There's a recession lurking round the corner

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The Independent Online
It is IMF time again. This week sees the annual meetings of the International Monetary Fund and World Bank in Washington, the most important date in the calendar of world finance. As always, the meetings are less important for themselves and more important as a focus for finance ministers and bankers reflecting on the world economy.

Sometimes a single issue dominates these meetings - the rescue of Mexico, for example. Sometimes, though, meetings themselves precipitate a dramatic event. Bankers might decide en masse that interest rates are going to go up or down, whereupon rates promptly follow suit.

Ostensibly, this is a quiet year, with few candidates for bankruptcy, no imminent threat of global recession, and the tiger of inflation apparently tamed. So what is hot?

The economic background to the meeting is set by the excellent World Economic Outlook, published by the IMF last week. Its "big picture" is encapsulated in the four graphs shown here. The first two show a quarter- century of economic progress: decent growth in the world economy since 1970, but marred by three recessions; and the more jagged but equally positive trend in world trade. World economic growth has averaged a touch under 4 per cent, world trade a little under 6 per cent.

But the graph also shows projections: nice solid growth of the world economy and of trade till the end of the century. Strangely, the graphs on the left show no dip forecast for the late 1990s - after three recessions in the previous 25 years. The presumption, then, is that something has changed.

The possible reason for that altered trade cycle, or, at least, why the next downswing of global growth might be more muted, is the fall of inflation. That element of instability is absent. Whatever happens in the next four years, it seems no-one is realistically expecting a surge in inflation like that which occurred in the 1970s and 1980s, or even in the early 1990s.

The good inflation outlook explains why the next cycle might be less malign than previous ones. But the fourth graph shows a contradiction. It gives real interest rates. During the 1970s, real interest rates were negative on two occasions. Since then savers have demanded high real rates of return.

It is worth remembering that the interest rates peak of the early 1980s was enough to plunge the world close to recession. So, what if real interest rates suddenly shot back up? The threat, then, would be no longer inflation but deflation.

The view of the IMF staff who prepared these forecasts is that this will not happen: they do not forecast a recession. But forecasters are notoriously dreadful at predicting recessions. In the report, the IMF's difficulties with such forecasting comes to light. It failed, for instance, to predict the early 1990s recession in any of the major world economies. Britain experienced growth of minus 2 per cent when the IMF had predicted growth of plus 2 per cent. Recession is not an immediate issue, indeed rather the reverse, for people are talking about the dangers of a synchronised burst of growth next year as the US economy carries on and the Continental and Japanese econ-omies start to recover. Even so, the realisation that some day there will be another recession lurks in their perception of danger. For those with long memories the very buoyancy of Wall Street has, itself, been a danger signal.

The trigger for a period of very much slower growth would be a sharp rise in real interest rates. This could happen in two ways. There could be a sharp rise in nominal interest rates with inflation rising only modestly; or there could be a fall in inflation, not just to zero, but perhaps beyond, while nominal interest rates fail to fall by as much. There could be a combination of the two scenarios. Either would reflect a global shortage of savings.

Much of the concern about the possibility of recession turns on the potential of people around the world saving enough to go on financing rapid world growth. East Asia as a region is no longer a net-saver; the Japanese are saving less than before; Europe saves, but not necessarily enough to finance North America; and most of Europe at the moment is now inward-looking, with the entire financial de-bate dominated by arguments about Maastricht.

So, the importance of this week's gathering really centres on the mood of the bankers and finance ministers. Will they be carried away by the apparent success of the world economy, which seems to have stumbled on the Holy Grail of steady, non-inflationary growth? Or will they reckon that it is all too good to be true, and react like frightened rabbits when interest rates start to climb?

There is a further twist here. Economists the world over still tend to think in terms of the performance of the big developed economies, the Group of Seven. They neglect the fact that, within 10 years, the "developing countries" will almost certainly have larger economies than the "developed" ones. These countries - in particular China and India, but interestingly also those of Eastern Europe - are at present helping pull along the rest of the world. Will they go on doing this? Or will they face disruption for reasons not yet apparent? And could they suck in so many savings and natural resources to maintain their rate of growth that interest rates and commodity prices rise and choke off growth elsewhere?

There are no pat answers to these questions. What one can sensibly say is that we are drawing towards the end of a period where economic forces were completely dominated by the West, and starting to catch a glimpse of a new economic order, of a changing balance of economic power.

Do not expect the next recession to be predicted and neatly laid out for everyone to read in their newspapers. It will, instead, come from an unexpected quarter, at an unexpected time. But come it will.