November 17, 2010

The World Economy Flounders

By Steve McCann

A worldwide economic crisis is brewing as disturbing news multiplies in Europe, Asia, and, of course, Obama's America, which has defaulted on its traditional leadership role.

A headline in the Financial Times on the 11^th of November signaled an ominous note for the rest of the world and the United States. It read, "China Inflation Surges to 25-month High." Consumer price inflation increased at an annualized rate of 12.1% in October, up from 5.2% the month before.

The Chinese blame the weak U.S. dollar, speculation in the commodities market brought about by U.S. monetary policy, and increased demand for these same items. While those are all factors, a good part of this inflationary cycle is the result of a relaxed monetary policy pursued by the Chinese authorities in order to keep economic growth at double-digit levels.

They have succeeded in that regard, as industrial production increased 13.1% in October compared to a year ago. However, the Chinese will now have to seriously consider a significant drop in new loans for economic expansion, severely curtail their previously huge stimulus measures, and introduce price controls if the inflation rate remains the same.

Among the byproducts of the recently announced quantitative easing by the Federal Reserve is not only the devaluation of the dollar, but also the potential massive inflow of dollars into developing economies such as China, Malaysia, and Brazil which would exacerbate the inflationary spiral. As a result, these countries have begun taking steps to reduce capital inflows into their countries.

Another Financial Times headline from 16 November: "Shanghai Shares Fall Further on Rate Fears." The prospect of a tighter monetary policy has begun to shadow the mainland Chinese, as they will be forced to cool their economy. The resultant impact that may have on global demand is being reflected in the market.

Interest rates will rise soon, as it is now being reported that China will introduce measures to control rising food prices (a potential catastrophe in a country of 1.4 billion people). South Korea has announced that they too will be raising interest rates in order to combat inflation. Many other countries will soon have to revert to this same option. This rise in rates will necessitate stringent measures to control capital inflows with the world awash in U.S. dollars.

The question then becomes what will happen to global demand and trade while the world has barely recovered from the financial crisis of 2008-2009.

From Europe, another headline: "EU in 'Survival Crisis' says Van Rompuy." Mr. Van Rompuy is the president of the European Union. He said,

"We are in a survival crisis. We all have to work together to survive in the eurozone, [countries that use the euro as currency] because if we don't survive with the eurozone, we will not survive as the European Union."

What prompted his remarks was the ongoing crisis in Ireland, Portugal, and Greece, as these countries see their bond rates continue to soar due to their huge budget deficits and lack of a coherent fiscal policy to reduce their debts.

Ireland is being pressured to accept a bailout in order to stabilize the bond markets, and Portugal is indicating that it will require a bailout in order to meet its needs. Greece continues to lag behind in its austerity budget and is again facing higher interest expenses. The potential rippling costs of these bailouts may well exceed the 440-billion-euro rescue fund set up over the past year to handle these crises. If so, then the rest of Europe and particularly Germany will be faced with the reality that the European Union concept is dead, and this financial crisis will trigger another massive global recession.

Why is the world facing this confluence of probable economic disasters?

Beyond the unique factors indigenous to individual countries, there has been for the past 65 years only one country that by its leadership, its overwhelming economic size, and the use of the dollar as the reserve currency could exert influence over the global economy to maintain a semblance of balance through measured monetary and fiscal policy. That was the United States.

Yet today, America acts as if it were simply another profligate nation bent on its own path of irresponsibility, led by the most incompetent administration and governing class in its history.

Without the leadership of the United States, the world will enter a period of instability, wandering about for a rudder. The days ahead will be dark indeed if America does not quickly change its course 180 degrees.