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Economic Monthly Report

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Is the age of excess over?

Tue, May 19 2009, 09:21 GMT
by La Caixa Economic Research Dept.

La Caixa

One peculiarity of the current world economic recession is how fully it has been a sychronized process, that is, the large number of countries that have undergone a drop in economic activity practically at the same time. Such a synchronized world recession is a very unusual phenomenon and to find precedents we must go back to 1975, 1980 and 1992, which were «oil shock» years. If we apply the criteria of the number of countries in recession, the International Monetary Fund calculates that the current total is the worst in 50 years.

Few people will be surprised by the present spread of recessive trends. For some years we have seen the accumulation of major imbalances at a world level. Economies such as those of Germany, Japan, China and other Asian countries have recorded persistent surpluses due to their orientation toward exports and a relatively low level of domestic consumption, with a subsequent greater capacity for saving. At the other extreme we find economies such as those of the United States, Australia, Spain, New Zealand and the United Kingdom with balances of payments that have shown persistent trade deficits arising from high spending levels that meant low levels of saving. Furthermore, they are exporters of commodities for which until recently buoyant sales have provided high trade surpluses and abundant reserves. The growing trade inter-connection of many economies, in which distance barely matters, is a distinctive phenomenon of the wave of globalization that came strongly onto the scene as of the Eighties.

The increase in trade was made possible and has been supported by financial globalization, a result in turn of the liberalization of capital movements and the sophistication of financial systems. As in the area of trade, the world has become split into two parts – the «savers», that is, those exporting commodities along with those that are net exporters of manufactured goods and the «spenders», headed by the United States. The US has been absorbing a good part of world savings in recent years through the issue of government bonds and other assets expressed in dollars. This is a situation that broke with the traditional scheme of things under which those in deficit were the emerging countries while those enjoying a surplus were their developed counterparts. This was the case in the earlier globalization wave between the end of the 19th century and the beginning of the 20th, when the United Kingdom, then the leading world power, came to record a surplus of 9% of gross domestic product.

The geographical imbalances in current accounts and savings flows at a time of very low interest rates, the reduction of risk premiums, the rise in asset prices and the increase in high-risk investment have been troubling for some considerable time. Attempts to explain this phenomenon began an interesting debate about its nature and persistent character, its causes and its consequences. With the onset of the recession, the risks being incurred by the world economy have become clear. When, as of the second half of 2007, serious upsets occurred in the financial systems and international capital flows came to a halt, those economies with current account deficits were obliged to quickly adjust their levels of spending to national savings. At the same time, the collapse of world trade as of the end of 2008 had devastating direct consequences for net exporters who were obliged to rapidly adjust their level of economic activity. In fact, global imbalances have worsened during the current economic recession so that this seems like a good moment to reflect on why we are where we stand and what are the prospects for the future.

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Published on  Tue, May 19 2009, 09:25 GMT