Earlier this year, the world seemed doomed to reprise the Great Depression. With economic engines in Europe and Asia finally beginning to fire, however, economists are increasingly confident that a global recovery has begun. Now, the question is: Will it last?
France, Germany and Japan all expanded in the second quarter, surprisingly so in the case of the two European economies. That cheered investors, as did tentative signs that the U.S. is poised to join the parade in the current quarter.
But if the celebration so far has been a bit muted, it's because much of the nascent growth came from two sources of limited duration: government stimulus spending that will peter out late next year, and businesses rebuilding inventories.
The reassuring hints of a global rebound also are threatened by a bigger issue. The global economy is starting to resemble a football team made up of nothing but quarterbacks: Everyone wants to throw the ball, but no one wants to catch it. In economic terms, that means just about every major economy — the U.S., China, Germany and Japan — appears intent on exporting its way to renewed prosperity.
"We can't all export our way out of this problem. Somebody's got to import, and nobody wants to play that role," says Michael Pettis, a professor at Peking University's Guanghua School of Management.
World leaders get an opportunity to take stock of the economic scene this month when President Obama hosts a Group of 20 countries summit in Pittsburgh. Finding a way to sustain the global recovery once fiscal adrenaline and inventory restocking play themselves out will be among the G-20's top priorities.
Avoiding a dreaded double-dip recession — such as that of the early 1980s — will require advanced countries to navigate a tricky transition, says Olivier Blanchard, chief economist of the International Monetary Fund. Globally, public stimulus will add 1 percentage point to world growth this year before tapering off to less than half a percentage point in 2010, according to UBS.
In the U.S., the Federal Reserve must turn off its extraordinary efforts to pump money into the financial system, and the federal government must trim its unprecedented budget deficits in time to prevent inflation from igniting. Once governments around the world withdraw their extraordinary support, they will leave a vacuum that private-sector demand must fill.
If it does, the recovery will chug along uninterrupted. But if private demand fails to surge, forward momentum will stall. "The recovery has surprised me a little bit with its strength. ... (But) I still don't see where the sustainable aspects of the recovery are coming from," says George Magnus, senior economic adviser to UBS in London.
The savior of private demand could come from three sources: consumption, investment and net exports. Consumers, however, are sidelined by the need to repay debt. Investment, too, is unlikely to contribute much to growth, because many industries already are saddled with unused capacity. (Think anyone will build a new auto plant any time soon?)
That leaves one option, the IMF's Blanchard explained in a recent analysis: "Sustained recovery is likely to require an increase in U.S. net exports and a corresponding decrease in the rest of the world, coming mainly from Asia." Economists call that kind of fundamental shift rebalancing. And they say it's long overdue.
The world economy entered the current crisis in a badly lopsided condition, with the American consumer borrowing massively to buy products from Chinese and European manufacturers who happily socked away all their extra cash while producing more than their home markets could absorb. Now, pressed by rising unemployment and the need to rebuild shrunken household wealth, the American shopper is tapped out.
The consumer's retreat is making itself felt around the world. The first six months of this year, Americans bought $18 billion fewer German-made goods than during the same period in 2008. For German factories, that meant the loss of more than 35% of their U.S. orders. It was the same story for Japan, which saw $31 billion worth of sales vanish — 42% of its total.
Major auto-producing countries weren't the only ones to feel the chill. Chinese factories shipped almost $21 billion fewer goods to the U.S. during the first half of this year than during the same period last year. And with consumers still confronting several years of paying down debt and repairing their balance sheets, many economists say the world confronts a permanent shift in economic drivers.
"The world is going to be adjusting for years to slow growth from the U.S. consumer," says economist Kenneth Rogoff of Harvard University. "The U.S. consumer has been the engine of world growth for the last quarter century; that engine has stalled."
