Hamish McRae: We're running out of time to put things right

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The Independent Online

There is going to be a double dip. Or to put it more precisely and a little less starkly, there is an overwhelming probability that the bounce off the bottom that most economies have experienced will falter later this year and that some at least will experience a fall-back in output.

This decline may not be protected enough to qualify as a second leg to the recession but it will be scary. It will be scary for policy-makers, who find themselves pretty powerless. They can, and did, prevent a meltdown, but they cannot create growth. It will be scary for businesses who thought they had come through the worst and then find demand for their output weakening again. And it will be scary for the rest of us because we have been led to believe that things would, come a year or two, be back to normal. They won't. A double dip was always a possibility, for many recessions follow this pattern. But two things have changed in the past month or so that have sharply increased the probability. One is in Europe, the other in the US.

In Europe we have all become aware that there is no time. There was never really much time: time, that is, to correct the fiscal deficits, but governments kidded themselves that they could wait until growth was running strongly before setting about the fiscal clean-up. The conventional view now is that Greece changed that, for it faced an utter melt-down in confidence and became the first country to be rescued by the eurozone – an act that focused attention on the other weak eurozone nations.

Actually I don't think it makes sense to load all the blame on to Greece. There is a structural problem within the eurozone, for we can now see clearly that its different economies need different interest rates. Had Greece not been in the common currency it would not have been able to run up such huge debts. It cannot realistically repay those debts, so anyone who has lent money to Greece faces a big loss. But the rising indebtedness is a burden on almost the entire continent and even the strongest nation, Germany, feels it has to eliminate its deficit.

There is a very practical reason for what people might see as German masochism. It is that a tough fiscal line holds down the country's borrowing costs. Spain has to pay two percentage points of interest more than Germany for 10-year money; Belgium has to pay one per cent more; and even France (which has been somewhat tardy in cutting its deficit) has to pay 0.5 per cent a year more. To be realistic, interest costs for all governments are likely to climb in the next two or three years as monetary policy gets back to normal. So it makes huge sense not only to cut borrowings but in so doing try also to keep interest costs as low as possible. So it is not really masochism; it is mathematics.

But – and this is the downside – a faster-than-expected return towards balanced budgets is likely in the short term to depress demand. It would be nice to be able to assure people that the boost to confidence and the lower-than-otherwise interest rates will more than offset the impact of fiscal consolidation. In the longer term that is almost certainly true. But we are talking about the next year and it is not realistic to expect the private sector to switch on the demand that the public sector is withdrawing, especially if the former is clobbered with higher taxes. The US outlook has also deteriorated. The head of the Federal Reserve Board, Ben Bernanke, said on Monday that he hoped the US would avoid a double dip. "My best guess is we will have a continued recovery, but it won't feel terrific," he said.

Let's hope he is right, but the fact that he should feel obliged to say so carries the implicit warning that another dip is very possible. What seems to have happened is that the various one-off schemes designed to turn the US economy around have now expired: for example, the "cash for clunkers" car scrap scheme and the tax credit for people buying new homes or trading up. The very latest job statistics showed a surge in employment, but only because of temporary government jobs associated with the US census. Jobs in the private sector only inched up. When those figures were published last week share markets around the world plunged.

That leads to two final indicators, that while not actually signalling a double dip, at least would be consistent with one occurring. One is share markets. They do reflect, in their incoherent way, the collective view of global investment community, the world's savers. Typically they give a few months' notice of big swings in the world economy. They plunged in the autumn of 2008, suggesting that 2009 would be a dreadful year for the world economy, as indeed it was. And they recovered from March 2009 onwards, suggesting that we were beginning to bottom out, as indeed we were. The markets are now suggesting there will be some sort of pause in the recovery and we should not ignore them.

Finally if you look at major recessions over the past century, they do often have double bottoms. Mercifully, it is also the case that the UK economy invariably surpasses its previous peak within about four years. Cling to that if we start downhill again.

In South Korea, they have their own worries

Power has indeed flipped in the world economy. There are few fears of a double dip in South Korea, where I am at an economic conference in Seoul. There was a mild recession last year, but the government this year predicts five per cent growth. Main worry? Aside from the obvious political concerns about the north, the topic that keeps coming up is European government indebtedness. Might a stagnant Europe hold their exports back? We used to worry about the Asian debt crisis; now they worry about our one.


For further reading

The IMF World Economic Outlook, downloadable at: www.imf.org/external/pubs/ft/weo/2010/01/index.htm

Tomorrow: International Studies, by Adrian Hamilton