Financial Imbalances In The Global Economy

By M. Isi Eromosele

The rebound in the global economy continues to be hampered by financial imbalances within the global economy. These difficulties, which include rising non-performing loans in Japan, have been present for many years. Others surfaced when global equity markets were severely affected by the still ongoing financial crisis.

As such, financial institutions in the United States and Europe have become much more cautious in extending business loans in the wake of major defaults. For many of these financial institutions, debt service problems have become more severe because of low nominal growth in global GDP as well as the prevalence of high spreads.

Financial stimulus actions taken by governments in developed nations have mitigated the fall of the global economy from worse effects of the financial crisis. The U.S. current account deficit is approaching an unprecedented level for this stage of the global business cycle. Financing the deficit has become less streamlined, given the substantial weakening of the dollar during the past year.

In this difficult environment, the global rebound is lacking in sectoral and geographical balance. Global growth is currently anemic for the second year of what should have been a full-throated synchronized soaring world economic resurgence. In many parts of the world, a recovery in fixed investment is virtually non-existent.

There is an increasing risk in the current global economic environment that macroeconomic policies may be running up against their limits of effectiveness, when they would be less stimulative, rather than being expansive.

Despite the above assessment, the fundamentals of the world economy should emerge in fairly sound condition as the global financial markets stabilize. This would support global growth at rates nearing longer-term trends akin to the early 2000s.

World growth potential has increased due to intensifying interconnected world trade and global financial integration, greater investment in human capital, wider availability of productivity enhancing technology and stronger institutional capacity all over the world.

Inflation has gradually been reduced in the high income countries, even as the economies of emerging nations are rapidly expanding. Double digit inflation has become an exception and a number of countries are experiencing deflationary conditions.

Strict and increasingly independent policies, fiscal restraint and labor-market reforms were key actions that helped to reduce inflation. On balance, this has been a beneficial development, as it has helped engender a more stable macroeconomic environment while increasing the flexibility of relative prices and real wages.

The trend towards deflation poses new challenges. Chief among these challenges is that debt dynamics can easily become destabilized in a deflationary environment. With this scenario as a backdrop, global Central Banks need to focus on avoiding the lower boundaries rather than the upper limits of the forward looking inflation targets when setting monetary policies.

Uneven Recovery In Developed Countries

The global recovery among the developed nations has been much uneven at best. In the United States, this recovery weakened in mid-2010. Quarterly real GDP in the major economies slowed considerably.

Central to this weakness is that the rebound in the growth of business investment from the slump of 2008-2009 has come more slowly than expected. The debt-financed excessive capital spending of the boom years had left many companies across the industrial world with a need to scale back on spending for capital equipment.

During this process, economies in the developed nations were essentially sustained by a sizable infusion of stimulus funds from governments. This, in turn provided certain stimuli to specific industries of demand, especially consumer spending.

However, at this time, the level of stimulus provided by microeconomic policies has passed its peak and the reliance on continued U.S. consumer spending has fizzled, further contributing to global financial imbalances. This has accelerated a tremendous growth in U.S. household debt growth and the widening of the U.S. trade deficit.

Expectations about the pace of global economic recovery in developed nations are now dependent on the extent to which the corporate sector can make necessary adjustments to fit the new world financial order.

The pace of GDP growth is expected to remain slow in the United States and Japan through the second quarter of 2012, while the Eurozone will continue to experience little change in its current sluggish growth.

Growth will accelerate going into the second half of 2012 and into 2013 as more progress is made in repairing corporate balance sheets and global monetary conditions are restored.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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