1

WORLD ECONOMIC CRISIS, DEFLATION, RECESSION AND THE COMING SHIFT IN THE BALANCE OF GLOBAL ECONOMIC POWER

OUTLINE

• Nature of crisis

• Sources of crisis

• Actual and future policy responses

• Prospects for the advanced countries

• Prospects for the developing countries

NATURE OF CRISISNATURE OF CRISIS

General Nature of the Crisis

• Financial

• EconomicEconomic

• Global

Financial crisis

• Bursting of housing bubble• Liquidity crunch – shortage of

cash• Credit crunch – lending activity

ceases• Global crash of stock markets*• Collapse of major financial

institutions

Beginnings of an Economic Crisis and Recession

• Fall in Industrial Production and GDP

• Rise in unemployment

• Collapse in consumer and business confidence

US Industrial Production, Jan 1989 – Sept 2008

-8

-6

-4

-2

0

2

4

6

8

31-1-89 31-1-92 31-1-95 31-1-98 31-1-01 31-1-04 31-1-07% c

han

ge

SOURCES OF CRISISSOURCES OF CRISIS

Perceived Sources Of Problems

• Burst housing bubble (sub-prime mortgages) which spilt over into other sectors

• Greedy bankers and speculators (short-traders)

• Misguided policy makers

The Actual Sources

• Long business cycle– Long period increases and falls increases and falls in

economic growth, employment and inflation alongside rises and falls in profits, real wages, and interest rates

– ….resulting from major changes in the technologicaltechnological base of production

• Shift in global power

LONG WAVE

trough peak trough duration hegemonic power technology1790 1814 1848 58 Britain canals1848 1872 1893 45 Britain railways, steam (steam

engine)1893 1917 1940 47 Britain steel, combustion engine,

electricity, chemicals,telephone

1940 1975 2000? 60 United States electronics, plastics,aerospace, nuclear energy

2000 2030 2050 50 United States computers, biotechnology,robotics

Source: Goldstein 1988 (modified)

LONG CYCLE DATING

What Happens in The DOWNWAVE – i.e., 1980-Present

• Rise of Neo-liberal/Neo-classical type ideology• Fall in inflation*• Fall in growth rates of advanced economies*• Fall in interest rates• Rise of financial sector and speculative activity

– repeated “asset bubbles” (1)(2)*• IllusionIllusion of prosperity

US Inflation Period Averages 1950-2007

0

2

4

6

8

10

12

1950-59 1960-69 1970-79 1980-89 1990-99 2000-2007

per

cen

tag

e

Williams Official

US Long-Cycle Average Growth Rates: Official vs Williams

-1

0

1

2

3

4

5

1950-59 1960-69 1970-79 1980-89 1990-99 2000-mid2008

per

cen

tag

e

Williams Official

2.6%

3.6%

1.1%

US TOTAL Debt as % of GDP

SourceSource: US Federal Reserve and Financiële Strategie: US Federal Reserve and Financiële Strategie

260

220

180

140

100

20031933

1926 35 45 55 65 75 85 95 03

In In % of GDP% of GDP

264%264%

330%330%

Derivatives Growth

1997 2007

Outstanding derivatives contracts

$75 trillion $600 trillion

As percentage of World GDP

250% 1100%

Source: Bank for International Settlements

Relative Decline of The US Economy Using Published Data

US share of world economy

0

10

20

30

40

50

60

1950 1960 1970 1980 1990 2000 2006

per

cen

tag

e

INTO THE NEXT LONG INTO THE NEXT LONG UPSWING?UPSWING?

What Is Needed For The Upswing To Start And Progress?

• A major crisis and a shift in global economic power• Destruction of debt (1)• Elimination of excess capacity• Restoration of productive profit rates from;

– Lower costs of capital– Relocation of production to lower cost areas– Less competitive environment

• Change in dominant economic thinking and policy making (towards Keynesianism) (2)

• More transparency in and regulation of the financial system• Recognition and elimination (or at least reduction) of fraud in

economic data computations (3)• New international financial system• New international trading system

ACTUAL AND FUTURE POLICY ACTUAL AND FUTURE POLICY RESPONSESRESPONSES

Actual responses

• Fixing the financial sector– Injections of liquidity (money) into the system

(1)– Bail-outs of banks

• Purchase of “toxic assets” (2)• Nationalisations and capital infusions• Guarantees of deposits

– Talk about tightening financial regulation

• Sharp reductions in interest rates

Proposed Responses

• More interest rate cuts

• Massive increases in budget deficits (1)(2)

• Bail-outs of certain sectors

• “Nuclear option” (3) - Economist

PROSPECTS FOR THE PROSPECTS FOR THE ADVANCED COUNTRIESADVANCED COUNTRIES

Short-term (1-2 years)

• More turmoil in the financial system – insurance companies and pension funds

• Bankruptcies in the productive and non-financial service sector (1)

• Fall in GDP to zero or below zero*• Rise in unemployment• Threat of deflation (2)*

World Growth Forecasts

Deflation Coming – Economist primary Commodity and Metals index, Jan 1989- end Oct 2008

0

50

100

150

200

250

300

350

31-1-89 31-1-92 31-1-95 31-1-98 31-1-01 31-1-04 31-1-07

Ind

ex 2

000=

100

All Metals

Longer-term (1)

Stagflation (2)Stagflation (2)

or

Depression (3)Depression (3)

PROSPECTS FOR THE PROSPECTS FOR THE DEVELOPING COUNTRIES DEVELOPING COUNTRIES

(1)(1)

Short-term

• Balance of paymentsBalance of payments and exchange exchange raterate weakness problems

• Exchange rate/inflationinflation vicious cycle

• Sharp falls in economic growtheconomic growth

• Worst affected will be those countries where Neo-liberal ideologyNeo-liberal ideology still dominates policy making (1-3)

Balance of Payments and US Dollar (and Yen) Shortage

ProblemsCurrent account problems(1)• 80 developing countries have current account deficits of

more than 5% of GDP• Turkey (-6.4%), Pakistan (-8.7%), South Africa (-7.7%),

Bulgaria (-25%) Ukraine (-10%), Hungary (-5.5%), Poland (-4.9%), Baltic states (-6% to -15%)

Swap facilities with US (2)• Brazil, South Korea, Singapore and Mexico

Yen debt problems• Affecting South-East Asian countries that borrowed in

Yen – so-called “carry trades”

…..Possible Short-term Silver Linings

• Benefit from expansionary policies in the advanced countries and richer developing countries

• Relocation of capital from the advanced countries and high cost developing countries

• Lower international borrowing costs

The Long-term – Shift in Economic Power to The Non-

OECD Countries• Non-OECD countries have more flexible production

bases• Many developing countries will benefit from increases in

primary product prices• Relocation of capital from advanced to developing

countries• Increasing South-South cooperation• The rise of Asia and the advent of an Asian currency

bloc• Hypocrisy of Neo-liberal development and stabilisation

policy prescriptions become apparent

The Long-term – The Potential Dangers

• Policy makers still steeped in Neo-liberal/Neo-classical thinking or jumping into Keynesian follies (1)

• New development policy thinking – poverty alleviation and Aid-based infrastructure development

• EPAs, Doha Multi-lateral trading round and Breton Woods II