Not everyone agrees. Christian Broda, head of international economic research for Barclays Capital, says the world may be headed for slower growth, but that doesn't mean no growth. Substantial monetary and fiscal easing that has been put in place has yet to make itself felt. As it does, growth will improve. Stories of a complete change in Americans' behavior, he says, have been overdone.
"Savings will go up, but these processes will take years. ...You won't rebuild your wealth in a year," he says.
Rather than seeking to restart the same engine in the same way, U.S. policymakers say, they want to construct a more durable economic foundation. Lawrence Summers, head of the president's National Economic Council, said last month that the U.S. economy "must be more export-oriented and less consumption-oriented" as it emerges from the crisis.
That's a sensible goal, but unfortunately, the U.S. isn't alone in embracing it. German Chancellor Angela Merkel says there is "no alternative" to continuing her country's longstanding reliance upon exports rather than boosting demand at home. Japan, too, shows no signs of making a fundamental shift. And Chinese officials, while acknowledging a desire to promote greater domestic consumption in the long run, are wary of moving too quickly for fear of killing jobs in their export factories.
"The world can't cope with the U.S. and China both acting like China," Magnus says. "What's going to give?"
That's not clear. Chinese consumption could accelerate faster than expected, though there's no sign that is imminent. Through July, Chinese savings deposits rose at an annual rate of 29%, vs. 11.3% in the same period in 2008, according to DBS Group Research in Singapore. Alternatively, China might continue binging on investment. But that's only a short-run fix, which would ultimately swell both production capacity and inventories, depressing global prices. Or the world recovery could limp along at an especially anemic pace for years.
The difficulties in achieving the sort of global rebalancing required are evident in the U.S.-China relationship. U.S. exports in June ticked up for the second-consecutive month, but by a modest 2.2% from the month before. And the value of total shipments remains deeply depressed compared with the year-ago period.
Rising exports, aided by the slumping dollar, have whittled away at the U.S. trade deficit. China's corresponding trade surplus also is shrinking, but bigger reductions depend on getting Chinese consumers to buy more.
Chinese household consumption is among the lowest in the world, amounting to roughly 35% of economic output, vs. nearly 70% in the U.S. Chinese consumers save rather than spend, in part, to guard against unexpected medical expenses in a country that lacks a health insurance system.
Until China can put in place a national health care system, household consumption is unlikely to rise. "We need to be aware of the difficulties and should not be over-idealistic," central banker Zhou Xiaochuan, head of the People's Bank of China, said in a July 3 speech.
But reorienting China's producers to serve local consumers rather than distant markets also would require far-reaching changes in several other national policies. An undervalued currency, rock-bottom interest rates set by government fiat and a lack of labor rights all effectively subsidize producers at the expense of consumers.
"There's a whole bunch of policies that constrain consumption and boost production," says Pettis, a former investment banker.
Former World Bank economist Uri Dadush, now heading the Carnegie Endowment's international economics program, says any recovery in growth must emerge in countries outside the epicenter of the financial crisis. Roughly two-thirds of the world's $50 trillion gross domestic product is produced in countries such as Brazil and South Korea, which did not have highflying banks but are suffering from the downturn in global trade, he says.
Clouding all forecasts of the emerging global recovery, however, is the likelihood that the past will not be prologue in the current episode. Banking crises occur with some regularity in modern economies, but each is unique in its ultimate costs and duration, according to a study by three economists at the Bank for International Settlements in Basel, Switzerland.
Based on a study of crises in 35 countries since 1980, the BIS team concluded that the current financial trauma will have "lasting negative impacts" on output for years. In one-quarter of the crises, the cumulative lost output exceeded 25% of gross domestic product. One-third of the countries saw their economies continue shrinking for more than three years.
The U.S. may be more fortunate. Most indicators point to growth returning this year, and output should be back to its pre-crisis peak by the second half of 2010, according to the BIS paper. But all such predictions are cloaked in unusual amounts of uncertainty. "This is not a classic business cycle," says Magnus. "Therefore, it doesn't have a classic aftermath."