Storm clouds on the global economic horizon

By John Rapley

The Summer Olympics provided Britain welcome respite from the doom and gloom of the bad economy. But, like many a blow-out party, it came to a shuddering end. When the country's overpaid footballers walked onto the pitch just vacated by the world's volunteer athletes, reminding everyone just how bad English football can be, the glow of the Olympic torch faded fast. And we were all left pondering how much more satisfying a story the pursuit of glory makes, than the pursuit of money.

It was a fitting lesson, given that our eyes have turned back to our money woes. In this respect, we're all feeling the pain. The world, not just Jamaica, is heading for more rough seas. At the moment, the world economy has found its way to calm waters. But before long, there is a good chance a global storm will resume blowing.

The recent decisions by the European and American central banks to provide aggressive support to their respective economies have lessened the sense of panic that had been building in recent months. The European Central Bank (ECB) has said it would backstop the bonds of European governments, ensuring none of them risk insolvency.

This move restored investors' confidence in European government debt, causing interest rates to fall. Lower interest rates have given governments a bit of breathing room to implement needed structural changes.

Meanwhile, stateside, the US Federal Reserve announced yet another round of quantitative easing. By buying government bonds, the American central bank will also keep interest rates low. The hope is that cheap credit will prod consumers to spend and businesses to invest, strengthening growth.

That gives us all a bit of a breather. But we shouldn't relax for too long. The new year will bring the US to its "fiscal cliff." Because the White House and Congress couldn't agree on whether spending or tax cuts should drive US deficit reduction, they agreed a budget deal last year which kicked the can down the road. In return for a budget that kept the US government in business (literally) until after the election, a set of automatic reductions in spending will kick in next year. Between now and then, unless a new agreement is reached, the US will experience cuts in spending so dire, a return to recession is likely.

Nothing will happen until after the election. That leaves just two months for a deal to be reached. And if Republicans take the Senate but the Democrats retain the White House, the conditions for a new stand-off will be in place. And even if a deal is reached, the likelihood of budget cuts remains high. In 2013, American demand won't be strong.

As for the Europeans, let's face it, they're masters at kicking cans down roads. I wouldn't place too much money on the odds of governments putting their fiscal houses in order over the next few months. The ECB said they'll force them to get serious, imposing conditions on its purchase of government bonds. But governments are already hinting they'd rather not adhere to those conditions, preferring to take the lower interest rates and go quietly about their business.

Too high for comfort

If, and when, bond markets judge European governments aren't serious about reform, interest rates will surge. Then we'll be back in a crisis mode. There's no guarantee this will happen. But the probability remains too high for comfort.

Meanwhile, we shouldn't count on China, the only economy large enough to sustain world demand, rescuing the world economy. Its own economy is slowing. The Chinese leadership is showing signs of growing anxiety about its attempts to engineer a transition from a capital-driven phase of growth, to a consumption-driven one.

We're all in a bit of an Indian summer right now, enjoying an unexpected burst of pleasant weather. But lest anyone think that central bankers have banished winter, it's good to remember that only politicians can deal with the underlying structural problems. And for the moment, the jury on their actions remains out. Even if a storm is averted, a dreary wet season seems certain.

John Rapley is a research associate at the International Growth Centre, London School of Economics and Political Science. Email feedback to columns@gleanerjm.com and rapley.john@gmail.com.