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Saturday, February 13, 2010

In the past 18 months governments have pumped cash into their economies to fight financial seizure and recession. This infusion prevented the financial catastrophe. Today, assets prices are rebounding and every major economy has stopped constricting.

The big emerging economies (China, Brazil, India) are growing briskly. But in the US and Europe, recovery is fragile and will depend for the foreseeable future on government stimulus (deficit spending). But the rich countries cannot spend their way out of economic stagnation. Budget deficits are rising and public debt is mounting. If the current situation in Spain, Ireland and Greece is anything to go by, the so called rich countries may soon be out of fiscal wiggle room.

China’s economy is predicted to grow at 12 percent this year. This growth reflects a revival in exports and strong consumer spending. China’s economy is now widely perceived as the preeminent engine pulling the rest of the world out of economic recession.

But internally, this rapid growth is worrying the China’s politburo. Public spending binge and state directed lending could trigger catastrophic asset bubbles and cause dangerous inflation. A month ago China raised banks’ reserve requirements and began to clamp down on lending.

China’s commercial banks have become important lenders to the rest of the world as American banks have considerably reduced lending. There are fears that raising bank reserve ratios could slow the pace of global recovery.

It is abundantly clear that the Chinese authorities are becoming more concerned about containing inflationary expectations and managing the risk of asset price bubbles as a following aggressive expansion of credit over the past 18 months.

China’s national bureau of statistics show that annual inflation in producer prices had more than doubled in January 2010 from December 2009, to 4.3 percent. Average housing prices in large and midsize cities were up 9.5 percent in January from last year, the fastest rate of increase in 19 months.

Authorities in Beijing are walking a delicate and difficult line. They consider controlling inflation as key to domestic peace because in the past the erosion of the spending power of workers has led to unrest.
The United States had strong growth in the fourth quarter, leaving many wondering when Washington will start increasing interest rates. The Fed has indicated that this is still months away. In his first State of the Union address, Barack Obama proposed tax cuts and spending worth an extra 1.8% of GDP in the next two years.

Japan has added to its deficit spending plans. Many more countries, such as Germany, will see budget deficits rise as parts of earlier stimulus packages kick in. Tighter budgets are on the way.. Bond-market troubles are forcing the Greeks to freeze public-sector wages and raise taxes. Portugal’s and Spain are constrained to accelerate budget cuts. When the Conservatives take power in June, Britain will have to pay attention to its large and growing budget

Clearly, fiscal policy responses are disparate. And they will continue to be shaped by domestic political imperatives. But can we expect that an “invisible hand” created by the conjunction of national interest is capable of steering the global economy back to a path of robust and sustained recovery?

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