Euro Bailout

The recent Euro Bail Out was greeted with some relief by markets. At least European leaders could agree on something. But, bond spreads have continued to rise and the fundamental problems remain.

Some notes from the recent bailout.

• Firstly, as many widely expected a European country (Greece 50% cut in debt) has defaulted on its debts for the first time since after Second World War. This is still quite a significant milestone sovereign debt default in an advanced country is very rare. - Note for many months, the EU had hoped to muddle on and avoid Greek debt, but this just shows a misplaced optimism.
• Now sovereign debt default is a reality, investors will be repricing many other countries debt. It is likely to put increased pressure on Portugal, Italy and Spain and lead to higher bond yields.
• The bailout does nothing to tackle the collapse in money supply that is occurring in countries like Portugal. As part of the deal, the Germans insisted that the ECB stop any bond purchases. (Presumably we still have to worry about inflation despite a collapse in the money supply and nominal GDP that is occurring in the south of Europe)
• A new dynamic is that The EU are hoping that China will become a major beneficiary of the new EFSF fund. China will demand in return free access to European markets and freedom to buy advanced technologies. No mention was made of political issues like human rights abuses, but if China is to become the EU's saviour expect the EU to suddenly go quiet on issues such as Tibet.
• As part of the new deal the EU has new regulations with the powers of 'rigorous surveillance and laws enforcing balanced budgets. Just what you need when when you've got a deep recession, some EU commissionaire to impose more spending cuts and austerity on you.

What The Bailout doesn't do

• This deal doesn't solve the 30% gap in competitiveness between the North and South. The EU kind of hope that a decade of 'internal devaluation' will eventually restore competitiveness. This means a decade of mass unemployment and stagnant growth.
• It Forbids any chance of monetary stimulus to help the beleaguered south escape debt deflation and mass unemployment.
• There is no fiscal union just a 'stability union' There is no joint bond issuance only greater scrutiny of other countries debt.

Related

• European debt crisis
• Problems with Greece Economy
• UK and Euro Crisis

Video Animation on Bailout

• Europe's Punishment Union Telegraph
• Problems of G20 Growth at Guardian
• EU Bailout animation
  

Failures of the ECB

I was writing a short piece on the functions of a Central Bank. The interesting thing is the extent to which the ECB is failing to carry out certain functions. This failure of the ECB threatens to undermine the whole EU economy.

Failures of

Ignoring Economic Growth. A Central Bank definitely has to target low inflation, but not to the exclusion of other macroeconomic objectives such as economic growth and unemployment. The ECB seem to give the impression that inflation is the only thing they care about. As the global economy was slowing down, the ECB increased interest rates this year. Yet, to keep inflation on target at the cost of a recession, is a pyrrhic victory - especially when the inflation is temporary anyway.

Unwillingness to Buy Government Bonds.

Why does the UK have low interest rates on government bonds, but countries like Italy and Portugal have much higher bond rates, despite similar levels of borrowing? Markets know the ECB wouldn't buy Italian bonds in a liquidity crunch. Even one month's shortage would cause great problems and therefore markets push up interest rates on Italian bonds. Occasionally, the ECB has bought bonds, but when they buy bonds they always do it with a loud feeling of guilt and they say they will reverse it as soon as possible. The ECB successfully lose any confidence the market may have in the operation. Paul De Grauwe explains in more detail at Vox

The impact of this decision, is that it puts greater pressure on European governments to pursue deflationary fiscal policy at a time when they need the opposite.

Unwillingness to Pursue Unconventional Monetary Policy

The ECB seem stuck in past economic situations. They don't seem to realise that in the Eurozone, especially south, there is a real threat of deflation and prolonged recession. Faced with this kind of crisis, a Central Bank should be galvanised to do everything in its power to avoid recession. This may mean a temporarily higher inflation target for countries in the north of Europe, it may mean unconventional monetary policies such as quantitative easing. But, the problem is they have an almost religious devotion to low inflation and can't see wider issues.

