Global slump fears resurface over eurozone fallout

02/05/2010 | Phil Thornton

Rich countries must take coordinated action to prevent fiscal woes in Europe and other advanced nations triggering another global economic downturn, leading economists have warned

Rich countries must take coordinated action to prevent the fiscal crisis in Greece and other advanced nations triggering a global economic downturn, leading economists have warned.

A surge in eurozone interest rates could trigger a collapse in asset prices and a slump in world trade, they warned.

Willem Buiter, chief economist of Citi, said that the global advanced country sovereign debt problem “extends way beyond Greece and affects not just Europe but all industrialised countries – the US, UK, Japan.

“While it is not as serious as Greece – because Greece is in a unique league of awfulness of its own – the fiscal situation of countries such as the UK, the US and Japan is not certainly better than Spain and Portugal.”

He said that rich countries must engage in a “large scale” fiscal tightening. “When I say ‘large scale’ I mean on a scale completely unmentioned by politicians and completely beyond the world view of the great public.

“We are going to be with a savagery that no politician has really owned up to and the public at the moment does not even what to hear about,” he said.

He called for a fund to be set up to which EU member states, and potentially other countries, would subscribe between E1.5 and E2 trillion. “You don’t have to pay it in, but you have the right to call it in as and when [a crisis] emerges,” he said.

Buiter spoke to Emerging Markets from Athens as the Greek government prepared to announce a Eu120 billion rescue package funded by the European Union and the IMF, and anti-cuts protesters clashed with riot police in Athens.

Simon Johnson, a former IMF chief economist, said the “nightmare scenario” for the eurozone would be a surge in bond yields in major economies such as Spain and Italy.

“As rates rise traditional investors in eurozone bonds will refuse to take more. There will be no buyers in the market and governments will not,” he told Emerging Markets.

He said once that crisis took hold it would be too large for the European Central Bank or the German government to solve. “The eurozone will be at risk of collapse,” he said.

He estimated a bailout of the four weakest economies – Greece, Portugal, Spain and Italy – could cost $1 trillion.

“The funds would need to come from the G20, and extremely tough decisions over fiscal and monetary policy need to be handled in a fair and reasonable manner.”

If Europe does experience a double-dip recession this would impact the world, Johnson said.

Barry Eichengreen, professor of economics at the University of California, said in Tashkent yesterday that the Greek rescue package “is not a solution – that is a holding action”.

He told Emerging Markets that the sovereign debt problems in the eurozone would impact Asia, because “Europe is as important as the US for Asian exports” – but that “the hit to exports will be nothing like 2008”, and a run on the banking system such as that experienced in the US in 2008 was not to be expected.

Buiter said emerging markets need to take policy actions to help alleviate the risk of a global downturn. “The fiscal consolidation in advanced countries should put downward pressure on their real exchange rates vis a vis emerging markets,” he said.

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