Growth glitchesFT specialistsreport from theeurozone, China,the US and the UKPages 2, 3

Inside »

If Obama wins. . . or Romney

Some differencesseem moresymbolic than realPage 4

Cash conundrumThe IMF and WorldBank have plentyof money but facenew challengesPage 5

Risks ahead ifQE continuesEffect on realeconomy will showhow well it worksPage 6

Pulling out stopsPageantry replacespain for Japan as ithosts IMF-WorldBank meetingsPage 7

FT SPECIAL REPORT

World EconomyFriday October 12 2012 www.ft.com/reports | twitter.com/ftreports

Athreat of double-dip reces-sion is stalking the worldeconomy. Advanced econo-mies are struggling to raiseinsipid growth rates, while

the fast-growing emerging economiescannot maintain their previousmomentum. If anything goes wrong –and there are known potential shocksin the coming months – the risk isrising of a dangerous economic slide.

The Brookings Institution-FinancialTimes Tracking Indices for the GlobalEconomic Recovery shows a steepdrop in 2012 so far, leading professorEswar Prasad of Brookings to describethe global economy as “on the ropes”.

In the International MonetaryFund’s twice-yearly World EconomicOutlook, published this week, OlivierBlanchard, the fund’s chief economist,said the world economy was ham-strung by uncertainty, which was pre-

venting companies from investing andhouseholds from spending.

“Worries about the ability of Euro-pean policymakers to control the eurocrisis and worries about the failure todate of US policymakers to agree on afiscal plan surely play an importantrole, but one that is hard to naildown,” he said.

The renewed concern about thehealth of the global economy marks adepressing return to fear after an ini-tially strong global recovery. Worldoutput jumped 5.1 per cent in 2010, afigure which dipped only to 3.8 percent in 2011 even with the eurozonecrisis pulling the rug from under pre-vious optimism last year.

The hope was that 2012 would wit-ness a return to more rapid expan-sion, but the latest IMF forecasts nowexpect only 3.3 per cent global outputgrowth, split between 5.3 per cent

expansion in the emerging world and1.3 per cent growth in the developedworld. So the slow descent backtowards recession – defined as globalgrowth below 2 per cent – is a bigworry for the whole world, ratherthan one part of it.

That raises a big question for cen-tral bankers and finance ministersarriving in Tokyo this week for theIMF and World Bank’s annual meet-ings: are the world’s problems in 2012a temporary glitch in a long march

forward, or are fears justified that thelast few months of this year are but aphoney war before the crisis againrears its ugly head?

The answer depends primarily onevents in the US and the eurozone.

The US, still the world’s largesteconomy, is pivotal for the global out-look. With the presidential and con-gressional elections imminent, itseconomy is still growing at a moder-ate pace close to 2 per cent a year.This recovery, however, is not suffi-cient to reduce unemploymentquickly. One good month’s data inSeptember brought the rate below 8per cent, down from a 2009 peak of 10per cent, but the decline in jobless-ness is slow for a US recovery and isundermined by evidence of a signifi-cant body of discouraged workers whoare not officially unemployed.

In response to what Ben Bernanke,

Federal Reserve chairman, called a“far from satisfactory” recovery, thecentral bank launched an ambitiousand open-ended third round of quanti-tative easing in September, underwhich the Fed committed to create atleast $40bn a month. It said themoney would be used to purchasemortgage-backed securities and wouldcontinue for as long as “outlook forthe labour market does not improvesubstantially”.

Even with the Fed’s brute force, thefear in international circles is that itsaction will be undone by politiciansunable to stop the US economy fallingover the edge of what is known as the“fiscal cliff”. Unless existing legisla-tion is repealed, the US authoritieswill impose tax increases and spend-ing cuts of 4 per cent of nationalincome in January 2013.

Continued on Page 2

Hopes turnto fear anduncertainty

Answers to the big issues facing the globaleconomy depend mainly on events in the USand eurozone, writes Chris Giles Meeting of minds: logo for the IMF­World bank events beginning in Tokyo today Bloomberg

The slow descent backtowards recession is aworry for the whole world,rather than one part of it

2 ★ FINANCIAL TIMES FRIDAY OCTOBER 12 2012

matically in response to pol-icy tightening to restrainexcess and the global slow-down. Latin America’s larg-est economy is expected toexpand by only 1.5 per centthis year, while India’sgrowth rate is likely to bearound half of the 10.1 percent it achieved in 2010.Even oil exporting coun-tries, such as Russia, havefelt the effects of the uncer-tainties.

With new weakness, mon-etary policy around theworld is attempting to stim-ulate demand growth eventhough it is near its limit ofeffectiveness.

For most countries, thefiscal room to limit deficitreduction programmes issmall and precludes muchaction. So all eyes are onthe US and eurozone to takethe steps necessary toremove uncertainty andbuild a little confidence.

If successful, Mr Blan-chard says he would be“happy if [the IMF’s] base-line forecasts turn out to beinaccurate – in this case,too pessimistic,” but no oneis counting their chickens.

deepen one more, ChristineLagarde, managing directorof the IMF, has again calledfor “urgent action” to see“co-ordinated implementa-tion – multiple players play-ing one game”.

If the two largest eco-nomic areas are facing bigrisks in the months ahead,emerging economies arestruggling to maintain themomentum with whichthey started the year. Nolonger does anyone believethey have decoupled fromadvanced economies.

In October, the WorldBank cuts its forecast forChinese growth to 7.7 percent from 8.2 per cent inMay, the lowest rate ofexpansion since 1999.

With a once-in-a-decadechange of Chinese leader-ship imminent, the low cur-rent rate of growth, worsethan that achieved in thedepths of the financial cri-sis in 2009, is further unset-tling the world’s secondlargest economy.

China’s weakness is mir-rored in other large emerg-ing economies. Brazil’seconomy has slowed dra-

where the economic num-bers are again slippingbehind the latest eurozone/IMF programme and dis-bursements of loans havebeen held up – cannot beignored for much longer.The IMF is playing tough,unwilling to lend into a pro-gramme it sees as off-trackand where the Greek gov-ernment has not lived up topromises of structuralreforms.

European governmentsare more understanding,but a resolution of theimpasse is needed soon toprevent the nation runningout of money.

It is also looking evermore likely that Spain, too,will need to apply for a for-mal EU/IMF programme totrigger the ECB purchasesof bonds, but MarianoRajoy, Spain’s prime minis-ter, is still holding out. Andall the while, the eurozoneeconomy deteriorates. TheIMF predicts it will contractby 0.4 per cent before doinglittle better than stagnatein 2013.

