The G7 issued a bland communiqué in Washington, D.C. last Friday. The finance ministers and central bank governors from the biggest rich countries downplayed financial market worries. Here’s what they might have said under a dose of truth serum.
After five years of robust economic growth, the global economy looks depressingly shaky. We are concerned that recessions in many countries will be hard to avoid if, as now seems likely, asset prices fall rather than rise.
Recent global market turbulence suggests to us that the world’s financial architecture might be structurally unsound. The economic dependence on high house prices is worrying, despite the US economy’s ability so far to withstand the downturn in the housing market reasonably well.
However, the downward correction in US housing is not over. Also, we fully agree with the International Monetary Fund’s assessment that house prices are overvalued in the UK, Spain and other countries. We are wary of a widespread downward spiral in which recession reinforces house price falls.
It would be wrong to focus uniquely on housing, however. We also see a substantial risk of falls in equity markets, which have probably benefited from the very loose monetary policies pursued since 2001.
Should house and equity prices fall, the dangers for the financial markets would be considerable. We are concerned that the financial derivatives that have flourished in recent years may cause market failure in a wide range of asset classes.
The still rapid growth of developing countries, especially China, is encouraging. But we are troubled by China’s explosive accumulation of foreign reserves and credit boom. A far more rapid appreciation of the renminbi is necessary. Without it the euro will bear the burden of reducing the US trade deficit and Europe may face recession.
Policymakers might want to cut interest rate in order to ward off recession. But we are wary of repeating the previous mistake of using easy money to pursue ultimately unsustainable growth. We are aware that our policies have helped make the financial world so dangerous. That, however, does not stop us from looking forward to new careers as financial consultants who will authoritatively criticize our successors’ efforts to deal with the mess we will leave them. Our admiration for Alan Greenspan, former Fed chairman, in this regard knows no bounds.