The global economy
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Start the engines, Angela
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The world economy is in grave danger. A lot depends on one woman
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Jun 9th 2012
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“TO THE lifeboats!” That is the stark message bond markets are sending about the global economy. Investors are rushing to buy sovereign bonds in America, Germany and a dwindling number of othersafe economies. When people are prepared to pay the German government for the privilege of holding its two-year paper, and are willing to lend America’s government funds for a decade for a nominal yield of less than 1.5%, they either expect years of stagnation and deflation or are terrified of imminent disaster. Whichever it is, something is very wrong with the world economy.





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That something is a combination of faltering growth and a rising risk of financial catastrophe. Economies are weakening across the globe. The recessions in the euro zone’s periphery are deepening.


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Three consecutive months of feeble jobs figures suggest America’s recovery may be in trouble (see article). And the biggest emerging markets seem to have hit a wall. Brazil’s GDP is growing more slowly than Japan’s. India is a mess (see article). Even China’s slowdown is intensifying. A global recovery that falters so soon after the previous recession points towards widespread Japan-style stagnation.
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But that looks like a good outcome when set beside the growing danger of a fracturing of the euro. The European Union, the world’s biggest economic area, could plunge into a spiral of bank busts, defaults and depression—a financial calamity to dwarf the mayhem unleashed by the bankruptcy of Lehman Brothers in 2008. The possibility of a Greek exit from the euro after its election on June 17th, the deterioration of Spain’s banking sector and the rapid disintegration of Europe’s cross-border capital flows have all increased this danger (see article). And this time it will be harder to counter. In 2008 central bankers and politicians worked together to prevent a depression.


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Today the politicians are all squabbling. And even though the technocrats at the central banks could (and should) do more, they have less ammunition at their disposal.



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Made in Athens, made worse in Berlin



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Nobody wants to test these various disaster scenarios. It is now up to Europe’s politicians to deal finally and firmly with the euro. If they come up with a credible solution, it does not guarantee a smooth ride for the world economy; but not coming up with a solution guarantees an economic tragedy. To an astonishing degree, the fate of the world economy depends on Germany’s chancellor, Angela Merkel (see article).




.In one way it seems unfair to pick on Mrs Merkel. Politicians everywhere are failing to act—from Delhi, where reform has stalled, to Washington, where partisan paralysis threatens a lethal combination of tax increases and spending cuts at the end of the year. Within Europe, as Germans never cease to point out, investors are not worried about Mrs Merkel’s prudent government, whose predecessor restructured the economy painfully ten years ago; the problem is a loss of confidence in less well-run, unreformed countries.




.But do not get too sympathetic. To begin with, past virtue counts for little at the moment: if the euro collapses, then Germany will suffer hugely. The downgrading of some of its banks this week was a portent of that. Moreover, the undoubted mistakes in Greece, Ireland, Portugal, Italy, Spain and the other debtor countries have been compounded over the past three years by errors in Europe’s creditor countries. The overwhelming focus on austerity; the succession of half-baked rescue plans; the refusal to lay out a clear path for the fiscal and banking integration that is needed for the single currency to survive: these too are reasons why the euro is so close to catastrophe. And since Germany has largely determined this response, most of the blame belongs in Berlin.



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Be bold, bitte


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Outside Germany, a consensus has developed on what Mrs Merkel must do to preserve the single currency. It includes shifting from austerity to a far greater focus on economic growth; complementing the single currency with a banking union (with euro-wide deposit insurance, bank oversight and joint means for the recapitalisation or resolution of failing banks); and embracing a limited form of debt mutualisation to create a joint safe asset and allow peripheral economies the room gradually to reduce their debt burdens. This is the refrain from Washington, Beijing, London and indeed most of the capitals of the euro zone. Why hasn’t the continent’s canniest politician sprung into action?




