"It could be that we are seeing the beginning of the next big financial crisis actually being generated in the emerging markets," says Martin Wolf, senior economic commentator at the "Financial Times," and one of the world's most influential economics writers in the world, in an exclusive interview with "Globes" at the annual World Economic Forum Annual Meeting at Davos.
Wolf particularly seeks to send a message to those economies currently booming, including Israel's, and warns, "Emerging markets that are not wary of this process, will find themselves with very good years of growth that will end in a big bang." Should Israel be worried? No, at least not as long as Stanley Fischer remains at the head of the central bank, he says.
What are the main dangers for the global economy this year?
"Let's start with the obvious ones: public and private debt in the developed economies. The banks are very exposed to this debt, and that is particularly true of the eurozone. The second danger is inflation, stemming from the very expansive monetary policy adopted around the world, and from the rapid growth of the emerging markets, which have raised demand for commodities very strongly. This phenomenon substantially reinforces the inflationary pressures, and highlights the dilemma facing decision makers: whether to rein in policy in order to rein in inflation, or to continue with the policy of expansion in order to support growth and employment.
"A jump in oil prices to $140 a barrel, although it doesn't seem to be on the horizon, or a debt crisis, could certainly rock the global economy. Incidentally, I don't think that protectionism is a danger to the global economy; it can be kept under control.
"For the time being, the developed economies are at the height of a recovery process. Growth in them is still low and unemployment is still high, both in the US and in Europe. This situation entails fiscal and monetary expansion. The problem is that it is necessary to institute a restrictive fiscal policy in order to reduce the debt and the deficit, and so monetary policy has to be relaxed. But, as is well known, monetary policy is already completely expansive, and interest rates are almost zero. Therefore, the only measure left is quantitative easing, which is a very controversial step, because is liable to cause inflation and could hit the exchange rate. Therefore it can be said that decision makers in the West are contending with difficult dilemmas."
So, despite everything, they need to make cuts and to reduce the deficit and debt?
"Yes, but not too fast. The adjustment and reduction in public spending must happen over time, even over several years, and delicately. This is through structural reforms in the pension system or the health system, but not through quick cuts or a quick tax rise, because then the entire burden will fall on monetary policy, which, as mentioned, is already very aggressive in any case."
And how should we deal with global inflation, which is raising its head?
"There aren't many things that can be done. The jump in prices reflects two processes. The first is surplus liquidity, but that explains a small part of the phenomenon. The second process is the significant one here, and that is the very rapid growth of the emerging markets, including China and India, whose growth is commodity intensive. This is a pattern of growth that will continue over the coming years.
"Look at what happened in the last crisis. Although it was the most severe since the Second World War, commodity prices didn't fall. They moderated, but they didn't plummet or collapse. Therefore, the rise in prices of these products represents a true reflection of real demand pressures stemming from a shortage of these resources. At the same time, you have to pay attention to the fact that nominal wages are rising in a restrained way and at a reasonable rate, with long-term inflation expectations being maintained."
What about the emerging markets? There are risks there too, such as speculative capital movements liable to cause shocks.
"In my view, the massive movements of capital into the developing markets will not cause a crisis this year. There's a clear process here: No-one wants to put their money in the developed economies, because they don't trust their financial institutions, and interest rates there are very low. Everyone wants to put their money in markets with high growth rates. In their history, emerging markets have found it very hard to deal with these movements. There are ways of coping. You can impose restrictions, but that's very difficult. Therefore, those emerging markets that are not wary of this process, will find themselves in the end in a big bang."
Then, according to your theories, Governor of the Bank of Israel Stanley Fischer is very cautious and alert. He has imposed restrictions on capital movements.
"Fischer has seen this very many times. I spoke to him about this issue when I was in Israel at the "Globes" Israel Business Conference. That is why he is very concerned that it might happen in Israel too. He has to be very careful about local credit, he has to prevent a real estate bubble, and he has to prevent a sharp appreciation of the shekel. For such a small and open economy like Israel, this is a formidable challenge. The only thing I can say to you on the matter with certainty is that Stanley is aware of the problem, and dealt with it from the outside when he worked at the Fund (The International Monetary Fund, A.F.) more than anyone else in the world. So, if Stanley can't solve it, no-one else can. But the risk certainly exists."
So you assume that the lack of balance that has characterized the global economy will remain with us this year as well.
"Indeed. The imbalance within Europe and the imbalance between the developed economies and the developing economies create a real challenge for long-term economic growth."
Published by Globes [online], Israel business news - www.globes-online.com - on January 27, 2011
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