With so many reasons tofear the eurozone crisis will

stabilised and confidencecan return.

Member states need toagree the definition of bank-ing union, which is aimedat breaking the vicious cir-cle that exists betweenweak sovereign states inthe eurozone and theirweak banks. Parts of thecore of Europe want a mini-mal agreement on a com-mon European bankingsupervisor of only the larg-est banks, with sovereignstates remaining responsi-ble for bailouts of failingbanks.

The periphery naturallywants to socialise the riskssurrounding its banks andintroduce common depositinsurance. In early October,the two sides were as farapart as ever.

The issue of Greece –

over the summer. Com-ments by Mario Draghi, pre-sident of the European Cen-tral Bank, that he would dowhatever it took to ensurethe euro remained a stablecurrency were wellreceived, as was the policyannounced a few weekslater of “outright monetarytransactions” by the ECB.

These will give it poten-tially unlimited monetaryfirepower to bring downshort-term borrowing costs,so long as the nations signup to a deficit-reductionprogramme imposed fromthe outside.

Other welcome develop-ments for the eurozonehave included the highestGerman court ruling thatthe European StabilityMechanism, the new rescuefund, did not breach theGerman constitution, andDutch elections demonstrat-ing public support for politi-cal parties keen to make theeuro project work.

But after months of pre-varication, the summer’sprogress still requires sig-nificant further actionbefore the eurozone can be

With fiscal policy a liveelection issue, there are nobipartisan efforts as yet tomitigate the cliff andalthough most expertsexpect the issue to beresolved after the Novem-ber 6 elections, the prece-dent from 2011 suggestsbrinkmanship will ensureuncertainty continues tothe last minute.

Gerard Lyons, chief econ-omist of Standard Char-tered bank, says minds willbe concentrated by the cer-tainty of a new recession ifno agreement is struck. “Sobad is this outcome that itis unlikely to happen, asneither party could shoul-der the fall-out. More likely,there will be a last-minutecompromise . . . The troubleis that any decisions needto be agreed before year-end– in the so-called ‘lame-duck’ session of the US Con-gress.”

If the US suffers from anuncertain political and eco-nomic outlook, the euro-zone situation is more criti-cal, even though a period ofcalm soothed the eurozone

Continued from Page 1

World Economy

Hopesturn tofearsacrossglobe

Further action isneeded before theeurozone canbe stabilised

Mario Draghi, president ofthe European CentralBank, has crafted whathe calls a “fully effectivebackstop” against the dis-

integration of the eurozone. The ques-tion now is whether Europe’s leaderswill use it to push for a resolution tothe region’s crisis or whether, zombie-like, the bloc stumbles through a lostdecade.

The 17-nation region contracted inthe second quarter and, in spite of theECB’s actions to slash its main inter-est rate to a historically low 0.75 percent, it is proving hard to reignitegrowth. Even businesses in the euro-zone’s strongest economy, Germany,are forecasting further gloom inrecent surveys, rather than seeingthis as a golden opportunity to invest.

There are suggestions the centralbank may cut rates yet further by theend of this year or early next, shrug-ging off concerns about inflationwhich, although above the ECB’s tar-get of “below but close to 2 per cent”over the medium term, is expected toslow down in coming months.

But, as the bank admits, that classi-cal tool of monetary policy is effec-tively broken. Rates set in Frankfurtare no longer adequately reflected inthe cost of borrowing for companiesand households in Seville or Porto,due to speculation that countries withdistressed bond markets may leavethe euro.

The most recent ECB dataset onlending rates to small and mediumenterprises shows that a German com-pany seeking a loan of €1m forbetween one and five years might typ-ically pay 3.8 per cent – a record low –while a Spanish company would pay6.6 per cent, the highest since late2008 when central banks cut ratesafter Lehman Brothers collapsed.

The spread between those rates hasbeen getting wider, although the lat-est data for August predate MrDraghi’s backstop – dubbed outrightmonetary transactions or OMT by theECB. OMT has yet to be deployed, butits announcement alone has alreadymanaged to bring down the sovereignborrowing costs of countries such asItaly and Spain.

Mr Draghi’s idea is to stand ready tomake unlimited purchases of bondswith short-dated maturities on thesecondary market for countries withelevated sovereign borrowing costs, ifthe ECB judges that those costs arecaused by speculation about a eurobreak-up.

This is deeply controversial in Ger-many, where the Bundesbank hasopposed it outright and said it is tan-tamount to printing banknotes.

German concern – and an effectiveGerman veto by its parliament of anyapplication – is one reason why nocountry has yet applied for the bond-buying to begin. This would entailfirst signing up to structural reformsand possible deficit cutting measuresby applying to the eurozone’s perma-nent rescue fund, the European Sta-bility Mechanism.

But even when, and if, OMTsare used, Mr Draghi has repeatedlymade clear his “backstop” is just that– a measure aimed at preserving thesingleness of the eurozone and guar-anteeing the “irreversible” nature ofthe euro.

As a tool of monetary policy themeasure is not meant to address thefiscal problems of countries with bigbudget deficits and high levels of debtto gross domestic product. Nor is it anattempt to address the economicimbalances that created the problem.

“The ECB has done everything pos-sible and it could certainly create anenvironment which is conducive toreforms because it could remove whatwe call the redenomination risk,” MrDraghi said after this month’s meet-ing of the ECB’s rate-setting govern-ing council. “So, it could remove tailrisks but ultimately, the initiative isin the hands of governments.”

Some economists identify the cur-rent phase of the crisis as one of“muddling through”, where periodicspikes in the borrowing costs ofcountries such as Spain and Italyare addressed but no fundamentaleurozone-wide reforms are under-taken to eliminate grounds for finan-cial market speculation about thefuture of the euro.

The outlines of some kind of settle-ment are emerging in the form of

discussions about a banking union,common European banking supervi-sion, and a fiscal pact, but ultimatelythe shift from the “muddlingthrough” phase to a resolution willrequire the commitment of Germanyand others to still deeper fiscal inte-gration.

A looming German federal electionin about a year’s time is unlikely tohurry that debate along, with thepolitical risks all too obvious forAngela Merkel, the chancellor, ofadvocating tighter integration at atime when much public opinion issceptical of bailouts for southernEuropean states.

