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October 2011 Economic Overview

TWO messages emerged from the weekend’s IMF meetings: striking and deeply disconcerting. The high level of fear and anxiety among the participants and Euro-zone governments are still struggling to put in place an agreement reached in July. Europe is sliding toward recession. America is uncomfortably close behind. A renewed downturn across major economies would be very painful, given the lack of recovery in many labor markets and the stress contraction places on budgets. Were a double-dip to strike, far fewer economies would have the political will to intervene to support the economy, even among those with the fiscal room to help.

It’s just shocking to think about the dangers that loom and consider the extent to which they’re driven by governmental failures. Despite having been in a state of constant crisis for more than a year, the euro zone is far away from a real solution; America’s fiscal policymaking has steadily deteriorated, and the Congress needlessly sent confidence tumbling over the summer with a battle over the government’s debt ceiling. At the same time, Ben Bernanke seems to have forgotten everything he once knew about the crises in the 1930s and in Japan in the 1990s. America is sinking back toward recession while the global economy nears a cliff, and the Fed—by its own acknowledgment—has plenty of heavy ammunition sitting untouched on the shelf.

It is a damning performance. If the world economy does indeed face a new crisis and a new contraction in the weeks ahead, rich-world citizens will have every reason to question the institutions of global capitalism. If the liberal order begins to falter, even darker times still may lie ahead.

US
If incomes are to grow, aggregate credit and debt has to keep growing. Whether the growth is private or governmental is immaterial. It is the total that counts. The truncated responses of government and of markets to the recent crises, are shaking underlying confidence and heightening risks of contagion in all markets.

Eurozone
A vicious feedback loop between growth, sovereign-debt concerns and banking woes is now in train. S&P cited weakening growth prospects as a crucial reason why it lowered its credit rating for Italy: a more sluggish economy will make it harder for the government to achieve its fiscal targets. The rising risk of recession will damage a fragile European banking sector, which already faces potential losses of around €200 billion from higher risk on sovereign debt, according to new IMF estimates. And if the German economy falters, that is likely to make it even trickier for Angela Merkel to convince German taxpayers that they must dip deeper into their pockets to rescue the euro. Dealing with the debt crisis just seems to get harder and harder.


WHAT does Germany want? The question comes up in every discussion about the euro. What it does not want is clear enough: no “transfer union”, no pooling of national debts and no break-up of the single currency. But it is hard to know how it hopes to reconcile these aims, harder still to discern the ultimate goal of Germany’s European policy.

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