.Her critics cite timidity—and they are right on one count. Mrs Merkel has still never really explained to the German people that they face a choice between a repugnant idea (bailing out their undeserving peers) and a ruinous reality (the end of the euro). One reason why so many Germans oppose debt mutualisation is because they (wrongly) imagine the euro could survive without it. Yet Mrs Merkel also has a braver twin-headed strategy. She believes, first, that her demands for austerity and her refusal to bail out her peers are the only ways to bring reform in Europe; and, second, that if disaster really strikes, Germany could act quickly to save the day.



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The first gamble can certainly claim some successes, notably the removal of Silvio Berlusconi in Italy and the passage, across southern Europe, of reforms that would recently have seemed unthinkable. But the costs of this strategy are rising fast. The recessions spawned by excessive austerity are rendering it self-defeating. Across much of Europe debt burdens are rising, along with the appeal of political extremes. The uncertainty caused by the muddle-through approach is draining investors’ confidence and increasing the risk of a euro disaster.




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As for Germany’s idea that it could all be saved at the last minute, by, for instance, the European Central Bank (ECB) flooding a country with liquidity, that looks risky. Were Spain to see a full-scale bank run, even an emboldened Mrs Merkel might not be able to stop it. If Greece falls out, yes, the German public would be more convinced that sinners would be punished; but, as this newspaper has argued before, a “Grexit” would cause carnage in Greece and contagion around Europe. Throughout this crisis, Mrs Merkel has refused to come up with a plan bold enough to stun the markets into submission, in the same way that America’s TARP programme did.




In short, even if her strategy has paid some dividends, its cost has been ruinous and it has run its course. She needs to lay out a clear plan for the single currency, at the latest by the European summit on June 28th, earlier if Greece’s election spreads panic. It must be specific enough to dispel all doubt about Germany’s commitment to saving the euro. And it must include immediate downpayments on deeper integration, such as a pledge to use joint funds to recapitalise Spanish banks.



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This would risk losing her support at home. Yet with these risks comes the possibility of rapid reward. Once Germany’s commitment to greater integration is clear, the ECB would have the room to act more robustly—both to buy many more sovereign bonds and to provide a bigger backstop for banks. With the fear of calamity diminished, a vicious cycle would become virtuous as investors’ confidence recovered.



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The world economy would still have to grapple with ineptitude elsewhere and with weak growth. But it would have taken a giant step back from disaster. Mrs Merkel, it’s up to you.



Europe’s banks

Slouching towards a banking union

The prospects of big bank bail-outs are intensifying calls for a central fund

Jun 9th 2012





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The growing number of capital calls across banks on Europe’s periphery is leading to a freeze in funding markets, as investors fret that banks may be hiding big losses and as banks lose trust in one another. “The interbank market is totally closed,” says the boss of one large European bank, adding that he is keeping excess cash at the European Central Bank (ECB) rather than lending it to other banks.



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It is also causing jitters in government-bond markets as risk-averse institutional investors such as pension funds and insurers worry that governments in the periphery may be swamped by mounting losses in their banking systems. Money is flooding into the safest option, Germany, where the government borrowed five-year money at just 0.41% on June 6th. Despite these signs of panic, the ECB left rates on hold at its June meeting.
The crisis is intensifying calls for the establishment of some sort of banking union, with centralised powers and funding to regulate and supervise banks as well as to recapitalise ailing ones and to insure retail deposits. On June 6th the European Commission took the first steps towards this with a proposed framework for dealing with failing banks that includes plans for sharing some of the costs of recapitalising cross-border banks.



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The crisis is most acute in Spain, mainly because the sums of money involved are largest. On June 5th Cristóbal Montoro, the budget minister, said the country needed help from European institutions to recapitalise its banks because the “door to markets” was closed to the Spanish government. This was preventing it from issuing €19 billion of bonds to recapitalise Bankia, a troubled agglomeration of local savings banks that incurred huge losses on property loans. Two days later the Spanish government sold €611m of ten-year bonds at 6.04%, compared with 5.74% in April.