Related

• Criticisms of ECB

Historical National Debt

see: Historical national debt

A Spike in Inflation and other Questions

Recent readers questions and posts on my other economics blog

• Bankers vs People - Another look at the role of bankers in current crisis. When the economy experiences real difficulties it can become tempting to lay blame on a particular groups of people (and bankers make an attractive target). Have your say.
  
  
• In a week when UK inflation reached 5%, a look at whether The Bank of England should worry about inflation?

• Pros and cons of inequality - the extent to which inequality is desirable in a free market economy.
  
• Is it possible to have negative interest rates? - The difficulties of monetary policy when interest rates reach 0%
  
• Is inflation caused by economic growth?
• Could you explain pegging currency to dollar? - a look at how and why China pegs its currency to the dollar.
• Chain Weighted inflation measure - If the price of a good rises, we tend to switch to cheaper goods and don't buy the more expensive ones, therefore according to this measure, conventional inflation arguably over-estimate inflation rates. (not good news for those who have benefits set by RPI and feel it underestimates changes in living costs
  

Don't forget you're always welcome to ask economics question

Understanding Financial Crisis

Readers Question. I have recently been trying to better understand the financial crisis and it has been very useful, however I am curious to your own opinions, as the articles are very neutral.

Where possible, I try to avoid preconceived ideology / expectations. Of course like everyone I have my preferences and prejudices. Not everyone would think my articles neutral.

Bankers can make millions from a recession, and as people suffer in Greece for example, they continue to do so, making profit from the taxpayer´s bailouts as austerity measures leave thousands homeless and without work. I for one am mad as hell and I want to clarify that I have my facts straight.s

Some bankers can make millions from a recession and financial crisis, though some have also lost their jobs. Many had their job saved through government intervention (which wouldn't have occurred in other industries) Even the Bank of England have issued a blunt warning about unjustified bank bonuses [BBC]

Subprime mortgages and CDOs and derivatives were made legal under Greenspan, right?

Alan Greenspan was chairman of the Federal Reserve (1987-2006). He primarily was responsible for setting interest rates, though the Federal Reserve do have a role in overseeing aspects of the financial system. (see: mistakes of Alan Greenspan)

During the 1980s and 1990s there was a general move to deregulate the financial sector in both UK and US. This was partly due to legislation by governments; sometimes it was the Federal Reserve, e.g. adopting different interpretations more favourable to banks (e.g. in 1996, Fed reinterpreted Glass-Steagall act - banks could now devote up to 25% of business to investment banking.)
Also, there is an element that financial institutions were creative in selling and expanding new financial instruments that didn't fall under any regulation. One problem is that it wasn't always clear who was responsible for financial regulation (e.g. Central Bank or government). The outcome of this financial deregulation was:

1. Easier to lend subprime mortgages (less checks on people's incomes - especially in US)
2. Easier to buy and sell complex financial derivatives.
3. Banks able to take on more risky (and profitable) lending practises.
4. Greater competition between banks in attracting custom.
5. In the UK many (non-profit) building societies became public companies listed on the stock market. This changed their business model. They were more likely to lend money with smaller reserve ratios, e.g. Northern Rock were borrowing money to lend for profitable loans. - This led to liquidity shortage at start of credit crunch.

People were falsely sold mortgages by banks who then bet against the said mortgage, so as people were evicted, bankers got fatter.

Yes, mortgages were miss sold. Mainly this problem was confined to the US. (problems US housing market) But, banks didn't benefit when people started to default. In fact banks lost a significant amount of money because people defaulted and house prices started to fall; therefore banks could only recover a fraction of initial loan. Many mortgage companies went bankrupt.
Also, as a result of US mortgage defaults, many banks (e.g. European banks) who had bought these CDO's and sub-prime mortgage derivatives lost money too. It was because these mortgage bundles were sold on, that problems in US subprime market became widespread leading to global credit crunch. See: Credit Crunch Explained

The first UK bailout, as you say in one blog, was to revive the banks so they would begin lending again. That didn´t happen.

