Bill Emmott - International Author & Adviser


GDP Drop - A Crisis But Not The Apocalypse
Corriere della Sera - August 15th 2008

This global economic situation continues to make a nonsense of all predictions. One year ago, when the “credit crunch” based on American subprime mortgages began, it looked obvious that the worst-hit countries would be those that reckless American-style banks and that had enjoyed rapid rises in house prices. So the likeliest to enter a recession were obviously America, Britain, Spain and Ireland. The opposite has happened. The Eurozone has announced the first fall in quarterly GDP since the currency was created, one day after Japan too announced a drop in GDP. Yet Spain has actually had one of the stronger GDPs in the Euro area this year, and neither America or Britain has yet suffered any recession.

            Why? The answer seems to be that this economic “crisis” is a lot more boring and conventional than most people thought. Last year, the wise economists at the IMF claimed we were in “the worst financial crisis since the Great Depression”. But so far there has been no true collapse of banking of the sort seen in the 1930s, nor any sign of deflation, which is the mark of a real depression. Instead the dominant forces have been inflation and currency movements.

            That is why the Eurozone countries are suffering. The combination of an incredibly strong euro against the dollar and sterling, with oil prices more than doubling in the past year and food prices soaring too have created a shock which European economies could not absorb. Exports have become less competitive, input costs have risen and the European Central Bank has had to maintain high interest rates in order to prevent inflation from spiralling out of control.

            This is not at all as exciting as a financial meltdown. But that is good news: none of us should want to be excited in that way. A simple repeat of the 1970s, and its combination of stagnation and oil-led inflation is quite enough excitement, thank you. The question now, though, must be: the economy may not get as bad as the 1930s, but will it get as bad as in the 1970s?

            We have to admit, first of all, that we don’t know. If predictions in the past year have been so bad, there is no reason why predictions made now will be any more accurate. But we can probably work out what will make the most difference to whether this bad quarter in Europe is the beginning of a serious recession or whether it might just be a slow period, following which we will recover.

            The place to start looking is in the commodity markets, which have been the source of our recent inflation problems. In the past month the oil price has fallen by 25% and food prices have also been falling. Partly, this is because more oil is being pumped by Saudi Arabia and more food is being grown by many countries, especially America. But also this good news has happened for the bad reason that global economic growth is slowing and hence demand for energy and food. Much of that slowdown has happened in America and Western Europe. More critical, though, could be the slowing of demand in China and India.

            If we are worried about inflation of 4%, then India must be panicking at its inflation rate of 12%. China’s consumer-price index shows inflation of 6.3% but its producer prices are rising by 10% annually. What needs to happen is for these countries’ central banks to follow the ECB’s example and tighten monetary policy to kill inflation. This has begun to happen in India but not yet properly in China, probably because the authorities don’t want to do anything controversial during the Olympics. Most likely, though, China will crack down on inflation after this month.

            If it does so, then oil and other commodity prices will be likely to fall further, since slower economic growth in China and India will mean slower growth in demand for oil and commodities there. For Europe, that will be good news for inflation, eventually permitting the ECB to cut its interest rates, and a currency revaluation in China would also help make the Euro more competitive again. It would be less good news for European companies that export to China and India, which certainly include firms in both Germany and Italy.

            In the end, though, what it would mean is that the whole world would pass through a period of slow growth, of readjustment of all our economies. It would be a little bit painful and certainly quite boring. But it would not be the financial apocalypse of which so many people have been talking.


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