders’ incentive to address problems with the eurozone’s underlying economic and political dynamics. Easy ECB liquidity is now sustaining a vast swath of Europe’s banking system.

The eurozone is operating under the pretense that public and private debts will, at some point, be repaid, although, in many countries, the distress now is greater than it was at the start of the crisis almost five years ago. As a result, banks, borrowers and governments are dragging each other into a vicious downward spiral.

Politicians have exacerbated the situation by doubling down on fiscal austerity, which has undermined GDP growth while failing to shrink government debt/GDP ratios. And no decisive policy action aimed at healing private balance sheets appears imminent.

Moreover, Europe’s global trade networks mean that its internal problems are impeding world trade and, in turn, global economic growth. In 2012, world trade expanded by only 2.5 per cent, while global GDP grew at a disappointing 3.2 per cent rate.

Periods in which trade grows at a slower pace than output are rare, and reflect severe strain on the global economy’s health. While the trauma is no longer acute, as it was in 2009, wounds remain — and they are breeding new pathologies. The damage enables political interests to overshadow any sense of urgency about the need to redress the global economy’s problems.

EMERGING MARKETS FALTER

Against this bleak background, it is easy to celebrate the success of emerging markets, which are growing much faster than the advanced countries. But even the world’s most dynamic emerging markets — including China, Brazil, and India — are experiencing a sharp deceleration.

Consider India, where growth is now running at an annualised rate of 4.5 per cent, down from 7.7 per cent in 2011. To be sure, the IMF projects that India’s economy will rebound later in 2013, but the basis for this optimism is unclear, given that all indicators so far suggest another dismal year.

The emerging economies’ supposed resilience needs to be reassessed. Like the advanced economies, emerging economies experienced a boom in 2000-2007. But, unlike the advanced economies, they maintained high GDP growth rates and relative stability even at the height of the crisis.

This was viewed as powerful evidence of their new economic might. In fact, it was largely a result of massive fiscal stimulus and credit expansion.

Indeed, as the effects of stimulus programmes wear off, new weaknesses are emerging, such as persistent inflation in India and credit misallocation in China. Given this, the notion that emerging economies will recapture the growth levels of the bubble years seems far-fetched.

Economic forecasts rest on the assumption that economies ultimately heal themselves. But economies’ self-healing capabilities work slowly. Worse, a misdiagnosis can lead to treatments that impair the healing process. Overly optimistic economic projections based on mistaken assessments of the global economy’s ailments thus threaten recovery prospects — with potentially far-reaching consequences.

In Europe, the banks’ wounds must be closed — weak banks must be shut down or merged with stronger banks — before recovery can begin. This will require an extensive swap of private debts for equity.

For the global economy, the malaise reflected in anaemic trade growth calls for coordinated fiscal stimulus by the world’s major economies. Otherwise, the risk of another global recession will continue to rise.

ABOUT THE AUTHOR:

Ashoka Mody, a former mission chief for Germany and Ireland at the International Monetary Fund, is currently Visiting Professor of International Economic Policy at the Woodrow Wilson School of Public and International Affairs, Princeton University.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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