• True, lending remained very low. However, the main focus of the UK bank bailout was to prevent banks going bust, which would have caused a catastrophic decline in confidence and possible 'runs on the bank' (UK Bank bailout)
• Quantitative easing was a different program involving creating money and buying bonds from commercial banks. Banks only increased lending in a limited way in response to this quantitative easing. But, QE is not a 'bailout'
  
• In one sense lending didn't pick up, but the bank bailout did prevent a collapse in the financial system (bank failures were one of main reasons for the depth of the Great Depression in 1930s).

The Eurozone bailouts are now paying disappointed investors, through public money, rather than going to the people, who are without blame. This is lunacy, and yet nobody seems to be screaming it from the rooftops. Why??

The Eurozone bailouts are different. Here we are bailing out government debt, and each case is a little different.

Greece had a fundamental deficit before the crisis and has mismanaged its finances very badly.
Ireland had very low government borrowing until 2007. But then the Irish banks lost a fortune. The Irish government had to bail out the Irish banks (arguably, they shouldn't have given so much public money, e.g. Bank shareholders should have accepted much greater losses). But, after bailing out the Irish banks, Irish government debt rose rapidly and the Irish government needed its own bailout. So in Ireland's case it is definitely a case of taxpayers 'paying' for the mistakes of their big banks.

It seems the only people writing about this obscenity without censorship are the protestors of the 15-M movement in Spain and the Occupy movement which, quite rightly, has support globally.

No, there are economists who have criticised many responses to the current crisis. e.g. Nobel economist Joseph Stiglitz suggested 'let the banks fail'

My personal belief is that governments are slaves to the financial industry and big multinationals as much as the rest of us; if not they couldn´t possibly vote yes to these bailouts while (in Greece´s case) demanding that the people pay for banker´s greed and corrupt practices through austerity measures which seem designed to kill society.

I generally disagree with Europe's insistence on so much spending cuts and austerity. In the case of Greece, Spain and Portugal and UK, they are proving counter-productive pushing the economy back into recession.

To be honest, membership of the Euro has made it much more difficult to deal with this crisis because countries have much less flexibility (e.g. can't devalue, can't pursue independent monetary policy, face great pressure to cut costs) It was hoped the Euro would give many economic benefits, but it hasn't.

Since the credit crunch exploded in 2007/08 - there have been no really easy answers.

Initially I thought governments generally did the right thing:

1. Prevented banking collapse (even if bankers didn't deserve to be bailed out, it was still in interest of society to prevent banking collapse)
2. Tried to get out of recession - expansionary fiscal and monetary policy.

More recently I have been disappointed in the response of governments.

1. Banks haven't been effectively regulated to prevent future crisis (though there is time)
2. Governments have made a mistake in rushing to austerity before strong economic recovery. This has risked a double dip recession.
3. In US particular, there is a reluctance to contemplate taxes on the rich and wealthy. There is great political pressure to keep taxes low on the rich. Also there has been an attempt to ignore the fact it was the free market, the financial sector which failed spectacularly.

Related

• Whose to blame for the Credit Crunch?
• How will financial crisis end?
• Solutions to financial crisis
  

Inflation v Unemployment

Is inflation a lesser evil than unemployment?

Central Banks and governments often face a choice between reducing inflation or reducing unemployment. Which imposes the greatest cost on society - inflation or unemployment?

Firstly, it depends on the magnitude of inflation. If we are talking about hyperinflation (over 10,000% a year) then inflation can definitely devastate an economy leading to a breakdown in normal economic transactions. But, generally when we talk about high inflation in the UK / Europe, we mean an inflation rate of 5-20%. Off the top of my head, I believe the highest rate of inflation in UK since 1945 is around 27% in the 1970s.

