The recent stock market rallies around the world hold peril because they are encouraging governments, especially in Europe, China and India, into thinking that the worst is over and reforms are less urgent.
The toxic assets of major global banks are far from being on the path to purification, mostly because of policy confusion. This is despite the nearly 3 trillion earmarked by the US, Europe and China for domestic spending over three years to bail out banks, remove their bad debts and provide economic stimulus to create jobs by renovating basic infrastructure.
Inflationary pressures will increase quickly when these emergency funds start entering the real economy in coming months. This is bad news for Europe, China and India, where transaction costs are already two to ten times higher than in the US.
The irony is that the global economy got into the current mess because of very cheap money especially in the US that allowed homebuyers to obtain credit without enough risk analysis. Now, almost all the remedies hastily put in place to fight the recession involve providing still more cheap money by pouring more trillions as fast as possible.
The difference this time is that the recipients of the new trillions are institutions like banks and other companies, which are too large to be allowed to fail rather than poor homebuyers. These recipients are technically insolvent and in such dire trouble that they may require further money infusions after a few months, causing another flood of very cheap liquidity to enter the global economy.
The choices are very tough. Giant financial institutions need fresh capital to save them from utter collapse. But the infusion of capital means placing more cost free cash in the hands of some of the world’s most inefficient managers, who created the insolvency by performing poorly, irresponsibly and dishonestly.
Global inflation accompanied by very volatile stock and foreign exchange markets is certain to follow, placing the livelihoods of poor people at greater risk around the world.
Poor developing countries will continue to be battered by global inflation combined with severe shortage of investment funds. A few reasonably good international bank results and an uptick in stock markets have already caused a slowdown in actual delivery of government pledges made at the April G-20 meeting. It pledged over $1 trillion in fresh money for bailout and economic stimulus including about $500 billion for the International Monetary Fund to help developing countries fight balance of payments problems.
But several Western governments seem to think that making good on those pledges may be unnecessary because of a slight global upturn by the yearend. Whatever happens in the second semester, it appears quite certain that the IMF will not receive sufficient funds until the year-end and significant disbursements from it are almost 12 months away.
In addition, both the World Bank and its affiliate for Latin America want to spend about $140 billion in the near term to help developing countries build infrastructure. But they are also having etrouble finding the money to lend.
It is worth stepping back a little from the current glimmers of hope and optimism to listen to financial giants like Warren Buffet and Georges Soros who remain pessimistic about further downturn.