Thursday, September 24, 2009

Looming 'Age of Austerity'

Global leaders may be saddled with the weakest recovery since World War II if they are to pay off the $9 trillion tab they ran up rescuing the world economy from the deepest financial slump in seven decades.

U.S. President Barack Obama and his counterparts from the Group of 20 nations meet in Pittsburgh today warning that the recovery is still too weak to start reversing lifelines to banks and the broader economy. Their next challenge will be to reduce the resulting debt before it sparks higher bond yields and erodes their governments’ creditworthiness.

“There’s no question that the most significant vulnerability as we emerge from recession is the soaring government debt,” said Harvard University Professor Kenneth Rogoff who is a co-author of a new history on financial crises. “It’s very likely that will trigger the next crisis as governments have been stretched so wide.”

Unwinding the borrowing will probably require leaders to raise taxes and cut spending, ushering in what HSBC Holdings Plc Chief Economist Stephen King calls an “age of austerity” that saps growth prospects for years to come even amid recovery.

The Organization for Economic Cooperation and Development predicts the world economy’s potential growth rate will fall to 1.1 percent next year, compared with 2.4 percent in the decade before the crisis. The International Monetary Fund says G-20 debt will reach 82.1 percent of gross domestic product in 2010, almost 20 percentage points more than two years ago and the equivalent of about $37 trillion. (Link Bloomberg)

Carmen Reinhart, Professor of Economics at University of Maryland has provided a synopsis of the paper she did with Professor Kenneth Rogoff titled "Eight hundred years of financial folly" that is referred to in the above article. This paper which predicts the next likely financial crisis is available on VoxEU. The two professors have also written another sobering paper, "Is the 2007 US Sub-Prime Financial Crisis so Different? An International Historical Comparison."

Most of the major governments around the world have cast a vast safety net by propping their economies with millions of taxpayer dollars and in the process are running massive deficits. Now the world waits for the next financial crisis as has happened for the last eight hundred years and more.

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