It is also possible inflation is too low. Inflation or 0 or 1% would be most likely to cause economic stagnation. Some argue in climate where there is chance of deflation, we should target a higher rate of inflation (e.g. 3 or 4%)

Inflation imposes several costs on Society

• Inflationary growth is unsustainable. High inflation is often a sign the economy is overheating (demand growing faster than supply). This kind of boom is often followed by a bust (recession) This occurred in UK in Lawson boom of 1980s - inflation rose to 10% due to high growth and when the government tried to reign in inflation, it lead to the 1991 recession and higher unemployment. Therefore, an inflationary boom can lead to a recession. Targeting a low rate of inflation helps to keep economic growth sustainable. Therefore, low inflation can help avoid recession and prevent a sudden rise in unemployment.
• Inflation discourages investment. High and volatile rates of inflation can discourage firms from taking long-term investment decisions. This is because of the uncertainty and confusion around future revenues and profits. Therefore, it is argued countries with higher inflation rates tend to have lower growth rates over time. In the post war period, it was often argued Japan and Germany had better growth rates because of their low inflation.
• Decline in international competitiveness. High inflation is likely to make your goods and services less competitive leading to a fall in exports and current account deficit. Often this high inflation will be offset by a fall in the exchange rate to restore competitiveness. But, in the case of countries in the Euro, they can't devalue, so inflation and higher wage costs have been very damaging to their economy.
• Inflation can reduce real incomes. If inflation is above income growth, we can experience a fall in real incomes. This is an issue in 2011. High cost-push inflation of 5% is above wage growth leading to falling real wages.
• Inflation can erode savings. If inflation is higher than interest rates, then inflation can wipe away people's savings. Inflation reduces the value of money, so people who rely on income from savings see a reduction in their living standards. This is often a problem for pensioners who rely on savings. Therefore inflation can cause a redistribution of income in society from old to young and from savers to borrowers.
• Legacy of Inflation. If people suffer from inflation, (e.g. lose savings, become worse off) then it will impact their future decisions. For example, people may be reluctant to buy government bonds because they fear the government will effectively default through inflation. People will be more reluctant to save, leaving less room for investment.

See also: other costs of inflation

Economic Costs of Unemployment

Inflation definitely has economic costs, however arguably the costs of unemployment are far greater. Some of the costs of unemployment:

• Much lower income. The unemployed have to rely on unemployment benefits and they will see a drastic fall in income. Unemployment is one of the biggest causes of home repossessions (when you fail to keep up with mortgage payments) Losing your home is one of most traumatic events.
• Psychological costs. Unemployment is one of the biggest causes of stress. Without work, people feel a lack of purpose and low self-esteem. This can precipitate health and psychological problems.
• Social Problems. Unemployment can create a feeling of alienation from society. When you have a high unemployment rate amongst a particular group (region, ethnicity, age). feelings of social exclusion can be exacerbated. High unemployment rates are certainly one factor behind riots in cities in Spain, France and UK. It is not to excuse rioting, but if you have high unemployment and poor economic prospects it can only increase the risk of crime and vandalism.
• Higher Government Borrowing. A rise in unemployment leads to lower tax revenue (less income tax) and higher government spending on benefits. This may require lower spending elsewhere in economy.
• Negative Spiral. Higher unemployment will lead to lower spending in the economy leading to lower growth. The threat and fear of unemployment may be sufficient to reduce spending.

Which Has been the Biggest Cost To Society?

It is usually assumed inflation makes savers worse off. But, in the post war period, this hasn't occurred, interest rates have been higher than inflation meaning most savers don't lost out. They still get an interest rate higher than inflation. Even now with base rates at 0.5% and CPI close to 5%, their are still saving accounts with a respectable interest rate. Also the inflation is caused by temporary cost push factors and is likely to decline soon.

The economic and social costs of unemployment are far greater. However, it is not incompatible to have both low inflation and low unemployment. But, sometimes Central Banks (especially ECB) have made the mistake of focusing on reducing inflation at the expense of lower growth and higher unemployment.

Trade off Between Unemployment and Inflation

Related

• Is unemployment a price worth paying for lower inflation?
• Trade off between unemployment and inflation
• Economic growth v inflation
• Policies to reduce inflation and unemployment

Should We Blame The Bankers?

