DAVOS – The future of the global economy will depend greatly on whether President Barack Obama launches a comprehensive and coherent set of measures, and on how successfully he carries them out. How the Chinese, Europeans, and other major players respond will be almost as important. If there is good international cooperation, the world economy may start climbing out of a deep hole by the end of 2009. If not, we will face a much longer period of economic and political disorder and decline.
There is no way to reestablish economic equilibrium in one fell swoop. Instead, the economy must first be pumped full of money to make up for the collapse of credit; then, when credit begins to flow again, the liquidity must be drained from the system almost as fast as it was injected. This second operation will be both politically and technically more difficult than the first: it is much easier to give money away than to take it back. It is all the more important that stimulus packages be channeled into relatively productive investments. The bailout of the motor industry ought to be the exception, not the rule.
The effort to pump the American economy full of money will run into difficulties on two fronts: the exchange rate and interest rates. The dollar came under pressure early in the current financial crisis, but staged a strong recovery as the crisis worsened. The dollar’s strength in the latter part of 2008 was due not to an increased desire to hold dollars but to increased difficulties in borrowing them. European and other international banks had acquired a lot of dollar-denominated assets which they habitually funded in the interbank market; as the market dried up, they were forced to buy dollars. At the same time, periphery countries held a lot of dollar-denominated obligations which they had to repay when they could not roll them over. Russia and East European countries on the periphery of the euro were tied much more to the euro; but when the Russian market collapsed, the effect on the dollar was the same, because the Russian central bank had overbought euros and had to sell them to defend the ruble.