“The optimistic view is that even inthe muddle-through, we’re still mov-ing in the right direction,” says MarieDiron, a former ECB economist whoacts as economic adviser for Ernst &Young. “The danger is we don’t have5-10 years and that with muddlingthrough you are too close to the cliff.”

Returning to growth of 2 per cent inthe eurozone would be hard to seehappening in the next decade, MsDiron says, with 1 per cent in pros-pect only after a period of contractionand stagnation.

The other risk is that too harshlyimplemented austerity both strainsthe social fabric of countries beyondbreaking point and even harms thevery growth prospects so desperatelyneeded to lift the eurozone’s economyout of the doldrums.

Setting aside the wider problem ofintegrating the eurozone’s economies,some economists spy the potential forGermany to lead the way back out ofthe crisis, if fears of the euro breakingup can be dispelled.

“The ECB’s announcement (andimplementation, if required) that itwill buy unlimited quantities ofperipheral government bonds, if nec-essary, will gradually convince inves-tors over the next few months thatthe euro will not disintegrate, in ourview,” Ralph Solveen of Commerz-bank said in a note.

“This should at least soothe the cri-sis. Companies should then also turnless uncertain, with the current slum-bering [German] boom likely beingawakened as a result.”

Ball is in countries’ courtas ECB stands preparedEurozone The central bank has acted to guarantee the ‘irreversible’ nature of the eurobut resolution of the crisis lies with Germany and others, writesMichael Steen

When China reports itsthird quarter economic datanext week, it is widelyexpected to mark its sev-enth consecutive quarterlyslowdown in growth.

China is still doingremarkably well by globalstandards: the economyprobably expanded about7.0-7.5 per cent year-on-yearin the third quarter. Butrelative to the country’srecent past, the grindingslowdown has been a signif-icant change that manycompanies and investorsare struggling to digest.

“If you compare it toChina’s growth rate before2008, you’ve come down byabout a third,” says HuangHaizhou, chief strategistwith China InternationalCapital Corp.

The causes of the slow-down are clear enough.First, exports, once a lead-ing engine of the Chineselocomotive, have become adrag instead. Net exportsused to contribute about2 or 3 percentage points toChina’s growth rate. Now,with external demand soweak, sluggish exports willactually subtract about1 percentage point.

Second, investmentappears to have finallypeaked at nearly 50 per centof gross domestic product, arecord high for a big econ-omy in peacetime.

Although there is stillplenty of capital spending,there is now a huge base ofphysical capital and so aslower increase in its sizemeans that investment willgo from contributing about6 percentage points to 4 per-centage points of growth.

That leaves consumptionas the only driver of Chi-nese growth with the poten-tial to strengthen. Retailsales in real terms havebeen resilient this year butthe economy’s shift to aconsumption-led model isoccurring only gradually.

Tot it all up, and Chinawill struggle to do any bet-ter than 7.5 per cent growththis year and next year aswell – the slowest in morethan a decade. “We expectmediocre growth to be thenew norm in China,” saysDong Tao, Asia chief econo-mist for Credit Suisse.

The big surprise of the

past six months has beenthe central government’sreluctance to do more toarrest the slowdown. It hasallowed the central bank tocut interest rates twice and,at the margins, it hasboosted spending on invest-ment and provided moresupport for exporters.

But it has rebuffed callsfor anything remotelyresembling the Rmb4tn($640bn) stimulus packagethat it unleashed in 2008 topower the economy past theglobal financial crisis.

Many analysts hadexpected a more forcefulpolicy response from thegovernment and have hadcontinually to revise downtheir forecasts as Beijinghas stayed on the sidelines.

There are competingexplanations as to why ithas been so restrained.

The simplest is the cur-rent juncture in the coun-try’s politics. In November,the ruling Communist partywill convene a congress inwhich it will unveil China’snew leaders for the next 10years. Xi Jinping has beenanointed to replace Hu Jin-tao as party chief.

With officials from thevillage level to the nationalstage jockeying for promo-tions ahead of this once-in-a-decade leadership succes-sion, attention has beengiven over to politics at theexpense of the economy.“The policy paralysis due topolitical struggles this yearis the very reason why itmight take longer thanusual for the Chinese econ-omy to recover,” Lu Ting,an economist with Bank ofAmerica-Merrill Lynch,wrote in a recent note.

Another explanation isthat the government hascome to the conclusion thatslower growth is desirablefor China. In this view, Bei-jing has learnt from its2008-09 stimulus. Althoughhighly effective in proppingup growth in the shortterm, that gargantuanspending effort only madethe economy more unbal-anced in its reliance oninvestment.

In an editorial last month,Xinhua, the official newsagency, argued that anothersimilar stimulus was “notonly unlikely, but would be

detrimental to the country’ssustainable growth”.

A final view – and onethat raises a more alarmingprospect – is that the gov-ernment’s hands are tied.Even if it wanted to pro-mote faster growth, itwould be unable to getmuch traction. “Imaginethe scene when a car isstuck in the snow. Thedriver keeps stepping onthe gas pedal. The wheelsmove, but the car does notmove forward. This car iscalled the Chinese econ-omy,” Mr Dong says.

This bleak opinion isbased on the assessmentthat private businesses arerestricted to a series of sec-tors such as manufacturingand property that are besetby overcapacity.

Unless the governmentgives them greater access tostate-controlled parts of theeconomy, such as health-care and finance, they willbe unwilling to increaseinvestment and overallgrowth will inevitably fal-ter.

In contrast to the centralgovernment’s reserve, localofficials have been trippingover themselves toannounce bigger and biggerinvestment ambitions. Overthe past few months, pro-vincial and municipal gov-ernments have announcedmore than Rmb10tn inspending plans, from moresubway lines in the north-ern city of Xi’an to tourismdevelopment in the south-ern province of Guizhou.

Taken together, theseplans have been interpretedby many as a new stimulusfor China. But there is a bigproblem with this interpre-tation – the yawning chasmbetween what local govern-ments say and what theycan actually do.

Declining land sales havehit their revenues andbanks have shied awayfrom lending to thembecause they are still sad-dled with debts from theprevious stimulus.

There is, however, onescenario in which Beijingwould be likely to launch areal stimulus.

“In the event of a sharpdeterioration in globaldemand, we expect the Chi-nese government to provideadditional policy support,both fiscal and monetary,”says Wang Tao of UBS.With total government debtat just about 40 per cent ofGDP, it clearly does havethe capacity to act.