Last week I was in Manhatten, New York. I did think about going to visit the protesters on Wall Street, but preferred to sip cappuccinos in other suburbs of New York. I may not be an actual protester, but I can still be a 'coffee shop philosopher'. Are the protests against 'Wall Streets' greed, recklessness and selfishness justified? and can anything constructive come out of these popular demonstrations?

Essentially, we are experiencing a crisis due to failures amongst the financial elite. This crisis was caused by a combination of factor but foremost amongst this were mistakes, at least partly, driven by greed and arrogance.

If we look at the causes of the credit crunch. Top of the list would include:

• Encouraging selling of mortgages people couldn't afford
• Selling on risky assets to try and make them look safe.
• Failure to take appropriate steps to ensure stable banking.
• A pursuit of short term banking profit over long term sustainability.
• Failure of credit rating agencies to adequately reflect risk.
• Who is to blame for credit crisis?
  

For those uncomfortable with the idea the free market can fail, it is popular in America to blame the whole crisis on government mortgage agencies, even though they accounted for only very small % of bad sub-prime loans. But, the credit crisis of 2008 was essentially a failure of the free market and financial sector. To claim otherwise is to clutch at straws or engage in intellectual dishonesty. It was a failure of the financial system with both individual and corporate mistakes. There were too many willing to take risks and pursue profit at the expense of long-term prudence.

When the financial system ground to a halt. It was government intervention and the general taxpayers who stood in to solve the liquidity crisis. Governments did the right thing. If the taxpayer hadn't come to the rescue, we could have been facing a real depression.

But, there is a feeling financial institutions want the best of both worlds. When things go well, they advocate the free market, lower tax and the absence of government regulation. But, when things go badly, they anticipate state socialism to save them from their own mistakes. If an ordinary firm, had lost the billions financial firms did, there would have been no 'propping up of inefficient firms'. It is rather ironic that in the land of Capitalism, there was need for such state intervention in the most capitalistic of markets.

If your industry gets bailed out by the taxpayer, you can't complain if the taxpayer then starts asking questions such as why are you still getting so many bonuses? or Why do those living on investments, pay such a low rate of tax?

A few years after the credit crunch, little seems to have changed. The taxpayers got a raw deal for giving so much money. In America, there was not even the compensation of share ownership for all the money pumped into the financial system. There has been no fundamental change in regulation of the financial sector. Even very modest tax increases get scorned.

The past two decades have seen a rapid rise in inequality. The proceeds of economic growth have increasingly benefited the higher earners. Those at the lower end of the spectrum, have faced rising unemployment, stagnant incomes and increased pressure on living standards.

It is the case, that many of the wealthiest pay lower tax rates (e.g. capital gains 15%) than those on average incomes (35%). There is a feeling that the system is staked towards benefiting the richest, and they are right - it is. If there is any suggestion for increasing taxes on the rich, there is a media empire ready to shout how damaging to job creation it will be. But, the tax cuts for the high earners we have seen in the 80s, 90s and 2000s have not created the jobs or prosperity advocates would claim. Instead, the tax cuts saw the US with an increasing budget deficit in the boom years, leaving them less room for manoeuvre in the good years.

Alternatives

You can be very critical of capitalism and how it operates without being anti-capitalist. In the post war decade, the US and western Europe experienced rising economic prosperity and near full employment. The fruits of economic growth were shared across the income spectrum; it wasn't the preserve of the financial elite. The banking system worked relatively well. There was a focus on sustainable lending and encouraging saving to finance lending. This was a period of financial regulation and high tax rates. (The very tax rates critics argue would be devastating, were actually were complementary to a period of economic stability, growth and prosperity.)

Marx was wrong because he felt Capitalists would squeeze the workers until they wanted a revolution. Actually what happened is that capitalist paid higher wages to workers and workers were happy to be able to buy cars and goods. Who wants a revolution when you have a job and reasonable income?

Also as workers prospered, capitalists could sell even more goods and make more profit. Canny capitalists realised the better the average worker was, the better for them. Successful capitalism requires the spoils to be shared with a degree of fairness and equality. Reducing inequality in society, removing the scope for unnecessary financial risk taking, will not lead to stagnant growth - It would be good news for everyone, even those at the top.

