Brian Fallow: Trapped in a vicious economic circle

Brian Fallow

You have to be a superannuitant to have seen harder times than these for the world economy.

Global output is set to shrink this year for the first time since World War II, the International Monetary Fund says.

Its latest World Economic Outlook paints a picture of a global economy caught in a vicious circle. Banks, facing trillions of dollars of losses - most of which they have yet to own up to or be relieved of - have tightened credit and plunged the "real economy" of jobs and businesses' order books into recession, which in turn puts more stress on the banks.

The IMF forecasts the rich countries which make up just over half the world economy will shrink by 3.8 per cent this year (in New Zealand's case by 2 per cent) and not grow at all next year.

The rich countries' club, the OECD, takes a darker view, forecasting its members will shrink 4.3 per cent this year and New Zealand by 2.8 per cent. This hits the rest of the world through a shrivelling of trade, weak commodity prices and a strong tendency for capital to head for home when times are hard.

The IMF seems particularly worried about Eastern Europe, whose banks, unlike ours, have not insured themselves against the risk that when their large foreign loans have to be repaid the exchange rate will have moved against them.

The IMF's study of previous recessions finds that the worst are those which arise from a banking crisis - when a hook-up of reckless banks and feckless borrowers ends in tears. They tend to be longer and deeper than those triggered by an oil shock or a sharemarket crash.

And this one is aggravated by the fact that it is global. No major part of the global economy has escaped it, which makes export-led recoveries, of the kind New Zealand had been hoping for a remote possibility.

Governments and central banks have responded by standing on the accelerator.

The IMF estimates that across the advanced economies the average budget deficit this year will be more than 10 per cent of GDP. If that were true in New Zealand, it would be a deficit of $18 billion.

The problem, it says, is that the longer the downturn continues to deepen, the slimmer the chances of a strong rebound, as pessimism about the outlook becomes entrenched and balance sheets are damaged further.

As the situation gets worse Governments and central banks are running out of options. Official interest rates in a growing list of countries have been cut to zero, which means their cental banks have to resort to the risky practice of printing money to provide further stimulus.

And Governments face rising concern about the longer-term implications of mounting debt.

Sounds familiar.