Global fears of a recession grow stronger

Posted in Other | 07-Oct-08 | Author: Mark Landler| Source: International Herald Tribune

Even countries that had little to do with the U.S. subprime crisis have become vulnerable to a sudden halt in the flow of money.

WASHINGTON: When the White House brought out its $700 billion rescue plan two weeks ago, its sheer size was meant to soothe the global financial system, restoring trust and confidence. Three days after the plan was approved, it looks like a pebble tossed into a churning sea.

The crisis that began as a made-in-America subprime lending problem and radiated across the world is now circling back home, where it pummeled stock and credit markets on Monday.

While the Bush administration's bailout package offers help to foreign banks, it seems to have done little to reassure investors, particularly in Europe, where banks are failing and countries are racing to stave off panicky withdrawals after first playing down the depth of the crisis.

Far from being the cure for the world's ills, economists said, the rescue plan might end up being a stopgap for the United States alone. With Europe showing few signs of developing a coordinated response to the crisis, there is very little on the horizon to calm rattled investors.

The vertiginous drop in stock markets on both sides of the Atlantic on Monday reflected not only those fears, experts said, but also a growing belief that the crisis could tip the world into a global recession.

Indeed, the ripple effects from Europe and the United States were amplified as they spread to stock markets in Russia, Brazil, Indonesia and the Middle East.

These countries had little to do with the subprime crisis but were vulnerable to a sudden halt in the flow of money. They lack even the veneer of national or regional cooperation that protects Europe and the United States. Stock markets in emerging economies recorded their worst one-day decline in 21 years on Monday, with trading in Russia and Brazil halted to stem an investor panic.

"It looks pretty ugly down the road," said Simon Johnson, an economist at the Massachusetts Institute of Technology and a former chief economist of the International Monetary Fund who specializes in financial crises. "Everybody is going to get caught up in this."

The global nature of the crisis and its growing collateral damage ought to galvanize countries to work together to fashion a concerted response, Johnson said. There is a chance to do that this week, with dozens of finance ministers and central bankers converging on Washington for the annual meetings of the IMF and the World Bank.

The trouble is, these institutions no longer have the resources or authority to lead such an effort. The IMF, which played a central role in the Asian crisis, has been relegated to the sidelines this time its credibility tarnished by that episode and its skills ill-suited to a crisis in advanced economies. These days, it mainly issues lonely warnings about the impact on developing countries.

The Group of 7, which once functioned as a sort of command center for the global economy, is similarly depleted, according to critics. It no longer represents the world's economic drivers, they said, and badly needs to be expanded to include rising powers like China and India.

"The globalization of the crisis means we need a globalization of responses," said C. Fred Bergsten, the director of the Peterson Institute for International Economics. "But most of the responses will be national. For all the institutions we have, we don't have the right institutions to do this."

That is particularly true in Europe, which has an effective central bank but lacks a unified legislature or treasury to coordinate or finance a rescue of the banking system. So far, economists say, Europe's response to the crisis in its banks has been mostly marked by denial and dissension.

From London to Berlin, governments are clinging to a piecemeal approach. The British and the Germans have resisted a broader solution, because they fear they will end up rescuing their neighbors.

A weekend meeting of European leaders in Paris, called by President Nicolas Sarkozy, ended with a pledge that Europe would not countenance a bank failure like that of Lehman Brothers, but little else.

Part of the problem, experts said, is the nature of this crisis: bailouts of banks are costly and unpopular with taxpayers ? even more so, as in Europe, where burden sharing is a perennial sore point.

"Taxpayers won't agree to bail out the banking system of other countries," said Thomas Mayer, the chief European economist at Deutsche Bank in London. "Not even in Europe, where you have a neutral framework, could you get people to cooperate on a joint effort."

As the problems in Europe have worsened, the crisis has taken on an "every country for itself" quality. When Ireland placed a guarantee on all bank deposits and debt last week, it angered neighbors, who feared capital would flee their banks to the safer haven of Dublin. Now, Germany, Sweden, Denmark and Austria have all pledged to guarantee deposits.

"If you do this one by one, it destabilizes people's deposits in other countries," Johnson said. "It's mind-boggling that the Europeans have coordinated so little up until this point."

With Europe and the United States deep in crisis, economists said, the rest of the world could not help but suffer. Robert Zoellick, the president of the World Bank, warned that the crisis could be a "tipping point" for the developing world.

"A drop in exports, as well as capital inflow, will trigger a falloff in investments," Zoellick said in a speech on Monday. "Deceleration of growth and deteriorating financial conditions, combined with monetary tightening, will trigger business failures and possibly banking emergencies."

The immediate danger, economists say, are countries in Eastern and Central Europe, like Bulgaria and Estonia, which run steep trade deficits and are vulnerable to a sudden flight of foreign capital.

Iceland, with an overheated economy and suffocating foreign debt, may prove to be the first national casualty of the crisis. On Monday, threatened by a wholesale financial collapse, the government in Reykjavik assumed sweeping powers to intervene in its banking industry.

"We were faced with the real possibility that the national economy would be sucked into the global banking swell and end in national bankruptcy," Prime Minister Geir Haarde said on Monday.

But with global growth slowing sharply, the problems could spread to larger emerging markets, even China, which has a hefty current account surplus and immense foreign reserves.

"Where is China going to sell its exports?" Johnson of MIT said. "Everyone is going into recession at the same time."

This week, the focus will be on the Group of 7 , whose finance ministers and central bankers are scheduled to meet on Friday at the Treasury Department. The group issued a perfunctory statement of support for the United States, after the Treasury secretary, Henry Paulson Jr., briefed members about the rescue plan in a conference call two weeks ago.

But European finance ministers, notably Peer Steinbr├╝ck of Germany, noted that the crisis began in the United States, and played down the need for a systemic European response.

Zoellick, in his speech, said flatly that the Group of 7 "is not working." He advocates expanding the group ? which includes the United States, Canada, Britain, Italy, France, Germany and Japan ? to include emerging economies like Brazil, China, India and Saudi Arabia.

The urgency of the moment, experts said, demands a bolder response from the Group of 7. Bergsten said the group should commit to a coordinated stimulus plan to stave off a recession.

"Just as the U.S. rescue plan may not be enough," he said, "a U.S. stimulus plan by itself will not be enough."