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Were the capital hole in Spain limited to €19 billion the country would probably have little trouble raising the money, although an idea to bypass markets and hand bonds directly to the bailed-out bank fizzled out. Yet many people now think this sum is just the tip of the iceberg. Analysts at Credit Suisse reckon that Spanish banks may have to set aside another €150 billion against losses, mainly on loans to property developers. To remain solvent after such losses the Spanish banking system may have to raise €50 billion-70 billion, or 4.5-6.5% of Spanish GDP, analysts reckon.



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That figure looks relatively manageable when set against Ireland’s recapitalisation of its banks, which has so far amounted to almost half of its GDP. Yet the call for government cash in Spain comes at a time when the country is already struggling to retain the confidence of bond investors amid growing capital flight. Almost €100 billion, about one-tenth of GDP, was pulled out of the country’s banks and bond markets in the first quarter.




.Losses are also mounting elsewhere in Europe’s banking system. Portugal, which won praise on June 4th from the European Union and the International Monetary Fund for its austerity programme, is injecting capital into its banks to fill a shortfall identified in stress tests conducted last year by the European Banking Authority. Cyprus too needs to inject money into its banks before July..
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.Yet as quickly as banks are filling their existing capital holes, new ones seem to be appearing. Analysts at Nomura note that non-performing loans are rising in several European countries, including Italy and Germany. They reckon that a severe recession in Europe could cost the region’s 90 biggest banks €420 billion in losses and consume about a third of their capital, with big shortfalls in Britain, France and Germany in addition to those already emerging in Spain (see chart).



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A deep recession is not inevitable, and banks would probably be able to generate some of that capital from profits or asset sales. The real worry is that local regulators will allow banks to hide losses rather than force them to set aside provisions and perhaps ask for capital from their governments. That would further undermine investors’ confidence and could accelerate capital flight from weak banks and weak economies.


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Signs that this is happening are already apparent. Confidence in the Bank of Spain has been badly dented by the revelation of large losses at Bankia just weeks after senior bank supervisors trotted around financial capitals to assure investors that Spanish banks were well capitalised. This loss of confidence is also infecting healthy banks and has prompted the bosses of several Spanish banks to call for capital injections into the country’s weaker ones.



.It also reinforces calls for strengthening bank oversight. The commission’s proposals for dealing with failing banks are a small step in this direction. Under its scheme, big cross-border banks would have to draw up resolution plans and issue debt that could bebailed in” or converted into shares to recapitalise them if they fail. It also proposes the creation of national funds worth at least 1% of bank deposits that could help to deal with failing banks. In a step towards greater integration of banking oversight, it said these funds might be used to help banks in other European countries.


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These proposals are unlikely to go down well with investors in bank bonds, who are at greater risk of loss, nor with governments with well-regulated banks, which would be in danger of paying for the losses of poorly regulated ones. Yet strengthened oversight and the ability to recapitalise banks quickly with combined euro-zone resources are essential to break the vicious spiral linking failing banks and overindebted governments.


The economy

Downdraught

America’s economy battles uncertainty, both home-made and imported
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Jun 9th 2012
WASHINGTON, DC





THE much-vaunted recovery began to show signs of slowing a few months ago. Even so, the revelation on June 1st that employment grew by just 69,000 in May, a 12-month low, suggested a more serious deceleration than anyone had imagined. The stockmarket plunged, giving up all its gains since January. Online punters slashed the odds that Barack Obama would be re-elected to a little over 50%.


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As recently as February payroll growth was running at 250,000 a month. Many of the headwinds that had held back growth for so long were abating. State and local government lay-offs have eased, and housing, though deeply depressed, has been reviving: both sales and construction of new homes are rising, as are prices, by some measures.
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The abrupt reversal of mood recalls both 2010 and 2011, when a promising burst of growth in the early months petered out in spring and summer. Last year the culprits were obvious: Libya’s turmoil had sent petrol prices sharply higher, Japan’s tsunami disrupted supply chains, and over the summer politicians flirted with defaulting on the national debt.


