Federal Reserve chairman Ben Bernanke and IMF managing director Christine Lagarde have publicly chastised political leaders on both sides of the Atlantic for their failure to develop policies that stimulate economic growth. But given the political divisions in Europe and the US, their blunt talk is not likely to lead to policies that restart the rich world’s stalled economic recovery. Prolonged stagnation in the Euro-Atlantic area will only accelerate the shift in global economic power to the emerging world.
Bernanke pulled no punches in rebuking Congress at the annual gathering of central bankers in Jackson Hole, Wyoming. With the Fed divided over further quantitative easing to strengthen the sagging American economy, the chairman called on lawmakers to end their dysfunctional discord and endorse a short-term fiscal stimulus to ease long-term unemployment. Lagarde likewise sharply criticized plodding European policymakers, warning them to recapitalize banks to avoid what could be a coming liquidity crisis.
Largely because expectations of a new monetary stimulus from the Fed were low, the reaction in the US to the Bernanke speech was muted. European officials, however, including European Central Bank president Jean-Claude Trichet, hastened to defend their actions, retorting that the stress tests conducted last month found only nine banks that failed to meet tier-one capital ratios. Depending on how banks currently value risk assets, their defense may be persuasive. Nonetheless, the amount of capital held in reserve to cover future loan losses, which is what worries the IMF, may be insufficient. Valuing the thinly traded bonds of Greece and the other peripheral countries, not to mention their contagious effect on the debt of core countries, is no easy task. French banks, which hold more Greek, Spanish, and Italian debt than any other eurozone country, are especially vulnerable.
Lagarde’s call for radical action was refreshingly candid. The bloom quickly left the rose of the second Greek bailout in July. The community’s seventeen member countries have yet to approve the 109 billion euro bailout or increase the lending capacity of the European Financial Stability Fund, which would reduce market pressure on Italian and Spanish debt. German chancellor Angela Merkel has rebuffed the mooted creation of eurobonds, as have other surplus countries loath to support a perceived expedient that will increase their interest rates and introduce additional moral hazard by abetting the fiscally prodigal policies of deficit countries. Besides, the introduction of a eurobond would require a time-consuming change in European treaties and national constitutions, to say nothing of the political rancor it is sure to provoke.
The petty Finnish demand for a cash collateral agreement with Athens as a guarantee against Greek default further reinforces the parochialism and political divisiveness that is eroding European economic cohesion. Angered by the Finns’ deal, other surplus states – Austria, the Netherlands, Slovakia, and Slovenia as well as Germany – also demanded the right to take their share of Greece’s hide. Even though the Finnish agreement is “off the table,” according to German finance minister Wolfgang Schauble, the growing polarization in Europe is beginning to mirror the ideological stalemate in the US.
Like Lagarde, Bernanke is hoping that his frank appeal will inhibit Republicans and Democrats from holding the American economy hostage to their partisan differences. So are corporate leaders in the US, some of whom have begun to champion more vocally the need for a balance between a short-term fiscal stimulus–extension of the payroll-tax cut, forgiveness of mortgage debt, tax incentives for businesses that hire new workers, increased spending on infrastructure, education, and technology–and long term deficit reduction. Discouragingly, during the recent Republican debate in Ames, Iowa , none of the candidates was willing to endorse even modest fiscal enhancements. Monetary measures, if not another QE3–extending the maturities of the Fed’s securities portfolio , say, in an effort to reduce long-term interest rates –is still possible, but Bernanke faces political opposition from other Fed governors as well as from Tea Party supporters. Texas governor Rick Perry, whose virulent anti-government rhetoric has propelled him to the top of Republican polls, has labelled (libelled ?) such action on Bernanke’s part as “traitorous.”
While the developed West struggles to stave off a relapse into recession, the economies of the emerging world continue to grow. According to recent data supplied to The Economist, the combined output of developing world economies amounted to 38 percent of global GDP in 2010. In purchasing power parity terms, combined growth is projected to reach 54 percent of the total this year. Emerging economies already account for over half of all inflows of foreign direct investment and more than half of all capital spending, or double their level in 2000. Moreover, some large emerging powers–Brazil, China, and India–either willingly or, in India’s case, under duress, are introducing policies to address inflation, corruption, and other impediments to growth.
Of course, this trend could be reversed. The self-destructive policy stalemate in Europe and the US could intensify, depriving emerging economies of markets and investment capital and setting the stage for renewed global recession, or worse, from which no one will prosper.
Hugh De Santis is a strategic analyst and international consultant. He is a former career officer in the Department of State and chair of the department of national security strategy at the National War College.