What caused the Greek crisis?
Greece built up a huge external debt by running large budget deficits for many years. The deficits were incurred to pay for loss-making government enterprises and excessive social programmes.
By Linda Lim, For The Straits Times
They were funded by borrowing from foreign banks and other investors who mistakenly thought that Greece's membership of the prosperous euro zone made it a low risk for default on its government bonds.
Is the crisis over?
Yes, but only for now. The European Central Bank (ECB) and International Monetary Fund (IMF) have agreed to extend their loans to Greece on condition that it enact austerity measures (government spending cuts and tax increases) to slash its budget deficit, and privatise state assets (sell them off to foreign buyers) to pay off its debts. This means that Greece will not default on its government debt.
What are the remaining risks for the world economy?
The major risk is that Greece will find it politically difficult to follow through on austerity. If this leads to withdrawal of ECB and IMF funds, the result would be default or a 'restructuring' of Greece's debt that would force creditors to 'roll over' their loans (extend repayment terms) or take a 'haircut' (be repaid less than they loaned).
This could panic creditors of other debt-ridden euro members (Portugal, Spain, Italy) who might then pull out funds from these countries. European banks holding Greek and other PIGS bonds would suffer losses from defaults or haircuts. This could trigger a renewed financial crisis in Europe, capital flight from the euro, and rising world interest rates - all of which would threaten an already weak global economic recovery.
Did the United States Federal Reserve's second round of 'quantitative easing' (QE2 monetary stimulus), which just ended, achieve its objective?
Yes, in that the previously feared 'double-dip' recession, and deflation, were averted, US gross domestic product (GDP) growth continued to be positive (if low), and corporate profits and stock markets recovered, helped by near-zero interest rates.
No, because US unemployment remains high at around 9 per cent, and households and financial institutions remain mired in housing debt ('underwater' mortgages). So, American firms and households remain reluctant to spend on the consumption and investment necessary to propel further growth.
What is the significance of the fight in the US Congress over raising the US debt ceiling?
Congress has to approve the amount of money the US government can borrow (via the US Treasury bonds it issues) to cover its budget deficit. The current debt ceiling of US$14.3 trillion (S$17.5 trillion) was reached back in May and Congress has to approve raising it by Aug 2, or the government will be unable to make some of its payments for goods, services or debt.
In the past, the debt ceiling was routinely and repeatedly raised through Republican and Democratic administrations, which have always managed to reduce deficits through a combination of tax increases and spending cuts - even achieving a budget surplus by the end of the Clinton administration.
The difference today is that Republican Tea Party activists in Congress refuse to approve raising the debt ceiling unless the deficit is reduced by spending cuts alone, without any tax increases, even though the US' current tax burden is not high by international or historical standards, and non-defence discretionary spending accounts for only 16 per cent of total government expenditure
It is likely that some compromise will be reached and the debt ceiling will be raised, with its conditions including the scaling back of increasingly unaffordable entitlement programmes (like Social Security and Medicare).
Why has inflation been rising in Asia and other emerging market economies?
In many of these economies, fiscal and monetary policy have remained too loose for too long, given over two years now of global economic recovery and strong emerging market growth.
China's massive monetary stimulus and negative real interest rates have fuelled an infrastructure boom and incipient domestic property bubble, at the same time as a tightening labour market has led to double-digit wage increases, and the undervalued currency continues to stoke inflationary pressures. (When a currency is pegged at below its market rate, import prices are higher, and export prices lower, than they should be; both contribute to domestic inflation.)
Brazil and especially India continue to run significant budget deficits despite being at or close to full employment, meaning that governments are adding to already strong domestic and international private sector demand, causing prices of goods and services to rise.
On top of this, low investment returns in sluggish developed economies, exacerbated by QE2 and the weak US dollar, encouraged capital to flow instead to faster-growing emerging markets, fuelling asset price inflation which in turn raises domestic demand and costs. (With rising fears of emerging market inflation and asset bubbles, there has been a partial reversal of these flows recently.)
Not surprisingly, given strong global demand, commodity prices have also risen, including for food, with food supply in some markets disrupted by bad weather and diverted by biofuel subsidies into non-food uses. In manufacturing, China's restriction of rare earth exports, and the disruption of electronics and automotive supply chains resulting from the earthquake and tsunami in Japan, also caused supply shortages and some temporary price spikes.