So while somewhatslower growth might beChina’s “new normal”, it ishard to see it getting muchworse than that.

Slowdown in growthlikely to continueChina

Consumption-ledmodel to the fore aseconomy adapts to‘new normal’, writesSimon Rabinovitch

Buy, buy: consumption is the only growth factor with the potential to strengthen Bloomberg

7.5%China’s slowest growth ratein more than a decade

Chris GilesEconomics EditorAlan BeattieWorld Trade EditorJavier BlasCommodities EditorRobin HardingUS Economics EditorClaire JonesOnline Economics EditorBen McLannahanTokyo CorrespondentJames MackintoshInvestment EditorJames PolitiUS Economic andTrade CorrespondentSimon RabinovitchBeijing CorrespondentMichael SteenFrankfurt Bureau ChiefRobin WigglesworthCapital MarketsCorrespondentAndrew BaxterCommissioning EditorAndy Mears, PicturesSteve Bird, Design

For advertising contactCeri Williams, tel +44(0)207 775 6321,ceri.williams@ft.com

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‘The optimisticview is thateven in themuddle-through,we’re stillmoving in theright direction’

Cobbled together: a euro sculpture is partially reflected in a puddle outside the European Central Bank’s Frankfurt headquarters Reuters

FINANCIAL TIMES FRIDAY OCTOBER 12 2012 ★ 3

World Economy

In autumn 2010, a confidentBritain felt it was leadingthe world.

The economy was recover-ing rapidly from the finan-cial crisis. The new coali-tion government showed itcould act when itannounced a detailed multi-year plan to bring down thegaping public deficit.

Credit ratings agencieswere impressed and Stand-ard & Poor’s obliged byremoving the negative out-look on the UK’s AAA-credit rating. Public sup-port for tax rises and spend-ing cuts was high. And Brit-ain – as the poster-child fordeficit reduction – blazed atrail soon followed by oth-ers in shifting from stimu-lus to austerity.

Two years on, wherethere was confidence, thereis now doubt, disappoint-ment and confusion.

Although the numbers inwork are almost back to thepre-crisis peak with solidemployment growth despitemass lay-offs in the publicsector, output has lan-guished.

Real gross domestic prod-uct has bumped along thebottom, effectively stagnat-ing for two years and still 4per cent below the 2008high. Compared with thepre-crisis trend, the volumeof goods and services pro-duced in Britain is around14 per cent lower thancould have been expectedbefore the crisis.

The combination of lowgrowth and robust employ-ment is reflected in plum-meting productivity, sug-gesting the potential for theUK economy to growquickly has been severelydamaged.

With low growth hascome disappointing publicfinances. Instead of elimi-nating the bulk of the defi-cit by 2014-15 as the coali-tion government had

intended, George Osborne,the chancellor, has alreadyconceded that austerity willhave to continue to 2016-17.Other economic disappoint-ments in 2012 are likely todelay deficit reduction evenfurther.

With deficits not fallingas hoped, the credit ratingagencies are getting nerv-ous. Two of the three lead-ing agencies – Moody’s andFitch – have warned the UKgovernment they are likelyto downgrade the credit rat-ing over the next few years.

Even the InternationalMonetary Fund, whichhailed the new govern-ment’s deficit reductionplans in 2010 as “essential”,is having second thoughts.In its mission to the UKthis year, the fund sug-gested that if the Bank ofEngland could not kickstartthe economy and growthinitiatives also failed, thegovernment should con-sider slowing its austeritydrive until the economy isstronger.

For some, such as profes-sor Paul Krugman, theNobel prize-winning USeconomist and columnist,the UK’s predicament hasbeen the predictable conse-quence of a failed devotionto premature austerity.“Britain is suffering fromlack of demand; it couldhave a quick (not magical)recovery if policies were

taken to stimulatedemand,” he argues.

Many others, includingthe government, argue thatBritain does not have theluxury of being able todelay efforts to reduce pub-lic borrowing when the defi-cit is still 8 per cent ofnational income. Stagnation

since 2010 is not the conse-quence of what Sir MervynKing, Bank of England gov-ernor, calls a “textbook”deficit reduction strategybut three additional impedi-ments to growth in additionto fiscal tightening thatcould not have been pre-dicted in 2010.

First was the eurozonecrisis, which has hit UKexports hard, damaged con-fidence and reduced corpo-rate investment intentionsas the eurozone accountsfor half of UK trade.

Second has been the glo-bal commodity price spike,which squeezed householdand corporate incomes.

And third has been thecontinued slow repair ofBritain’s huge banking sec-tor, which has constrainedcredit supply and businessinvestment.

A study in the summer bythe National Institute ofEconomic and SocialResearch showed that thesethree depressing forcesaccount for the vast bulk ofthe disappointment since2010, not deficit reduction.

But the economic disap-pointments of the past twoyears have fuelled politicaldebate. The Labour partyinsists deficit reductionshould slow even though itaccepts it will not havemuch money to spareshould it win the next elec-tion, scheduled for 2015.

The causes of the collapsein productivity are evenmore puzzling for econo-mists and policymakers,who do not have a readyexplanation for whyemployment is growingstrongly despite stagnationin the UK, but the oppositeis true in the US.

Both Conservative andLiberal Democrat elementsof the coalition governmentare resolved, however, tostick to the tax risesand steady spending cutsannounced in 2010, allowingautomatic fiscal stabilisersto slow deficit reductionif growth remains elusive.

Ministers cling to thehope that the forces ofstagnation are slowly com-ing to an end, householdincomes are beginningto grow and with greaterstability growth canresume.

Confidence gives way to doubt,disappointment and confusion

Bank of England: governor Sir Mervyn King says deficitreduction is not the only obstacle to growth Charlie Bibby

One basic assumption iscommon to both sides ofthis year’s bitter presiden-tial race between BarackObama and Mitt Romney:

that the US economy is in bad, badshape.

Mr Romney, the challenger, hasmade slow recovery the subject of hiscampaign. “What America needs isjobs. Lots of jobs,” he said, declaringthat the “Obama economy hascrushed the middle class” as heaccepted the Republican nomination.

Mr Obama, the incumbent, implic-itly agrees that the economy is weakeven if he prefers entirely differentsolutions. In his acceptance speech hetalked about it taking “more than afew years” to solve economic chal-lenges. His campaign has put all itseffort into attacking Mr Romney’s pri-vate equity career.

