Since the financial crisis in 2008, many advanced economies have managed to emerge from deep recessions. The modest recovery was made possible through an influx of cheap money, spurred by historically low interest rates. However, while this monetary policy may have helped improve overall growth rates over the short term, it has merely added more debt to the global economy and kicked the can further down the road, with advanced economies seemingly unwilling or unable to address the legacies of the crisis.
Not only that, but the cheap money on offer has encouraged companies and governments to borrow en masse. Taking on more debt is not inherently bad, so long as the money is spent wisely. However, much of the money in this case has found its way to emerging markets, leaving developed economies exposed to external shocks like the one brought on by plummeting share prices in the Chinese stock market this summer.
The poor economic performance shown in the US and Europe has led to investors pegging all their hopes and dreams on China’s continued success
Three trials
According to José Viñals, financial counsellor and director of the monetary and capital markets department at the IMF, there are three key challenges to overcome for global financial stability to return. “One is for advanced economies to deal with the remaining legacies of the crisis; the second, for emerging markets to address some of the vulnerabilities that they have accumulated in the last few years; and third, to make sure that market liquidity is resilient”, he claimed. “Depending on how policymakers handle these different challenges, we may end up in different places. We may end up in a good scenario, where there is a normalisation of monetary and financial conditions and the world goes to a higher growth and strong financial stability, or we may slip, because of shocks or policy missteps or policy inaction, in a downside scenario, which is characterised by market turmoil, with lower growth and problems for financial stability”, he added.
“The difference between the upside and the downside scenario is equivalent to something like three percent of global output over the next two years. This means everybody must play their part, because we are all in this together.”
Sisyphean struggle
Outlining the economic challenges is easy, but overcoming them is beginning to look increasingly difficult. Seven years since the worst financial crisis since the Great Depression, major economies haven’t been able to reduce debt in the slightest. In fact, it continues to rise year-on-year. Global debt currently sits at over £61trn, completely outpacing world GDP growth.
Such sluggish growth rates mean that many of the world’s leading economies will struggle to pay off the interest on that debt, let alone take a meaningful chunk out of it. What’s more, it appears that policymakers have failed to learn from the mistakes made seven years earlier, while the fiscal and monetary measures that have been put in place have only made the situation worse.
Meanwhile, the poor economic performance shown in the US and Europe has led to investors pegging all their hopes and dreams on China’s continued success, putting financial markets at an even greater risk of another meltdown. Investors’ eagerness to put all their eggs into one basket is understandable, as China remains one of the few markets capable of offering a reasonable return. But China is a tinderbox and, if it implodes, there will be nobody left to prop up the global economy.
Despite all this, the IMF remains optimistic about the prospect of a successful normalisation of the global financial system, even though things are getting worse, not better, and economic crisis, not recovery, looks far more likely at this point in time.