Wednesday, July 13, 2011

Now its a global trade war. Soon. Modelling.

A global trade war is likely and a recession in the industrialised world certain unless the United States takes drastic action to unwind its budget deficit - action it is most unlikely to take, the Australian conference of economists has been told.

Unveiling economic modelling prepared for the World Bank, outgoing Reserve Bank board member Warwick McKibbin and trade economist Andy Stoeckel told the Canberra conference the biggest risk to the golbal economy lay in European nations cutting debt while the United States - one of the biggest debtors - did not.

“There is no incentive for the US to wind back debt unless they run into a financial crisis,” Professor McKibbin said. “The optimal policy is to inflate like crazy because that way they can solve their debt problem by getting rid of interest servicing costs. Because all the US debt is US dollars it is the easy way out. If they can’t raise taxes and they can’t cut spending, they can inflate.”

McKibbin and Stoeckel’s modelling shows that if all indebted countries but the US wind back their debts, the freed-up capital will go into financing the US deficit pushing up the US dollar and sucking in imports.

“The massive US trade deficits would get bigger. Looking at the scale of these things you could argue the policy response in the US Congress would be to slap on trade protection, bringing on a global trade war.”

In order to stabilise its debt by 2030 the US would need to shrink its budget position 12 per cent in the next decade. “It would need to turn a budget deficit of 10 per cent of GDP into a surplus of 2 per cent. It’s a massive challenge,” Professor McKibbin said.

“On the other hand Greece is not sustainable at all... It is not only fiscally bankrupt, but 30 to 40 per cent non-competitive. Even if it paid off all its debt tomorrow it would still need to depreciate by 30 to 40 per cent in real terms. It can’t do it within the Euro. It is already gone. I think the Euro won’t exist in its current form within 12 months.”

While a recession in the industrial world and a trade war centred around the US would be unsettle the globe, it would not bring on a worldwide recession. “Developing countries and Australia will continue to do well,” Professor McKibbin said.

“Debt levels in much of the developed world are unsustainable. Credible plans to unwind them would help. Plans that aren’t credible will cause much more pain.”

Published in today's SMH and Age

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