Banks need to be regulated to prevent situations which encourage unnecessary risk taking.

Bash a Banker

It can soon become very crude to blame all societies ills on bankers. I could easily have been a banker myself; it doesn't make you a good or bad person. It is just at the present time, society enabled a system where the financial system was encouraged to take reckless risks which were guaranteed by the taxpayer. When it is good, the rewards were taken by the wealthy. When things were bad, it was shared amongst everyone. In the UK David Cameron famously said 'We're all in this together' - What he meant is we are all sharing the austerity together. But, in the good times, we were definitely not sharing all the proceeds of financial derivatives.

Conclusion

I'm happy to read about the protests. The financial system still needs reform to make it work for everyone, not just those at the top. There has been too much shift in wealth and influence to a privileged minority. At the present time, there is a great need to tackle unemployment; and in the longer term make the financial system work for society rather than society bailing out the bankers.

Related

• How Much Should we pay bankers?

Keep Calm and Print Money

It is not often Central Bankers get carried away with emotive language, but the governor of the Bank of England recently wrote:

"This is the most serious financial crisis we've seen at least since the 1930s, if not ever,"

As if aware of his stark comparison with the great depression, he adds basically - 'keep calm and print money'

"We're having to deal with very unusual circumstances, and to act calmly and do the right thing. The right thing at present is to create some more money to inject into the economy.

What is Happening?

The Bank are worried about a global slump in demand and so are electronically creating an extra £75bn to buy bonds and securities. The aim of this quantitative easing is to

1. reduce bond yields - encouraging spending and investment
2. Increase money supply to boost economic activity.

See: Quantitative easing

Why the Need for More Quantitative Easing?

• Fears over state of eurozone have led to a rise in global saving rates as people hold back from consumption.
• Bank liquidity remains stretched as fears of sovereign debt default in the Eurozone threaten balance sheets of many European and global banks.
• Squeeze on household's income (e.g. VAT rise of 15%) has led to fall in spending in UK, growth has been much lower than expected and has barely been positive.

CPI inflation in the UK has spiked recently and is most likely to rise to over 5%, but the bank feel in medium term inflation will undershoot the inflation target of 2%.

Is this extra Quantitative Easing good for the government?

It is helpful for the government because it will produce extra demand to offset their fiscal squeeze. Without quantitative easing, the government would be faced with lower growth and higher unemployment. They should be grateful, they don't have the ECB to push through a monetary tightening and refusal to have any quantitative easing.
If quantitative easing does boost growth it will help the government in their deficit reduction strategy.

Is This an indication the government have Failed?

Two years ago, the chancellor George Osborne wrote (when Labour were in power") "Quantitative easing was the last refuge of desperate governments" -This move is an indication that the economy is in dire straits - and this is partly due to the government's decision to be so pro-active in cutting spending and going for austerity rather than growth. But, if quantitative easing is able to deliver economic recovery. The government may get the best of both worlds - higher growth and deficit reduction.

However, there is no guarantee in this economic climate that quantitative easing will be able to wave its magic wand; it is largely untried unorthodox monetary policy.


Is this Bad news for savers?

Yes, at least in the short term. Quantitative easing will push down bond yields leading to lower interest rates and lower incomes for those who rely on savings. Combined with high inflation, this represents a squeeze on income for savers.

However, in the long run, it is in the best interests of savers to have economic recovery which will enable a return to normal growth rates and normal interest rates. Now is not the time to fight 'temporary inflation and risk pushing UK into a deflationary trap like the Great Depression.

Don't Banks just use proceeds of Quantitative easing to speculate on gold and other safe investments and not lend to business?

To some extent, the impact of quantitative easing is limited. There has only been a small boost to economic activity from previous rounds of quantitative easing. However, the Bank estimate this small increase in economic activity was enough to prevent a prolonged recession.

