Spend More

There comes a time when monetary policy must concede to fiscal policy.  One of those times is now, when private spending has slowed down considerably and the most potent of monetary policies, interest rates, is not as effective as it could be.  In Europe, all eyes are on the governments that make up the 17-member Eurozone, but more particularly on Germany, which along with France, is attempting to lead the rescue effort.  The members of the European Community which use the Euro as their currency are the principal economic agents that could provide the much needed money to take care of the troubled sovereign debt of its members.  No one expects it to last, but the willingness of the International Monetary Fund (IMF) to encourage governments of major economies to spend more and not less was probably the last thing some expected from the world body.  That was the call coming from its new Managing Director last week in an effort to help stave off the collapse of the Euro.

The IMF spends most of its time preaching the virtues of sound macroeconomic policies which often means sound monetary policy and the need to stay away from too much government spending.  This sermon, more often than not, is delivered to the governments of developing countries, and only one year ago, the IMF was expressing concerns about the threat that unprecedented spending by governments was posing to the international financial system.  However, recently, the IMF has found itself at odds with its own policies and purpose, particularly when it comes to keeping European economies afloat.  The cause of course is the protracted global economic crisis that was spawned by the global financial meltdown three years ago.  The location of the trouble today is in Europe and North America, two regions of the world that account for essentially half of world output and the major worries currently confronting the global economic community.

Tsunami

LUCAS STOCK INDEX The LSI declined by half of one percent in trading this week. While the stocks of Banks DIH (DIH), Demerara Distillers Limited (DDL) and Republic Bank Limited (RBL) remained stable that of Demerara Bank Limited (DBL) declined by 3.17 percent. No other stocks were traded. As a consequence, the spread between the index and the risk-free Treasuries due to mature in December 2011 remained below 20 percentage points.

The thing on the mind of the IMF is the risk that the once promising signs of economic growth in the major industrialized countries would stall and send the world economy into recession.  Europe is in the throes of a serious financial crisis that looks like the delayed rush of a tsunami that follows an undersea earthquake.  The financial equivalent of an undersea earthquake occurred three years ago in 2008 when investment and commercial banks in the USA and Europe began to collapse as the assets/collateral underpinning their loans and mortgages were found to be toxic and of dubious value.  Not knowing what their true worth was, commercial banks and other creditors held on to their money until they could get a true picture of what they owned.  This frugality made it harder for anyone to borrow, especially businesses that relied on short-term capital.  The sudden withdrawal of credit, the fuel of the economy, forced businesses and consumers to cut back their activities.  The chain reaction led to job cuts and employee layoffs with the added result that demand for goods and services declined further.

Cracks

At first it looked as if Europe had weathered the storm with the adverse economic force seeming to hit the US the hardest.  But then the stress of the economic crisis began to show up as cracks in the economy of Greece, Portugal, Ireland and Spain which, like staccato on a seemingly undamaged building, began to break loose and fall.   The economic crisis in Italy now has created even more pressure on European economies as has the recent downgrade of Spain’s credit rating.  From the IMF’s assessment of the economic prospects for Europe, it is clear that many Europeans have grown suspicious of financial markets and are less willing to take on risk.  This new attitude is being accompanied by a growing reluctance by consumers and private businesses to spend. The threat from this type of behavior is the deepening of the crisis gripping the euro area and the likelihood of it dragging even some of the stronger economies down.

Immediate Threat

The immediate threat is to the 17 countries that make up the Eurozone and about 20 percent of the global economy.  These countries use the Euro as their currency and they face the humiliating prospect of a currency collapse if member countries are unable to solve the debt crisis involving some of its members.  Like in the US three years ago, some major European banks face collapse if they cannot redeem the assets, in this case bonds, which form part of their investment portfolio.  Ultimately, economic reform will be necessary but the immediate issue is keeping the financial system afloat.   Investors are being pushed to accept a lower share of their investment.  The loss will impact the sufficiency of funds and the disposition towards future lending.  Yet, there will be need for money to keep the system going.  That situation has caused the IMF to moderate its position at least temporarily.

Low-growth Trap

The IMF attempted to assume a larger role in solving the European crisis by backing a G-20 idea that sought to double the size of its Fund so that it would have money to intervene and lend support to the European Financing Stability Facility.  That effort failed when some of the important financiers of the IMF, among them Australia, Canada and the USA, rejected the idea.  As an alternative, the IMF finds itself encouraging European leaders to change their policy stance and spend more from their treasuries to help in the recapitalization of some of the banks.

The IMF fears what it calls the low-growth trap that can cause more than the already troubled economies of Europe to spin out of control.  While most other regions are at risk, the IMF appeared alarmed at the threat that the European crisis posed for Asia.

Already there has been a heavy disposal of Asian assets and there is growing fear if the European crisis is not brought under control soon, the selloff would continue to the detriment of Asian economies.

The uncertainty surrounding the future condition of the global economy has pushed the IMF to contradict its basic position on the management of individual economies.

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