Four years after the start of the credit crunch that prompted the first truly global slump since the 1930s, financial markets were in a state of high anxiety last week that the deadlock in Washington over US debt threatened a second, and even more serious, leg to the crisis.
With warnings from the head of the International Monetary Fund (IMF) ringing in their ears, Democrats and Republicans spent last week in a game of chicken with the highest possible stakes. The issue was whether the Obama administration would succeed in raising the US debt ceiling from its current $14.3-trillion, a common and relatively uncontroversial matter in the past that has taken on a hard political edge with the rise of the Tea Party movement.
Democrats said the ceiling had to be raised to allow the government to function. Republicans said it was time for the world’s biggest economy (and biggest debtor) to live within its means. In the wings were the three biggest rating agencies, Standard & Poor’s (S&P), Moody’s and Fitch. Although most analysts remained optimistic that the politicians would step back from the brink, markets were convulsed by fears that America might lose its coveted triple-A rating and, in the worst case, even start to default on its debts.
Christine Lagarde, newly appointed managing director of the IMF, said a default or downgrade “would be a very, very, very serious event, not just for the United States but for the global economy at large”. Until recently the French finance minister, she is acutely aware that Europe’s sovereign debt crisis is far from over and last week the euphoria that followed the new bailout for Greece proved short-lived. China, the third global economic powerhouse, is slowing as a result of an attempt by Beijing to combat rising inflation. This will have knock-on implications for commodity-rich countries that have provided the raw materials for China’s spectacular growth.
The IMF believes there are three conditions for a mega recession: it should affect the core of the global economy, have its genesis in the financial sector and should involve a large number of countries. A budgetary crisis in the US would, according to analysts, fulfil all those criteria, rippling out to the rest of the world and producing a wave of fresh losses for banks. Although the IMF believes the global economy will grow this year, it thinks the risks are skewed to the downside and that potential problems lurk in every continent.
World’s financial health
United States
A slow-moving economy. Unemployment above 9%. A shattered housing market. Political gridlock. America is beset by problems and is rapidly running out of policy options should things become worse. With short-term interest rates at zero and a high budget deficit, the only means available to stimulate demand would be a third dose of quantitative easing. The one upside for the world’s biggest economy is that its blue-chip corporations — such as Amazon and Ford — are posting healthy profits. But the US remains the hub of the global economy and a crisis there would have far-reaching and immediate effects on both the developed and developing world.
Germany
Europe’s pivotal economy has seen a remarkable turnaround since plunging into recession in late 2008. Lost output has been recouped, with a pick-up in investment reinforcing strong growth in exports. Germany’s capital goods have powered China’s industrial revolution, while capital flows that in the bubble years were financing property speculation in Greece and Spain are now funding projects at home. But Germany is highly vulnerable to events beyond its borders, such as a euro crisis or a marked slowdown in China .
Japan
Industrial production was devastated by the tsunami in March, but the signs are of a classic V-shaped recession, with a plunge in output followed by a swift recovery. Retail sales have bounced back and are now higher than they were before the earthquake, but employment growth looks weak. While unlikely to be the source of global instability itself, Japan’s export dependency means it would be an early victim of contagion.
France
As a much more self-contained economy than Germany, France saw a much smaller fall in output during the crisis and has had a slower recovery. The focus on the southern European members of monetary union has meant little attention has been paid to France’s modest performance since the single currency was created. An overvalued property market is the most immediate cause for concern.
Mexico
Rising oil prices have underpinned growth in Latin America’s second-biggest economy, which has taken a decade and a half to shrug off the impact of the mid-1990s currency crisis . With inflation low and its current account only just in deficit, Mexico is nNot currently high on the list of concerns for the financial markets.
Argentina
There is little Argentina could not tell the rest of the world about sovereign debt crises. Since the banks closed their doors after the country defaulted and abandoned its IMF austerity programme in late 2001, Argentina has since enjoyed healthy growth, helped by its natural resources, but inflation is about 10%. Vulnerable to a collapse in commodity prices and a flight of investors out of countries perceived to be high risk.
Brazil
Policymakers have announced measures to prevent the Real appreciating against the dollar, fearful that an overvalued exchange rate will put paid to the country’s strong export-led growth. The equation is simple: if China does well, Brazil does well.
India
The economy is booming and, social tensions aside, the government is optimistic. But interest rates have risen to 8% to choke off inflation that has jumped to 9.4%. Still largely an enclosed economy, shut off from the world, its stance restricts growth but means it poses few risks for other countries.
Russia
An important commodities exporter, especially oil and gas, its collapse would only hurt the outside world if it restricted energy supplies. Seen as a big buyer of Western goods, but in the future. Not a key global player yet.
South Africa
President Jacob Zuma has grand plans for Africa’s largest economy, but, like Russia, internal problems would only pose a risk to the rest of the world if it harmed mineral exports, which is unlikely.
Ethiopia
With inflation at 38% in June from a year earlier and millions of its people affected by drought, the country is already in financial trouble. Climate change is a bigger immediate problem than another recession in the West, though restrictions in food aid would be devastating. Poses no wider threat if it goes bust.
South Korea
Supplies much of the world with mobile phone handsets and flat screen TVs. A recession is unlikely and if it happened, from a spike in the price of oil or food, most of which it imports, would affect local Asian economies more than the wider world. Not yet a Japan.
Egypt
Rumours earlier this year that Egypt was about to default on its debts sent the World Bank scurrying to Cairo with sufficient bailout funds. A democratic crisis or a sharp rise in food costs, with most wheat imported from Russia, could spark a recession or default, but the sums are small enough for global agencies to handle.
China
Less plugged into the world financial eco-system than the US, but serious problems in the world’s second-largest economy would nonetheless trigger global recession, such is the importance of its exports and its purchasing of Western debt. It is not immune to problems in the west either. Beijing suffered a sharp fall in exports in 2009 and was forced to pump billions of yuan into the economy to keep it from falling over.
Greece
Many economists believe Athens could come back to haunt the eurozone, and it will, with GDP contracting by 5.5% over the past year and industrial production down 10%. But for the moment its €109-billion of extra loans and €20-billion of debt forgiveness reduces the threat of default.
Cyprus
Nominally independent of Greece but inextricably linked through its banks. Suffered a downgrade last week, heaping more pain on the eurozone. However, too small to affect deliberations in Brussels.
Portugal
Has stayed under the radar since an €80-billion bailout earlier this year. But a creaking property market and heavy private sector debts could see it cause more headaches. Government debts are small but local businesses and households have amassed loans worth around 240% of GDP.
Ireland
The scale of its private debts — equal to 320% of GDP according to research by Morgan Stanley — combines with large government debts to create a timebomb. Only its flexible labour markets and a willingness to suffer painful pay cuts is keeping investors onsideand saving it from further crisis.
Spain
Prime minister José Zapatero is playing the austerity game to stall a bailout, but high public sector and private sector debts make Brussels nervous. Protests could escalate as people rebel against a 40% youth unemployment rate. Only the potential for higher growth next year and beyond is keeping investors at bay.
Italy
Lack of growth and falling competitiveness have undermined finance minister Giulio Tremonti’s efforts to keep Rome out of the spotlight. Government debts of 119% of GDP don’t help. – guardian.co.uk