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The sources of this year’s weakness are harder to identify. Petrol prices are up, but by much less than last year. Other economic data have been mixed: gross domestic product grew by 1.9%, annualised, in the first quarter, and economists think it is growing a bit faster in the current quarter. Private surveys of purchasing managers showed both factory and service activity holding steady in May. And even as job growth has slowed, unemployment has trended lower. The slight increase in May, to 8.2% from 8.1% in April, was caused by more people bothering to look for work, a welcome reversal from previous months.


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The weather is partly to blame. An unusually warm winter pulled forward some hiring that normally occurs in the spring. Construction employment, for example, rose by 45,000 in the three months through January, and has since fallen by 48,000. Inventories are another factor: firms appear to have slowed the pace at which they are adding to stocks in the current quarter. As those temporary factors fade, and as consumers get the benefit of a recent drop in petrol prices, job creation may still rebound.


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Yet hopes that 2012 would be the year when America’s economy at last shook off its lethargy seem dashed. Employers and investors face increasing uncertainty in every big economy. China, India and Brazil have slowed sharply.


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The euro zone is dangerously close to collapse. Goldman Sachs reckons that the spillover of European stress into American financial markets will knock 0.2 to 0.4 percentage points off growth this year.


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Meanwhile, tax increases and spending cuts equal to 5% of GDP a year are programmed to take effect around December 31st. Most analysts assumed this “fiscal cliff would not be a worry until 2013. But economists at Bank of America, in a recent report, think it could become a significant drag relatively soon. The fiscal hit is huge, the date is set, and no resolution is in sight before the election on November 6th . This all gives firms a powerful incentive to postpone hiring and investment until the resolution is known. The bank sees a one-in-three chance of recession between now and mid-2013.
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In the past week both Bill Clinton and Larry Summers, Mr Obama’s former principal economic adviser, have urged early action to avoid the cliff. Without such action, the only source of support is the Federal Reserve. When the economy faltered in 2010 and 2011 it responded, first, with a second round of bond purchases paid for by creating money (“quantitative easing” or QE), then by buying long-term bonds in exchange for short-term ones, a move calledOperation Twist” (see chart).


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Buying bonds pushed their prices up and yields down. The Fed has also promised to keep interest rates near zero at least through 2014. And, until recently, it was not inclined to do any more than that. However, the present weakness in employment, the growing risks coming from Europe, and the fiscal cliff all suggest the Fed will give serious thought to easing monetary policy at its meeting on June 19th and 20th.


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Janet Yellen, the Fed’s vice-chairman, said on June 6th that although she still expects a gradual decline in unemployment and stable inflation, there are “significant downside risks to the economic outlook, and hence it may well be appropriate to insure against adverse shocks.”


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How the Fed might ease again remains unclear. It could promise to maintain interest rates near zero beyond 2014, its current commitment. Ms Yellen, however, suggested that that would have only a limited effect. Several officials favour more QE, the Fed’s most powerful tool, though some fret about potential side effects, such as rising commodity prices and a political backlash.


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The Fed could extend Operation Twist: the stash of one-to-three-year bonds it could trade for longer-term issues has dwindled, but it still has plenty of three-to-six-year paper. On the other hand, Macroeconomic Advisers, a consultancy, warns that selling such bonds could put upward pressure on consumer loan rates.


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Then there is the question of what more bond-buying would achieve. Long-term Treasury yields are already down to 1.7%, near the lowest ever recorded. Yet while its tool-kit may be less powerful, at least the Fed seems able and willing to use it. The same cannot be said of either the euro zone or Congress.


