The US Economy And The Rest Of The World: Anything But Decoupling

To this day, I still look back and shake my head in disbelief at the prognostications of the Wall Street charlatans - the so-called “strategists” and the clueless “chief” economists - who not only missed the boat on Great Depression 2.0, but who also argued that even if the U.S. economy headed south, the rest of the world would somehow keep chugging along.

Is it any wonder that the firms that employed these highly paid idiots are up a creek without a paddle (aside from the “help” they are getting from their friends in Washington, that is)?

Anyway, as anyone with only half a brain could have easily predicted, what we are seeing across the globe right now is anything but “decoupling,” as BBC News reports in “World Economy ‘to Shrink in 2009.’”

The world economy is set to shrink by between 0.5% and 1.0% in 2009, the first global contraction in 60 years.

In its gloomiest forecast yet, the International Monetary Fund (IMF) says that developed countries will suffer a “deep recession”.

The global economic body says “the prolonged financial crisis has battered global economic activity beyond what was previously anticipated”.

Just two months ago, the IMF predicted world output would increase by 0.5%.

But in its report drawn up for the G20 group of finance ministers, the IMF now says that the whole world economy will shrink, and predicts that the advanced economies will suffer a decline in output of between 3% and 3.5% in 2009, and barely grow in 2010, with growth of between 0% and 0.5%.

The IMF says this will happen despite a big fiscal stimulus from many G20 countries designed to boost growth.

It says that the G20 as a whole is adding 1.8% of GDP ($780bn) to boost growth this year - but that the EU is lagging behind with only 1%.

And it warns that the UK is building up the biggest fiscal deficit amongst all the G20 countries, which will amount to 11% of GDP by 2010.

Financial crisis unresolved

The IMF warns that the economic conditions could still deteriorate further if the banking crisis was not tackled head on by governments around the world.

“In the event of further delays in implementing comprehensive policies to stabilise financial conditions, the recession will be deeper and more prolonged,” the report says.

The IMF says its revised projections reflect “unrelenting financial turmoil, negative incoming data, sinking confidence, and the limited effect to date of policy responses with respect to the restoration of financial system health.”

Japan is forecast to decline the most, by 5.8% this year, while the eurozone will contract by 3.2% and the US by 2.6%.

The most urgent problem in restoring the banking system to health is in the United States, where the Obama administration has yet to reveal details of its plan for private-public partnership to buy up to $1tn in toxic assets.

At the G20 finance ministers meeting at the weekend, restoring lending by tackling problems in the financial system was cited as the “key priority” - a message reinforced by G20 business leaders who met in London on Wednesday.

Warning on Eastern Europe

Meanwhile, the IMF was also warns of a serious risk that emerging economies will be unable to secure external finance, as banks and investors in rich countries withdraw their money.

“The risks are largest for emerging countries that rely on cross-border flows to finance current account deficits,” it says.

And this makes central and eastern European countries likely to be the “most adversely affected” - with the Baltic states, Hungary, Romania and Bulgaria “suffering the greatest damage”.

The IMF is already in negotiations about a rescue package for Romania.

East Asian countries, which rely heavily on manufacturing exports, have also been hard-hit by the decline of world trade, particularly in the IT sector.

In relative terms, the developing and emerging market countries as a whole, which are predicted to grow by just 1.5% to 2.5%, below the growth of population in many countries, have suffered the biggest downward revisions.

Fiscal stimulus

In addition to fixing the banking sector, many countries are now spending more public money to boost economic growth.

The IMF estimates that the G20 countries as a whole will spend an extra 1.8% of GDP ($780bn) in 2009 on fiscal stimulus, not far from its earlier recommendation that they spend at least 2% of GDP on boosting growth.

Taking into account the “automatic stabilisers”, for example the increased spending on unemployment benefits that results from a slowdown, it says that in 2009 there will be a 2.4% boost to GDP from fiscal expansion.

It says the fiscal expansion could add around 2% to world growth in 2009 and create approximately 7 million new jobs (or 19 million if China and India are included).

But the IMF warns that there is much less spending planned for 2010, with extra government spending of only $580bn (1.2% of GDP) across the G20, and a total fiscal boost of only 0.4%.

This has caused much dissent among G20 members, with the US, whose huge fiscal stimulus plan runs well into 2010, urging other G20 countries to boost their spending further.

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