What are governments doing about rising inflation?
Governments around the world have for the most part responded appropriately to rising inflation, mainly by tightening monetary policy (the US being an exception, due to its weak growth and continued high unemployment).
Central banks have progressively raised interest rates in an attempt to choke off excess demand, by making borrowing-to-spend more expensive for businesses, consumers and governments.
China has notably preferred increasing bank reserve requirements (which reduces the share of bank deposits that may be loaned out), but is now also raising interest rates more aggressively. It has imposed restrictions on property purchases, is planning to implement price controls, and even fined Unilever for announcing that it may raise prices.
Currencies have been allowed to appreciate, particularly in Brazil and Asia, where the Malaysian, Philippine, Thai and Indonesian currencies are among those which have strengthened the most in the past year. Stronger currencies lower import prices, which help cool off inflation especially in very open, trade-dependent economies.
China's currency has appreciated the least, and only against the weakening US dollar, which means it is still weak relative to other major and minor currencies. To limit appreciation and contain inflation at the same time, China continues to recycle the excess foreign exchange earnings from its balance of payment surplus in overseas investments, lately favouring euro over dollar assets (and incidentally helping to prop up Greece).
Unfortunately for government policy everywhere, the 'trilemma of international finance' means that higher interest rates and appreciating currencies attract more capital inflow which, by boosting the domestic money supply, aggravates inflation and fosters asset bubbles. To discourage this, some governments have imposed various forms of capital controls, such as taxes on short-term inflows, with the approval of the IMF (which previously frowned on such restrictions).
In addition to tightening monetary policy, many governments in countries experiencing inflation still need to tighten fiscal policy - but cutting spending and raising taxes is never easy, even in the best of times.
Putting all this together, what's the prognosis for the world economy?
Monetary and fiscal austerity - or withdrawal of stimulus, primarily through higher interest rates - means slower GDP growth for the world economy, but also lower inflation. Slower growth is not likely to be a temporary phenomenon, with the world's largest economies - the US, Europe and Japan - all suffering from what are likely to be longer-term problems, slightly different in each case, but aggravated by ageing demographics which are common to them all (but least severe in the US).
The world's No. 2 economy, China, has already said it wants slower growth that is more beneficial to its increasingly restless (and also rapidly ageing) citizens. This is already starting to happen, with a slow shift away from increasingly expensive exports towards increased domestic consumption as the main driver of economic growth.
The global macroeconomic rebalancing, advocated by the G-20 as necessary for financial stabilisation, is already under way, though not because of any action by the G-20 itself. Monetary and fiscal austerity will eventually narrow savings-investment and government budget gaps in developed countries. Appreciating currencies, and continued higher GDP growth than in developed countries, will help reduce current account surpluses in emerging markets as their share of global growth and GDP continues to increase.
How will this affect Singapore?
Singapore will face increasing global challenges to its decades-long economic growth strategy of exporting manufactures to developed countries, while importing the capital, labour, skills and technology, and providing the government assistance, necessary to remain internationally competitive in targeted industries.
Singapore's traditional developed country markets, though still large, will grow more slowly, and must import less and export more to rebalance their domestic economies. They may even become more competitive in manufacturing, helped by weaker currencies, technological innovation, rising energy (transport) costs, and some retreat from globally dispersed supply chains as a risk minimisation strategy.
As developed countries' populations age, and as emerging markets grow wealthier, the share of manufactures in global GDP will shrink while that of services such as education and health care, and of non-tradable housing and infrastructure, increases.
At the same time, slower growth in export markets means lower demand for foreign labour and less pressure on Singapore's extremely scarce land resources. This will add to the effect of an appreciating currency in reducing inflation.
The moderation of high housing and rental costs, together with rising wages for Singaporeans (as the unsustainable dependence on foreign labour is reduced, and productivity is increased in line with the 2010 Economic Strategies Committee recommendation), will mean improved living standards, increased consumption of domestic services (some of which are also exportable), and reduced volatility and vulnerability to external shocks from the global economy.
It also reflects both what is typical in other developed countries, and especially cities, at a similar income level, and the aspirations of much larger and lower-income China.
Singapore must, of course, continue to export to pay for necessary import consumption - but increasingly this will be the export of services and 'solutions' to other Asians, rather than of manufactures to the West.
The writer, a Singaporean, is professor of strategy at the Ross School of Business, University of Michigan.
