Clearing up the mess in the global economy was never going to be simple. In the six months since the October meetings of the International Monetary Fund and World Bank there has been the sharpest and most widespread decline in activity since the 1930s. Last autumn, the Fund was expecting global growth of 3% this year; now it is predicting a contraction of 1.3%.
The downgrades for individual countries have been equally savage. Japan's projected growth of 0.5% has been turned into a 6.2% plunge in output; the modest 0.1% drop in Britain is now projected to be a 4.1% crash – worse than any year since 1945.
Yet chastened as they undoubtedly are, there is no real sense that policymakers have yet fully got to grips with the crisis. There is far too much focus on whether there are short-term signs of recovery rather than on whether the long-term causes of the downturn have been resolved.
Let's just recap on how we arrived at this juncture. Globalisation has led to the development of two groups of countries – those running big trade surpluses and those running big trade deficits. Germany and Japan provided the machines and high-grade capital goods that allowed China to become the source of low-cost manufactured goods. Countries where the industrial sectors had been hollowed out over the decades – such as the United States and Britain – were ready buyers for cheap imports. Inflation fell, allowing interest rates to fall.
But manufacturing was not the only sector to be globalised. Banks became bigger and bigger, expanding their business across frontiers to the extent that national regulators found it harder to supervise them properly. With low inflation making traditionally safe investments less attractive, there was a global search for yield. As we now know, this led to speculative money flooding into places such as Iceland and into complex derivative products that nobody really understood. The banks became so big and had so many different functions that it was beyond the capacity of any chief executive – no matter how brilliant – to manage them properly.
It would be wrong to think that there were no warnings of trouble to come. Indeed, the Fund brought together the US, the European Union, China and Japan in the hope that a system of multilateral surveillance would come up with a solution to the global imbalances. It didn't. The debtor countries wanted the problem to be solved by the surplus countries expanding domestic demand. The surplus countries told the debtor countries to rein in their booming housing markets.
Ironically, the crisis is proving to be even tougher for the advanced surplus countries – Germany and Japan – than it is for spendthrift Britain and America. Production was cranked up in expectation that the US would continue to be the global consumer of last resort, but the collapse in consumer and business demand has exposed the over-reliance of surplus countries on exports.
There is now a clear choice. Countries such as the US and Britain need to have a period in which the structure of their growth changes: they need to be less dependent on consumption and put a greater emphasis on investment and exports. But this will lead to the global economy running at a lower level of aggregate demand unless the surplus countries expand spending in their domestic markets.
So that's one problem. The other is what to do about the financial sector, where far too many institutions fall into the category of "too big to fail". Just over a year ago, there was a meeting of the G7 at which there was a discussion about how the leading western nations would cope if a major US investment bank went belly up. After humming and hawing for a while, the gathering decided that it was too difficult a question to answer and went to have dinner instead. As things turned out, it was the most expensive sushi in history.
The danger is that evidence of even a tentative recovery in the global economy over the coming months will convince policymakers that these two issues can be either ignored or tackled in their time-honoured leisurely manner. The bottoming out of the US housing market, a pick-up in German industrial production and a recovery in Japanese exports will be hailed as proof that better days are ahead.
But this is sloppy thinking for two reasons. The first is that it assumes there are no more crises lurking out there. But it doesn't take a genius to work out that the losses made by the banks have not gone away; the debts have simply been shifted from the private sector to the public sector. A potential meltdown in the global financial system last October was averted, but only at the risk of creating a sovereign debt crisis.
It would only take two or three of the emerging economies of eastern Europe or Latin America to default on their debts to see doubts surface about the viability of the bigger developed economies, including Britain. The idea that the next big shock will come in the emerging markets is plausible, because these countries have been heavily dependent on foreign capital, and those flows have reversed as banks have repatriated what's left of their capital.
The desire for good news is understandable. After the traumatic events since the collapse of Lehman Brothers in September, there is a desperate search for green shoots. They will appear. For the past six months, demand in the global economy has been met by running down excess stocks, but that cannot go on forever. What's more, the stimulus provided from monetary policy, fiscal policy and the so-called unconventional measures such as quantitative easing is colossal. It will have an effect.
But without addressing the real issues – a more balanced global economy and banks that are cut down to a size where they can be managed and regulated effectively – this will not be the end of the crisis. Merely half time.
Copyright Speakers Corner 2017