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.

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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