John Rapley - Foreign Focus THE WORLD economy appears to be emerging from its doldrums once again. While China failed to notice the 2001 downturn, Europe, Japan and the United States all went into recession. At the time, a global economic slump looked like a distinct possibility.
Today, the short-term indicators from all of these regions are looking up. As a result, optimists are speculating that the world economy is emerging from its downturn, and that we are back on the growth-track we were all promised in the 1990s.
That would certainly be welcome news here in Jamaica, where the fiscal situation is starting to resemble the crises that have already sunk countries like Argentina. We are growing desperate for a life-jacket to be thrown to us. Will a rebounding world economy give us the breather we need?
That may be too much to bank on. The short-term prospects for the world economy remain good. But looking down the road, say past the middle of next year, the prognosis looks less sure.
LOCOMOTIVE
As happened after the Asian Crisis in the late 1990s, the world economy is being pulled along by the locomotive of the US. Recent figures show that the American economy is bouncing back strongly from what was a relatively mild and short recession two years ago. Moreover, while the "jobless recovery" initially delivered economic growth but rising unemployment, job creation has now resumed, and is likely to persist. Spending will thus pick up, and the recovery will continue.
Yet whether or not it will prove to be an enduring rebound is another question. The prospects for the next year or so look good. After that, problems may resurface. The American economy cannot but grow strongly just now. With the Federal Reserve Board pursuing an ultra-loose monetary policy, and federal tax cuts pumping hundreds of billions of dollars into the economy, the country is simply awash in cash. With interest rates so low, it makes little sense to save; with debt costs declining, it costs nothing to take on more debt.
SPENDTHRIFT
So, Americans have returned to the spendthrift ways of the 1990s. Since yields on US government paper have plummeted, some of this money has found its way onto the stock market. This has put the brakes on the market's slide, at least for now. The resultant "wealth effect" has helped to arrest the decline in spending.
Down the road, though, difficulties await. For starters, the effect of the tax cut will peak by about next summer. In the meantime, with Americans spending rather than saving, the US current account deficit is setting new records. Consequently, foreigners are losing their appetite for US securities, worried as they are that the dollar will decline. This has set in motion a self-fulfilling prophecy, with anticipated declines in the dollar triggering a flight of capital, thus driving the dollar down. The low interest rates being offered on US investments are doing nothing to stem this tide.
The declining dollar will aid the US recovery by boosting the competitiveness of US firms. But if the slide continues, it will drive up inflation. This, in turn, will boost interest rates. When that happens, America's indebted population could experience a drop in its living-standard: debt expenses will rise while the value of assets will probably decline. If the adjustment is sharp, so too will be the reaction. The risks of a return to recession, and of a renewed stock-market collapse, remain real.
If I were a betting-man, I'd say that the odds are that the US economy will remain strong through the middle of next year, and may even carry President Bush to a second election victory. After that, all bets are off. Unless a strong economic recovery then takes hold in either Europe or Japan, the world economy will risk another slump. While Europe and Japan are growing again, it is too soon to call their recoveries sustainable. And even the Chinese power-house faces risks, given the exposure of its banking sector. This, in short, is a recovery that has central bankers crossing their fingers.
All in all, we have a window of opportunity to tackle our own fiscal difficulties, but it is a window that may not remain open for too long.
John Rapley is a senior lecturer in the Department of Government, UWI, Mona.
