Europe is in recession once again, having briefly recovered from the 2007-09 recession. Unemployment rates in Greece and Spain have reached 25%, with youth unemployment reaching 50%. The U.S. GDP is growing, but at a very low annual rate of 2% or less, with the unemployment rate still as high as 8%. China, India and Brazil are experiencing substantial reductions in their growth rates. Japan seems stuck in a long period of low growth and huge fiscal debts.
Several years of very large fiscal deficits and substantial money supply expansion have not managed to pull the world out of the great recession that began in 2007. Many nations now have fiscal debts so large that they are unsustainable. A rise in interest rates could make debt repayments impossible. Repeated financial crises in the Eurozone have been met with short-term stop-gap measures, while the EU has been reluctant to make the major institutional changes that many see as necessary for recovery. The U.S. "fiscal cliff" of the summer of 2011 is reappearing, as the U.S. once again approaches its legal "debt ceiling" and the President and Congress cannot agree on how to cut expenditures or raise taxes as part of a new fiscal "deal".
In many nations, the fall in house prices cut consumer wealth, and hence led to reductions in consumer demand. The commodity boom with its increases in output and prices seems to have burst its bubble. Developing nations, dependent on commodity exports face decreasing global demand. The world is stumbling as Europe and the U.S., with their 50% of global GDP have failed to revive, and thus have failed to stimulate global growth.
The risks of global contagion extend to all financial markets. The financial crises of banks and governments will cause stock markets to fall precipitously, and then to recover gradually when stop-gap measures temporarily restore some degree of stability. Consequent volatility in international capital flows will cause foreign exchange rates to be volatile as well. Some feel that the new global Basel 3 banking rules and new national regulations such as the Dodd-Frank Act in the US will also put a damper on the recovery.
The Euro Crises
For the euro zone, two very different paths lie ahead.
First, a continuation of financial crises will require spasmodic rescues by the economically successful EU governments, the European Central Bank and the IMF. Ireland and Greece will be followed by Cyprus, Spain, Italy, and Portugal. Banks will need injections of capital to prevent runs and collapses. Some governments will require loans, the purchase of their bonds, and organized debt defaults.
However, Germany seems wary of continuing this shift of funds to nations that it sees as having been too profligate in their expenditures. Some analysts feel that the rich nations may not have adequate funds to bail out the economically troubled nations even if they wanted to, and so some unfortunate members may have to default and perhaps leave the Euro. Banks and investors in many nations now hold the debt of banks and governments of the troubled nations. Exits from the euro may become inevitable and even foreign banks and investors, such as those in the U.S., would be hurt.
The second path lies in the transformation of the Eurozone into a single political entity, with new institutions such as:
A single Euro-wide banking system with a single regulator, with a single set of rules for banks in all euro nations, and with deposit insurance for all banks; nations would lose their rights to regulate or even supervise the financial sector.
A single decision-maker for fiscal policy; nations would lose their rights to determine their tax rates and expenditures. This would put clear limits on the ability of any nation to run fiscal deficits and build up its debt. This authority could issue Euro bonds for which all members would be liable. This sharing of debt would use the good ratings of nations like Germany to support the financial needs of the troubled economies.
A much more powerful ECB that could use the "quantitative easing" practices of the U.S. FED to greatly expand the Euro money supply. In the summer of 2012, the ECB did begin this practice.
Bailout funds to rescue banks in distress. While a fund has been established, some insist that funds go only to banks that encounter difficulties in the future; banks currently in trouble may have to rely on their nation's governments for bailouts. Thus, the current problems of banks will remain.
Perhaps, a new system for transferring funds regularly from rich nations to poor nations. However, such equalization funds seem unlikely. Hence, nations that have uncompetitive firms will experience ongoing unemployment and recession.
Many nations seem unwilling to give up their sovereignty in the ways required by this transformation. A concern of German leaders is the fear that a more powerful ECB could cause rapid inflation as a result of money supply expansion. However, others feel that rapid inflation is necessary to reduce debt as a percentage of GDP. A major degree of uncertainty continues.
The US Fiscal Cliff
In the summer of 2011, the nation faced a crisis when the fiscal debt approached the legal debt ceiling, and "Washington" had great difficulty in agreeing on a fiscal plan to raise taxes or cut expenditures. A compromise was that if no agreement could be reached by early 2013, then certain expenditures would be reduced automatically and the Bush tax cuts would be eliminated. The U.S. debt was downgraded. Without further agreement, the automatic expenditure reductions and tax increases could plunge the U.S. back into recession.
The Republican Party wanted to achieve budget balance by cutting government expenditures and reducing the size of government. The "tea party" movement was strong enough to block the attempts of Democrats to raise taxes on the rich and to raise the debt ceiling. In fact, a small group of Republican members of the House seemed prepared to block all compromises. The President seemed powerless to prevent the stalemate.
With the election of a divided Congress and Presidency, ongoing fiscal disputes and crises will be inevitable, with ongoing uncertainty for bond holders and tax-payers as the U.S. continues to run along the fiscal cliff. Inevitably, some crises will result in panics in all financial markets. Even a victory of the Democrats in the Senate and the Presidency may not be able to prevent the "tea party" Republican members from blocking a Democratic agenda, and hence sustaining the uncertainty.