Quantitative easing is imperfect, but there aren't many other alternatives.

see: who benefits from quantitative easing?

Related

• Quantitative Easing explained

Global Economic Problems - 2011

There are various global economic problems which are creating an unfortunate combination of rising government debt, low growth and rising unemployment. Markets are concerned that there is no effective strategy to prevent a second economic slump. Given the weakness and frailties of the banking sector, further debt default and a prolonged slump would increase risk of future bank failures and an ever-widening net of financial turmoil. Whilst headlines focus on the issue of bank failure and debt default, the economic problems will exacerbate the decline in personal living standards and the rise in unemployment we have recently witnessed.

See updated post - problems facing the global economy

Some of main Global Economic problems.

Debt Default in Euro

The threat of debt default in the Eurozone could cause a second 'credit crunch'. Like the 2008 Credit crunch, the present problems show how the financial system is deeply interrelated. If the Greece government defaults, other European banks will lose money, causing a knock-on problem. On it's own Greece is a relatively small % of bank debt. But, the fear is that if Greece defaults, it will increase the risk of other Euro-zone countries defaulting. If Ireland, Italy or Spain defaulted, it would cause much more substantial losses throughout the European and global banking system. Therefore, there would be knock-on effects to other banks. Losses would lead to lower lending and more fear of further knock on problems.

When commercial banks were failing in 2008, they could be bailed out by the government. But, it is not clear who, if anyone is willing and able to bailout governments. The EU is struggling to provide an effective long term solution and is dealing with problem on a piece meal basis. (global debt crisis)
Double Dip Recession.

Negative global economic growth will lead to higher unemployment. Negative growth also puts much more pressure on government finances. It leads to lower tax revenues and increases the debt to GDP ratio, making debt default more likely. The two problems are intertwined. Efforts to avoid debt default are causing lower growth; this lower growth is causing greater stress on government finances. A double dip recession would put more banks under pressure, further squeezing bank lending. It also seems all major economies are at risk from economic contraction, a decline in global trade will make it more difficult to recover.

Eurozone is fundamentally flawed.

Italy has a primary budget surplus. In many ways government borrowing is lower than in the US, where the deficit is much higher. Yet, bond yields on Italian debt are soaring, whereas US bond yields remain very low. This reflects investors fundamental nervousness about Eurozone debt. Without an independent Central Bank, Italy will struggle to deal with liquidity shortages and therefore investors are reluctant to buy bonds.

A bigger flaw in the Eurozone is the lack of flexibility to deal with an economic recession in the periphery. Countries like Greece, Ireland and Spain are being forced to pursue deflationary fiscal policy with nothing else to promote the growth and 'ease the pain' There is an inbuilt deflationary bias in the Eurozone which is damaging to the wider economy.

Low Consumption

Given all the focus on debt, it may come as a surprise that part of the global economies problem is a lack of consumption. Gross saving rates are forecast to rise from 24% of GDP to 26% in 2012. This is the highest level of global saving since the 1930s. This represents a substantial fall in global demand which will lead to lower growth and probably recession.

For example, China has a very low level of consumption at a mere 34% of GDP. The problem of a lack of consumption is that growth will be sluggish making it difficult for economies to post strong economic growth which will aid deficit reduction strategies. (protectionism beckons - Telegraph)

Global Imbalances

Since the credit crunch there has been an improvement in the global imbalances, e.g. US trade deficit has fallen. Nevertheless, there is still a global imbalances between East and West. China has accumulated reserves of $3.2 trillion - a reflection of their large current account surplus and undervaluation of their currency. (Chinese currency manipulation)

Demographics

Amidst all the problems, the long term outlook is not helped by an ageing population which puts more pressure on government entitlement spending. Despite pressures on government finances, it is often politically difficult to deal with these long term pressures, such as increasing the retirement age.

Other Problems

Other problems, which deserve an essay on their own right - environmental problems, economics of global warming, pressure on commodities / non-renewable resources.

Related

• Global economic austerity
• Gloomy outlook for global economy
• Updated post - problems facing the global economy