Yet even though the US recoveryhas been slow, it is actually one of thebrighter spots in the global economy,and if it manages to avoid a few nastypitfalls – notably the so-called “fiscalcliff” – the most likely outlook is forstronger growth ahead.

There are three basic reasons tothink the wounds of the financial cri-sis are starting to heal: the housing,credit and labour markets.

On housing, there is a growing con-sensus that the market has finally hitbottom. “Recent developments pointto a turnround in the housing mar-ket,” note analysts at HSBC. “Thehousing recovery continues to buildmomentum,” say their counterpartsat Bank of America Merrill Lynch.

That view is based on a broad set ofevidence. All the main house priceindices are now on the rise: the Case-Shiller measure is up on a year agowith every metropolitan area showinga month-on-month increase. Homesales are up, houses sell faster, andeven construction has come back alittle.

That is linked to another trend.Household debt – one of the main leg-acies of the crisis – has declined from100 per cent to 87 per cent of grossdomestic product and is now close toits long-run trend. Much of the declineis debt written off, rather than paiddown, and there is every chance thatthis measure will overshoot. But thereis now the prospect that households

could start to borrow more, especiallyif house prices do rise.

If households are ready to borrow,they will find that US banks are readyto lend. Unlike European banks, thosein the US were properly recapitalisedduring the crisis, and since the middleof 2011 there has been steady growthin outstanding bank credit.

Finally, although the labour marketis far from healthy, it is in a muchbetter state than a couple of yearsago. For example, the job openingsrate – which measures the ratio ofopen jobs to total employment – isback to a normal pre-recession levelof 2.7 per cent compared with below2 per cent in 2009.

Put all this together and it starts tolook like time truly is healing the USeconomy. All these gains could startto reinforce each other, as moreemployment supports more credit, let-ting people move houses, further

boosting the housing sector, and inturn creating more jobs.

But there is a problem with thisscenario. Every year since 2009 the USFederal Reserve, along with otherforecasters, has predicted that the fol-lowing year would be the year ofstrong recovery. Every year it hasbeen wrong. The headwinds havebeen too strong.

The Fed forecasts growth of 2.5 to 3per cent in 2013. Private forecastershave 2013 growth at 2.1 per centaccording to the Philadelphia Fed’smost recent survey. Several forces areexpected to weigh on growth – includ-ing the woes of the eurozone and aslowdown in emerging markets – but

by far the biggest problem is the“fiscal cliff”.

The fiscal cliff describes a series ofpolicy changes that current law willput into effect at the end of the year.

They include the expiration of allthe tax cuts passed by former presi-dent George W. Bush; the expiration ofa temporary 2 percentage point reduc-tion in social security payroll taxes;and indiscriminate spending cutsworth $1.2tn over the next decade.

“The point here is that putting allthese things together, you have a verysubstantial withdrawal of incomefrom the economy that will affectspending and will affect the ability ofthe economy to recover in the shortrun,” said Ben Bernanke, Fed chair-man, in a recent press conference.

Taken together, the fiscal tighten-ing written into current law is about 4per cent of GDP; if that happens, saysthe Congressional Budget Office, theUS is likely to suffer a recession, withoutput falling 0.5 per cent in 2013 andunemployment rising to 9 per cent.

The US is unlikely to fall straightoff the fiscal cliff. If Mr Romney winsthe election, the most probable out-come is that the payroll tax cut willexpire, but everything else will bepostponed for at least six months inorder to attempt a big tax reform.

If Mr Obama wins, the situation willbe a little trickier. Again, the payrolltax cut will probably expire, but MrObama will push hard to see that theBush tax cuts for those on higherincomes expire as well, while limitingcuts to spending.

Republicans in Congress will notaccept that without a fight, and whileleaders in both parties understand theperils of going off the cliff, last sum-mer’s debt ceiling fiasco suggests theywill be quite willing to dance alongthe edge of it. Even if all goes well,the expiry of the payroll tax cut willstill mean some fiscal tightening inthe US next year.

That limits the potential for rapidgrowth but there should still be someof it, especially with such active sup-port from the Fed, which shows nosign of resting on its $40bn a month,open-ended, QE3 programme to buymortgage-backed securities. Theworld’s largest economy may be readyto lead the global economy onceagain.

‘Fiscal cliff’ looms over growth hopesUS The wounds of the financial crisis are starting to heal but several forces could still blow recovery off course, writes Robin Harding

Annual % change in real GDPEconomic uncertainty is stopping companies andhouseholds from spending, causing growth forecaststo be revised downwardsIMF forecasts for GDP growth in 2013 (%)

0 2 4 6 8

All

Developingeconomies

Central & Eastern Europe

Russia

Developing Asia

China

India

Latin America

Middle East & North Africa

Sub-Saharan Africa

World

All

Advancedeconomies

US

Eurozone

Japan

UK

Jul 2012forecast

Oct 2012forecast

Source: IMF FT graphic

Global growth grinds down as spending stutters

UK Brazil

2010 11 12 13

1.80.8

-0.4 1.1

2010 11 12 13

7.52.7

1.54.0

Germany India

2010 11 12 13

4.0 3.10.9 0.9

2010 11 12 13

10.1 6.8 4.9 6.0

US China

2010 11 12 13

2.4 1.8 2.2 2.12010 11 12 13

10.4 9.2 7.8 8.2

Japan Russia

2010 11 12 13

4.5 -0.8 2.21.2

2010 11 12 13

4.3 4.3 3.7 3.8

Although the labourmarket is far fromhealthy, it is in a muchbetter state than a coupleof years ago

UK

Chris Giles finds thepotential for quickgrowth in theeconomy has beenseverely damaged

4%Amount by which real GDPis still below the 2008 high

4 ★ FINANCIAL TIMES FRIDAY OCTOBER 12 2012

thorny issue of agricultural subsidiesand tariffs.

Yet though Mr Romney has pledgedto push on with the talks, it is unclearhow he would be able to inject moremomentum into the process. A Repub-lican president would face the sameconstellation of domestic lobbyinginterests – the pharmaceutical andentertainment industries chief amongthem – and the same negotiating part-ners as a Democrat.

Grant Aldonas, managing directorat the consultancy Split Rock Interna-tional and an adviser to Mr Romney’scampaign, told a meeting in Washing-ton recently that the main differencebetween the two candidates on tradeis that Mr Romney would aggressivelyseek so-called “trade promotionauthority” (TPA) from Congress.

