Saturday, September 30, 2006

IMF's fears must be heeded

You can't expect the International Monetary Fund to come out and say the world is headed for a global financial crash. And it isn't saying that.

But what it is saying, in its own careful way, is that the risk of such a calamity is increasing.

This may sound quite strange, given the fact that its latest World Economic Outlook is forecasting for 2007 the fourth consecutive year of strong global growth.

But it is why Raghuram Rajan, the IMF's chief economist, told a press briefing in advance of the IMF and World Bank annual meetings that got underway in Singapore this weekend that he was feeling "a little schizophrenic."

As he put it, we are in a world with strong growth projections, but also one in which the downside risks are growing. And those risks have increased since the previous IMF economic outlook in April.

The most difficult risk is that of a "disorderly adjustment" of what finance officials call the global imbalances. This is a way of saying the global economy is skewed and it cannot keep on this way.

On one side is the huge and growing build-up of U.S. borrowings from the rest of the world to finance its unsustainable trade and budget deficits, and on the other, countries such as China and Japan ringing up huge trade surpluses with the United States and lending their surplus funds back to the U.S. to finance its deficits.

This cannot go on forever because the cost of servicing that debt would become too high, and well before that, the foreign investors in U.S. securities would become extremely nervous about continuing to add to their already high holdings of U.S. dollar assets.

The big question is whether these global imbalances can be corrected in an orderly way or whether there will be a disorderly adjustment instead. (If there is a disorderly adjustment, the IMF warns, there could be "a substantial further appreciation of the Canadian dollar.")

Kenneth Rogoff, the former chief economist of the IMF, warns that the U.S. "is now soaking up roughly two-thirds of all global net saving, a situation without historical precedent." This year, the U.S. is expected to borrow $800 billion (U.S.), or about $2.2 billion a day.

As he argues, though, "this borrowing binge might end smoothly," but world financial leaders are right to be worried about "a more precipitous realignment that would likely set off a massive dollar depreciation and possibly much worse. Indeed, if policymakers continue to sit on their hands, it is not hard to imagine a sharp global slowdown, or even a devastating financial crisis."

The General Accounting Office of the US government generally agrees with the above conclusion. Just read their recent report titled: The Nation’s Long-Term Fiscal Outlook, September 2006 Update, The Bottom Line: Today’s Fiscal Policy Remains Unsustainable


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