July 31, 2010 Patrick Oliver-Kelley

The outlook for the world economy is unusually uncertain. The US Financial Reform Bill was the mouse that roared. It restrains banks’ proprietary trading but does not stop it; banks can still invest in hedge funds and in Private Equity firms; as for the new consumer protection agency, we will have to see if it actually works. Enforcement is the challenge. There will be financial blowouts, but hopefully, not soon.

European Banks’ Stress Test Report, at first blush, appears to have been a cousin to the roaring mouse, above. It seems to have been more to reassure, than to examine. Of the 91 banks tested, only seven were found wanting in capital adequacy. Markets yawned. The reports was more a damp squib, than an real effort to assess actual financial worthiness. There was nothing stressful about the stress test.

World output is growing at a 5% rate, but that rate will slow since emerging economies need to tackle rising inflation and possible asset bubbles. China is in obvious danger. India has several bubble-like events in real estate and their stock exchanges underway. US growth may slow as our government stimulus tapers off. But the specter of another recession is diminishing. American shoppers have returned to the shops. Prospects look grimmest in Europe and the worst is in governments and sovereign risk. Europe needs a painful fiscal adjustment but also needs profound structural reform. Southern Europe’s profligate governments must become prudent. Uncompetitive economies must shake up their labor and product markets. Northern European surplus current accounts economies must help by avoiding belt-tightening measures and by encouraging spending. Germany should stimulate growth and China should rebalance its economy to encourage domestic consumption. UK’s new government spelled out useful spending cuts. The US however, badly needs a plan to deal with its budget deficit. Frankly the judgment of politicians, generally unreasonably bad, poses the biggest risk to the world economy.

Stimulus is out and austerity is in, though fiscal stimulus remains the essential prop to the economy, worldwide. Fiscal austerity coupled with structural reforms would yield far higher growth, but it could be a recovery that is weaker and slower than it should be with austerity alone.

The US economy’s slow pace has become a test of American confidence and whether policymakers can implement ideas to increase job creation. Job recovery has cooled; tax hikes and regulatory changes loom; per capita incomes remain below 2008 levels; banks are not lending; households are still loaded with debt. No wonder there is uncertainty about the uncertainty.

Fed Chairman Ben Bernanke says the economy would be helped by setting policies to bring down the federal deficit. President Obama supports more aid to state governments to reduce layoffs. We must commit to bring long-term spending on health-care and Social Security into line with taxpayers’ ability to fund it. The Fed could put more money into the system. Finally we must get a long-term growth strategy that the country can embrace. What is the next big thing? Mobile Applications could boost the economy just as previous high-tech breakthroughs have. There were 7 billion software downloads in 2009, by 2012 consumers will be making 50 billion downloads; each a potential e-commerce transaction. As mobile e-commerce catches on, the global value of mobile commercial or financial transactions will exceed $600 billion. That’s economic growth. Can jobs be far behind?

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