Viewpoint by Chris Williamson
Chief economist at global financial information firm Markit
BBC News Business
18 August 2011

Recent events, including stock market falls, the escalating sovereign debt crises, US credit rating downgrade and a near-stalling of growth in the developed world is leading increasing numbers of experts to wonder if the world is facing some fundamental changes.

In reality, many of the ideas reflect trends that have been under way for many years, but the crisis had accelerated the process of change.

Four years after the financial crisis began and the world has certainly not returned to normal.

No major developed economy has yet fully regained the output lost during the recession and global share prices remain almost a third lower than their peak prior to the crisis.

Financial stocks have lost two-thirds of their value. Government debt has spiralled due to the bank bailouts, although it has become apparent that not all governments can finance this debt.

If stage one of the crisis involved the transfer of liabilities from the financial sector to governments via bank bailouts, stage two is witnessing transfers from weaker governments to stronger governments, as the latter seek to prevent the former from defaulting and causing more financial turmoil.

Soul-searching

Government indebtedness has led to a sea-change in attitude towards risk.

Developed world government bonds are no longer the risk-free investment they once were. In fact, credit markets show that government debt is now perceived to be riskier than corporate debt in western Europe.

As banks around the world came close to collapse in 2008, some predicted huge changes
The downgrade of US debt from triple-A to AA+ by S&P also sparked a bout of soul-searching among sovereigns that remain triple-A rated by all credit rating agencies. Attention was focused on France last week.

The crisis has consequently taken on an increasingly political focus in recent months.

Political leaders are struggling to manage a situation where austerity measures designed to reduce deficits and retain credit worthiness have coincided with a near-stalling of developed world recoveries.

Economic growth slowed to 0.3% in the US and 0.2% in the UK. Germany – the eurozone’s hitherto star performer – expanded just 0.1% and France stagnated.

Sticking together

Increasing numbers of analysts are questioning the survival of the euro due to the political tensions.

Many see the euro – in its current guise at least – to be sustainable only if the euro countries are prepared to issue common eurobonds.

Such an “all for one, one for all” debt issuance is seen only as a last resort by Merkel and Sarkozy, and would require great change in terms of control over national economic policy and fiscal budgets among euro member states.

However, many analysts consider eurozone leaders to already be in the eleventh hour.

Currencies weaken

It’s not only the euro which faces problems.

The Chinese authorities are now calling for a new world reserve currency to replace the US dollar following S&P’s downgrade.

The greenback and the euro may never again be the strong currencies they were before the crisis struck (assuming the euro survives).

Likewise for sterling, where an inability of the Bank of England to meet its inflation targeting remit is testing its credibility and further encouraging investors to move out of currencies which are losing their value through inflation into safer havens – notably gold.

Power shift

China, of course, has the opposite problems to the West in many respects. It is accused of having an undervalued currency and continues to battle to cool near double-digit growth.

This means that, not only does China have a hold over the West due to its vast holdings of US debt, but ongoing recoveries in the West are also very dependent on whether the Chinese authorities can manage to engineer a soft-landing.

The financial crisis has therefore resulted in an acceleration in the existing trend of economic power and influence moving from West to East.

Trends exposed

So the big changes that are being mooted in terms of the world as we know it are in fact largely trends that were already in place – the shifting of power to the East, the accompanying perceived decline in the status of developed world currencies and government debt, and the need to reduce the developed world’s unsustainable dependency on debt and credit.

Even the viability of the euro has always been in question, with its creation having been seen by many to have been driven by political rather than economic reasoning.

The crisis has just brought all of these issues firmly into focus, but quite what will happen in the long run is of course speculation.

Low rates

The one change that seems quite certain, however, and that will direct affect most of us in the developed world in some way or another, is that interest rates look set to stay extremely low for the foreseeable future.

The US Federal Reserve has pledged to keep interest rates at close to zero for the next two years, and the Bank of England is also not expected to hike rates until 2013.

There again, perhaps even this is not guaranteed because we may yet see a fundamental change in economic policymaking.

Many see the current emphasis on inflation targeting to have failed, not least because central banks have a remit to control something which is effectively out of their control, as inflation is these days dominated by global factors. Nothing is for certain.