Formerly known as “fast-track”,TPA allows a president to submit awhole trade deal to Congress for asingle up-or-down vote rather thanbeing picked apart with amendments.

But Mr Aldonas also said that, ascurrently constituted, TPP “falls farshort of a revolution in trade policy”and questioned the point of an Asia-Pacific trade deal without Japan, so itremains unclear what the point ofgaining TPA at the moment would be.

For its part, the Obama campaignhas criticised Mr Romney for his ten-ure at Bain Capital, during which, it

said, he outsourced many jobs toChina, and has touted its impositionof special import tariffs on Chinesetyres in 2009, a move Mr Romneyopposed.

Again, the differences are moresymbolic than real. The Chinese tyretariffs – which Mr Obama allowed tolapse last month – were a one-off,with a predicted flood of copycat casesfailing to arise.

In truth, the most likely impactfrom a change in administrationwould come from the internationalimpact of domestic economic policy. Ifa Romney administration cut govern-ment spending rapidly, or if heappointed a Federal Reserve chairmanwith less willingness to experimentwith loose monetary policy than BenBernanke, the incumbent, the effecton American and thus global eco-nomic growth could be substantial.

But as regards international eco-nomic policy itself, and particularlytrade, it seems unlikely that muchwill hinge on November’s result.

record on trade negotiations by tout-ing last year’s passage of three bilat-eral trade deals – with South Korea,Panama and Colombia – which hesays will help create American jobs.

But not only do trade economiststend to regard the employment impactof such pacts as small, Mr Obama’scritics point out that he inherited thedeals from the Bush administration,and spent more than two years beforesubmitting them to Congress.

The main negotiating project of theObama administration has been theTrans-Pacific Partnership, which com-bines nine Asia-Pacific countries, withCanada and Mexico declaring theirintention to join later. But talks onTPP have progressed more slowlythan officials had hoped.

Comments by negotiators andleaked texts from the talks showcountries still far apart on subjectssuch as intellectual property rights,the ability of companies to sue gov-ernments for expropriating theirinvestments, and the perennially

weaken its currency. The renminbihas been more or less unchanged thisyear, at least against the dollar, butwith China’s foreign exchangereserves having also flatlined, itseems to be genuine capital outflowsrather than official intervention pre-venting it from appreciating.

As for the lack of other actionsagainst China, the Obama campaignsays it has brought several casesagainst Beijing to the WTO at nearlytwice the rate of the Bush administra-tion – including one last month onexport subsidies for auto parts, timedto coincide with Mr Obama’s visit tomanufacturing-intensive Ohio.

To remedy the alleged lack of tradenegotiations, Mr Romney has also pro-posed a “Reagan economic zone” – atrade pact bringing together like-minded free-trade countries. But theUS is having enough problems withits current negotiations, let alonestarting another, much more ambi-tious, set of talks.

Mr Obama has been defending his

ing to sign new trade agreements toproduce export opportunities forAmerican workers.

But Mr Romney’s specific proposalsto address these issues appear toinformed observers to be eitherimpractical or unlikely to make muchdifference. He has pledged to nameChina as a currency manipulator onhis first day in office, criticising MrObama for failing to do so. (Fouryears ago, Mr Obama attacked GeorgeW. Bush for the same reason, thoughfailed to follow through once elected.)

Yet under current US law, naming acountry a currency manipulator – andthere are many potential candidatesother than China, including firm USforeign policy allies such as SouthKorea – merely requires the Treasuryto open negotiations with its govern-ment, something it routinely doesalready.

In any case, to some extent thislooks like a solution to yesterday’sproblem, as there is little sign thatChina has recently been trying to

Going by the heated discus-sions of trade, currency andoffshoring on the campaigntrail, a casual observermight conclude that Amer-

ica’s place in the world economyhangs on the outcome of November’spresidential election.

Such a casual observation is likelyto be wrong. While Barack Obamaand Mitt Romney regularly hurl accu-sations at each other of selling outAmerican workers to China, theiractual policy differences are consider-ably less stark.

Though the eurozone crisis is proba-bly the biggest threat to the worldeconomy at present, it rarely gets alook-in during the exchanges betweenthe candidates, which centre on thequestion of China. Mr Romney’s cri-tique of Mr Obama is that he has“failed to take China to the mat” overBeijing’s policy of boosting exports byholding down the renminbi, noraddressed its many trade distortions.And he has chided Mr Obama for fail-

imposed excessive burdenson US businesses, and theEnvironmental ProtectionAgency could well be dis-armed under Republicancontrol of the White House.

Mr Romney has alsovowed to repeal both the2010 healthcare law knownas “Obamacare” and the“Dodd-Frank” Wall Streetreform legislation.

Though Mr Romney hassaid he planned to replacethe more popular provisionsof these bills, it is far fromclear how he would achievethis, or what exactly hewould seek to preserve.

Finally, Mr Romney hassaid he wants to do a lotmore to spur US domesticenergy production, arguingthat the Obama administra-tion has resisted opening upfederal lands for drillingeven amid the country’snatural gas boom.

Mr Romney has accusedMr Obama of having a biastowards renewable energysuch as solar and windpower, picking “winnersand losers” for governmentloan guarantees that led tosome high-profile bankrupt-cies, such as solar panelmaker Solyndra.

But his stance has raisedalarm bells among renewa-ble energy producers in theUS who might see their gov-ernment support cut off.

A win for Mr Romney inthe presidential race wouldprobably be accompaniedby a Republican takeover ofthe Senate – giving hisparty full control of the USCongress. But for some ofhis most sweeping objec-tives, such as broad taxreform and deficit reduc-tion, he would probablyneed some Democratic sup-port. Eyeing moderate vot-ers who may worry thatRepublicans have been toointransigent in resisting taxhikes in the recent budgetdebate, Mr Romney tried toshow that he would be will-ing to deal with the oppo-site party if elected.

“We have to work on acollaborative basis – notbecause we’re going to com-promise our principles, butbecause there’s commonground,” he said towardsthe end of the TV debate.

tions at $17,000. But he wasa little less specific duringthe debate, saying: “Makeup a number – $25,000 –$50,000. Anybody can havedeductions up to thatamount. And then thatnumber disappears for high-income people.”

