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Global Crisis Blog

Act Two: Which Country Will Be Smart Enough to Find a Happy End?

By Shlomo Maital

Oct. 31/2009

 

     As the world breathes a sigh of relief — the global crisis has not become a decade-long Depression, and GDP growth is restored in the U.S. —   there is room for gloom, or at least great caution.  We are not out of the woods yet.  Bad things still lie ahead. (What other message would you expect from an economist?).

     The reason is simple.  Both America and China, and to some degree other nations,  spent their way out of recession, through massive fiscal stimulus packages and huge deficits, plus enormous credit expansions.  America’s package exceeded $1.2 trillion.  China’s was over $586 b.  But as the Wall Street Journal’s widely-read column “Heard on the Street” notes,  “It is going to be a challenge for Beijing to rely on stimulus spending to keep growth going.”  And,  WSJ might have added, for America, Israel, and every country.

       America and China restored growth, or maintained it, respectively, by deficit spending.  For America, this has created a huge debt overhang, because the money was largely borrowed.  The deficits must be restrained, at some point.  Otherwise, the debt burden will soar impossibly and inflation may result.  But, what will replace government demand?  Exports?  We are seeing a wave of protectionism.  Investment?  No sign of that, only higher profitability will drive investment, and margins are down.  Consumer spending?  No way– with unemployment still high, and no signs that employment will revive any time soon,  why would consumers spend, rather than save? 

     There is no replacement for government demand. But governments cannot continue to give the economy artificial respiration, or CPR,  forever. 

     The near-term prognosis is for very very weak growth, in America and Europe,  and in China, a difficult transition from export-led growth to consumer-led domestic demand growth.

     Which country will be smart enough to write Act Two for its fiscal stimulus plans, and end the Act with a happy ending?  America? China?

      We are not yet out of the woods.

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Blog entries written by Prof. Shlomo Maital

Shlomo Maital
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