India’s slowdown
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Farewell to Incredible India
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Bereft of leaders, an Asian giant is destined for a period of lower growth. The human cost will be immense
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Jun 9th 2012               


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IN A world economy as troubled as today’s, news that India’s growth rate has fallen to 5.3% may not seem important. But the rate is the lowest in seven years, and the sputtering of India’s economic miracle carries social costs that could surpass the pain in the euro zone. The near double-digit pace of growth that India enjoyed in 2004-08, if sustained, promised to lift hundreds of millions of Indians out of poverty—and quickly. Jobs would be created for all the young people who will reach working age in the coming decades, one of the biggest, and potentially scariest, demographic bulges the world has seen.



.But now, after a slump in the currency, a drying up of private investment and those GDP figures, the miracle feels like a mirage. Whether India can return to a path of high growth depends on its politicians—and, in the end, its voters. The omens, frankly, are not good.

In office but not in power




Some of this crunch reflects the rest of the world’s woes. The Congress-led coalition government, with Brezhnev-grade complacency, insists things will bounce back.


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But India’s slowdown is due mainly to problems at home and has been looming for a while. The state is borrowing too much, crowding out private firms and keeping inflation high. It has not passed a big reform for years. Graft, confusion and red tape have infuriated domestic businesses and harmed investment. A high-handed view of foreign investors has made a big current-account deficit harder to finance, and the rupee has plunged.



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The remedies, agreed on not just by foreign investors and liberal newspapers but also by Manmohan Singh’s government, are blindingly obvious. A combined budget deficit of nearly a tenth of GDP must be tamed, particularly by cutting wasteful fuel subsidies. India must reform tax and foreign-investment rules. It must speed up big industrial and infrastructure projects. It must confront corruption. None of these tasks is insurmountable. Most are supposedly government policy.



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Why, then, does Mr Singh not act? Vacillation plays a role. But so do two deeper political problems. First, the state machine has still not been modernised. It is neither capable of overcoming red tape and vested interests nor keen to relax its grip over the bits of the economy it still controls. The things that do work in India—a corruption-busting supreme court, the leading IT firms, a scheme to give electronic identities to all—are often independent of, or bypass, the decrepit state.




.Second, as the bureaucracy has degenerated, politics has fragmented. The two big parties, the ruling Congress and the opposition Bharatiya Janata Party (BJP), are losing support to regional ones. For all the talk of aspirations, voters do not seem to connect reform with progress.


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India’s liberalisers over the past two decades, including Mr Singh himself, have reformed by stealth. That now looks like a liability. No popular consensus exists in favour of change or tough decisions.




.As a result, when the government tries to clear bottlenecks, feuding and overlapping bureaucracies can get in the way. When it suggests raising fuel prices, it faces protests and backs down. When it tries to pass reforms on foreign investment, its populist coalition partners threaten to pull the plug. It does not help that the ageing Mr Singh has little clout of his own: he reports to the ailing Sonia Gandhi, the dynastic chief of Congress. With a packed electoral timetable before general elections in 2014, Congress does not want to take risks.



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Is it time for a change at the top? Mr Singh has plainly run out of steam, but there are no appealing candidates to replace him. Mrs Gandhi’s son, Rahul, has been a disappointment. What about a change of government? The opposition BJP is split and has been wildly inconsistent about reform. Its best administrator, Narendra Modi, chief minister of Gujarat, is divisive and authoritarian. If it formed a government tomorrow, the BJP would also have to rely on fickle smaller parties.



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Some reformers pray for a financial crisis that will shake the politicians from their stupor, as happened in 1991, allowing Mr Singh to sneak through his changes. Though India’s banks face bad debts, its cloistered financial system, high foreign-exchange reserves and capable central bank mean it is not about to keel over. A short, sharp shock would indeed be useful, but a full-blown crisis should not be wished for, because of the harm that it would do to the poor.



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Instead the dreary conclusion is that India’s feeble politics are now ushering in several years of feebler economic growth. Indeed, the politicians’ most complacent belief is that voters will just put up with lower growth—because they supposedly care only about state handouts, the next meal, cricket and religion. But as Indians discover that slower growth means fewer jobs and more poverty, they will become angry. Perhaps that might be no bad thing, if it makes them vote for change.