Mr Romney has proposedto push through a similarkind of tax reform on a cor-porate level as well, withthe top statutory tax ratedropping from 35 per cent –one of the highest in theworld – to 25 per cent. Butthere too, it has been hardto discern how the Republi-

can presidential nomineesuggests paying for theeffort, beside his assurancesthat certain business taxbreaks would be limited.

On the international taxfront, Mr Romney hasembraced a shift to a terri-torial system of taxation –which does not impose lev-ies on foreign earnings –which is a top priority formany US multinationals.

On the regulatory front,Mr Romney would probablyseek to reverse some of theregulations put in place bythe Obama administrationthat critics argue have

of the looming “fiscal cliff”.While Mr Obama is

demanding that the Bush-era tax cuts be allowed toexpire for the wealthiestAmericans, his defeatwould remove virtually allhis negotiating leverage atthe end of the year.

But Mr Romney’s plan isbroader than extendingBush-era tax rates to all.The former governor ofMassachusetts wants thatmerely to be a step towardsa much broader effort com-prehensively to reform theUS tax code. This wouldinvolve a lowering of allrates by 20 per cent – withthe top rate falling from 35per cent to 28 per cent.

To ensure this does notadd to long-term budget def-icits, Mr Romney says hewants to make up the reve-nue by closing the myriadspecial tax deductions thatcrowd the US tax code.

But he has resisted out-lining exactly which oneshe would curb – since manyof these tax breaks, fromthe home mortgage interestdeduction and the charita-ble contribution deduction –are extremely popular, andhave dedicated politicalconstituencies that wouldbattle to preserve them.

The vagueness of the rev-enue-generating portion ofhis tax plan has exposed MrRomney to harsh criticismthat his maths do not addup, which the Republicannominee attempted to coun-ter last week with a pledgeto cap annual tax deduc-

The morning after whatwas widely perceived to bea victory over BarackObama in the first presiden-tial TV debate, Mitt Rom-ney told a conservativegroup in Colorado of whathe saw as the main wedgeover economic policybetween the candidates.

“I saw the president’svision as trickle-down gov-ernment and I don’t thinkthat’s what Americabelieves in,” said MrRomney – who had levelledthat charge against MrObama the previous night.

“I see instead a prosperitythat comes through free-dom,” he added.

In practice, a win for MrRomney on November 6would bring a significantshift in direction for the UStowards a much moreconservative “supply side”approach to fostering jobcreation across the sluggishUS economy.

Principally, Mr Romney isproposing a combination oflower taxes across theboard, coupled with alighter regulatory regime,that is intended to spur themyriad US businesses thathave been hoarding cash inrecent years finally todeploy their money forhiring and investment.

In addition, Mr Romneyhas vowed to pursue deepcuts to spending pro-grammes – except fordefence, which he haspledged to protect – and toreform, though not rightaway, some of the mostpopular federal pension andhealth schemes for the poorand the elderly to save thegovernment some money.

Mr Romney would proba-bly, even before he tookoffice in January, push a“lame duck” Mr Obama andCongress to extendall Bush-era tax cuts tempo-rarily, thereby defusingone of the main components

reform proposal into thebudgetary discussions.

The White House hasalready suggested loweringthe corporate tax ratefrom 35 per cent – amongthe highest statutory ratesin the world, though inpractice many companiespay less – to 28 per cent.

But much hard work stillneeds to be done in pickingout which corporate taxbreaks to limit or scrap inorder not to add to US debtlevels.

The Obama administra-tion has also rejected a shiftto a territorial systemof taxation, which doesnot tax foreign earnings,but may return to it ifsufficiently tough condi-tions are imposed to curtailthe shifting of productionoverseas.

Meanwhile, Mr Obamamay well try to reprisethemes that he has ham-mered at in several “state ofthe union” addresses duringhis first term, such as theneed for additional govern-ment investment in innova-tion, infrastructure andeducation – which someRepublicans scoff at.

In that vein, he couldseek to move the US furtherin the direction of indus-trial policy – specificallytrying to bolster America’smanufacturing base, whichhas been recovering butstill remains relativelyimpaired – through newtargeted tax breaks.

The biggest hope forMr Obama in a second termis that he will able tokeep government demandat fairly strong levels –while the US economy isgradually cured of someof the structural problems,such as long-term unem-ployment, that have doggedit since the last recession.

Since Mr Obamawould no longer be facingre-election, he may have alittle more flexibility tonegotiate with Republicansthan he has in the past18 months.

But the stakes will still behigh, for his legacy, as wellas for his Democratic alliesin Congress who will needapproval from voters againin 2014 and 2016.

and healthcare schemes forthe poor and elderly –known as Social Security,Medicaid and Medicare.

But come November 7,these could well be on thetable again in some form orother if Mr Obama tries tocraft a new agreement –worth at least $4tn in deficitreduction over a decade –that would lift a cloud ofuncertainty over America’scapacity to get its fiscalhouse in order.

During this time, MrObama will have to pick anew Treasury secretary,since Tim Geithner hasalready indicated that hewill be stepping down atthe end of the first term.

Among the names thatare being floated as possiblereplacements are Jack Lew,the White House chief ofstaff and former budgetdirector, and ErskineBowles, the co-chair of the2010 bipartisan fiscal com-mission.

Among the new ObamaTreasury pick’s biggest jobsnext year may well be toweave a broad corporate tax

and, while Mr Obama wantsto extend them for house-holds earning less than$250,000 per year, he wantsto allow them to expirefor the richest incomecategories.

Republicans have so farresisted this “decoupling” –claiming it would hurt busi-ness owners and job crea-tors, thereby inflicting fur-ther damage to the recov-ery. The key question in thewake of the election, assum-ing they hold on to controlof the House of Representa-tives, is whether theywould relent on this or fightit until the bitter end, possi-bly leading the US over theedge of the cliff.

But regardless of how thebattle over the Bush taxcuts plays out, Mr Obamastill has his work cut outfor him on the fiscal policyside. He may well pick upwhere he left off in July lastyear, when he tried in vainto negotiate a long-term def-icit reduction deal withJohn Boehner, Republicanspeaker of the House ofRepresentatives.

Mr Obama has shown awillingness to make somecuts to popular governmentprogrammes, even onhealthcare, as long as theywere accompanied withsome new revenues fromthe wealthy. But sincethose talks with Mr Boeh-ner broke off, Mr Obamahas adopted a much moreprotective posture withregard to federal pension

On the campaign trail,President Barack Obama’seconomic message has beenfairly simple and consist-ent. The sluggish US recov-ery is the result of the deephole the economy was inwhen he took office fouryears ago – and not a reflec-tion of failed efforts on hispart.

