Increasing Risks

From Bloomberg:

IMF Says Risks to Economy Have Risen ‘Significantly’ (Update2)

June 9 (Bloomberg) -- Risks to the global economic outlook have “risen significantly” and policy makers have limited room to provide support to growth, International Monetary Fund Deputy Managing Director Naoyuki Shinohara said.

Most advanced economies are experiencing a “subdued” recovery, Shinohara said in a speech in Singapore today. “A key concern is that the room for continued policy support has become much more limited and has, in some cases, been exhausted.”

Stocks have tumbled in the past two months on concern that the global recovery will be derailed by the European debt crisis. Policy makers are diverging on prescriptions for sustaining the global recovery, with U.S. Treasury Secretary Timothy F. Geithner calling on Japan and European countries with trade surpluses to boost domestic demand, while Europe’s representatives have said reining in budget deficits was the top priority.

As advanced economies suffer stunted recoveries, Asia will continue to lead the world economic rebound, according to Shinohara, the former top currency official at Japan’s Ministry of Finance. That brings its own challenges, with increasing capital inflows and the risk of overheating if policy makers fail to take “appropriate” action, he said.

Asia’s rebound is outpacing the rest of the world as companies from Nissan Motor Co. to Taiwan Semiconductor Manufacturing Co. increase exports and domestic spending strengthens. While the outlook for exports has become “challenging,” the region may avoid a major slowdown in growth should Western economies slump, according to HSBC Holdings Plc.

Stimulus Room

“The growth risk for Asia has certainly increased with fiscal consolidation on the agenda in Europe and the labor market not recovering as quickly as expected in the U.S.,” said Frederic Neumann, co-head of Asian economic research at HSBC in Hong Kong. “However, Asia has plenty of room to add extra stimulus, most notably in China.”

Some of the region’s central banks have started to withdraw monetary stimulus to stem inflation and asset bubbles while others are reluctant to increase borrowing costs on concern the European debt crisis may thwart the global economic recovery.

Macroeconomic policies have “appropriately” begun to normalize and the “strong” fiscal position in most Asian economies provides them with the “space” to respond flexibly, Shinohara said.


I have argued the bear case for some time, and now the increased sovereign debt is weighing on the markets and acting as a drag on growth.

As I pointed out in an earlier post, once sovereign debt reaches 80% of GDP, growth can not continue as interest costs outstrip the increased output of an advanced economy.

This is the deflationary scenario. Even tax and spend champion Mr. Obama yesterday asked government departments to trim 5% off their budgets.

When the public realizes austerity is inevitable, as the bond market forces sovereigns to behave more responsibly, I expect the velocity of money to fall substantially, reinforcing the deflationary spiral.