The blame, he says,should be apportionedchiefly to Republican poli-cies championed by GeorgeW. Bush, his predecessor,and Republican intransi-gence on Capitol Hill block-ing his plans to implementa more aggressive fiscalstimulus.

“We don’t need to doubledown on the same trickle-down policies that got usinto this mess in the firstplace. We don’t need poli-cies that just help folksat the very top,” Mr Obamasaid at a rally in Las Vegason September 30, three daysbefore the first presidentialTV debate.

“We succeed when themiddle class is getting big-ger – when more peoplehave the chance to getahead and live up to theirGod-given potential.”

If Mr Obama is re-elected,there are several certain-ties. He will try as hard ashe can finally to raise taxeson the rich – which he hassteadfastly aimed for,always encountering stiffresistance, throughout hisfirst term.

His first opportunity willcome during the so-called“lame duck session” of Con-gress, in which lawmakerswill have to find a solutionto the “fiscal cliff” – a$600bn mix of broad taxhikes and spending cutsthat could tip the US econ-omy into a fresh recession.

One of the biggest compo-nents of this budgetaryprecipice is the expirationof Bush-era tax rates

World Economy

Differencesseem moresymbolicthan real

US elections Both candidates would facethe same issues with China and negotiationsover trade deals, writes Alan Beattie

The Obama campaignsays it has broughtseveral cases againstBeijing to the WTO atnearly twice the rate ofthe Bush administration

President cannot make moveuntil election result is decided

Barack Obamawith Chinesepresident HuJintao at a G20summit in Mexicoearlier this year.China is aprominent item onthe US electionagenda AFP

Long on promised tax cuts butshort on substance in costingIf Romney wins . . .

If the GOP’s man iselected he faces sometough questions,reports James Politi

Put it there: Mitt Romney campaigning in Denver Reuters

20%How much taxes would fallunder broad reform plans

If Obama wins . . .

Fixing the ‘fiscal cliff’would be a toughsecond-term task,says James Politi

On the stump: Barack Obama at a rally in Las Vegas Getty

Obama would nolonger be facingre-election, andhave flexibilityto negotiate

FINANCIAL TIMES FRIDAY OCTOBER 12 2012 ★ 5

World Economy

There is an old saying thatthe IMF acronym does notstand for InternationalMonetary Fund, but “It’smostly fiscal”. This nick-name was acquired overmany years when the IMF’sstock position was to tellcountries in trouble theyhad no choice but sort outtheir public finances withspending cuts and taxincreases.

Everything changed inJanuary 2008 when Domin-ique Strauss-Kahn, the thenIMF managing director,stunned the World Eco-nomic Forum in Davos, bycalling for a fiscal stimulusto solve the gathering finan-cial crisis.

“I don’t think we wouldget rid of the crisis withjust monetary tools,” hesaid. “A new fiscal policy isprobably today an accurateway to answer the crisis.”

Public deficits soared ascountries used fiscal policymore than ever to help off-set the powerful forces ofthe 2008-09 financial andeconomic crisis.

But the clean reversal ofthe IMF position lasted onlytwo years. Since 2010, theIMF’s stance has becomeseemingly more confusedand contradictory.

It frets about theconsequences of potentialfiscal tightening in the USnext January. ChristineLagarde, now managingdirector, warned againstexisting US legislationwhich will impose a reduc-tion in the deficit next yearequivalent to 4 per cent ofnational income as “a seri-ous threat for the UnitedStates and, as the world’slargest economy, for theglobal economy”.

But in Europe, the IMF isstanding firm against dis-bursing money to Greeceunless the country stopsdragging its feet in impos-

ing spending cuts and taxrises. And for countriessuch as Spain, Ms Lagardesaid in the same speechthat everyone should recog-nise “there is no alternativeto the structural reformsand fiscal adjustmentneeded to get back on theright path”.

As far as Japan is con-cerned, the country withthe largest public sectordebt at over 200 per cent ofnational income, the IMFhas few recommendations.

David Lipton, the firstdeputy managing director,praised recent attempts toincrease the consumptiontax while stressing that“higher trend growth willbe key to bring downJapan’s high public debtratio”.

In many ways thereshould be no surprise thatthe IMF does not have asimple line on fiscal policy,since debate rages in theacademic world over

optimal fiscal policy after afinancial crisis and the IMFstaff reflect all sides of thatacademic opinion.

Olivier Blanchard, thechief economist, is moresympathetic towards slowerfiscal consolidation in hispublic pronouncementsthan his boss Ms Lagarde,although the public policysplits are more in thenuance of recommendationsrather than in hard differ-ences in policy positions.

The one unifying conceptupon which the IMF hangsis that of “fiscal space”.

Countries deemed to havesignificant fiscal space haveroom to adjust deficitsslowly “to avoid unduepressures on activity andemployment”, the IMF says,while those with little spacehave no option but to cutdeficits hard and fast.

In the medium term, theIMF recommends that all

advanced countries shouldbecome fiscal hawks andrebuild their lost fiscalspace so that they will haveroom to respond to a futurefinancial or economic crisis.

With this concept, theIMF seeks to reconcile itsseemingly contradictoryadvice since it says there isno “one size fits all” defini-tion of fiscal space.

The US has significant fis-cal space because it is alarge, relatively-closed econ-omy and holds the world’sonly reserve currency. Itcan therefore be more san-guine than smaller econo-mies about its very largebudget deficit. But in thelonger term, the US mustact to restore sustainabilityto its public finances.

By contrast peripheraleurozone countries, strug-gling to finance their defi-cits in markets, have no fis-cal space, and must consoli-date rapidly regardless ofthe short-term damage togrowth. Greece and othercountries accessing IMFfunds have completely runout of fiscal space.

Japan and the UK areintermediate cases withoutthe fiscal space enjoyed bythe US but, with lowborrowing costs and simplemarket access to debt, theyhave greater room thanmany eurozone economies,although these two coun-tries have much less roomto delay medium-term fiscalconsolidation.

Even though the fundaccepts that in the mediumterm few advanced econo-mies have much fiscalspace and should aim toreduce public sector debt,its latest research demon-strated how few examplesof successful debt reductionthere are.

“Widespread fiscal cut-backs, retreat by the pri-vate sector, population age-ing, and the aftermath ofthe financial crisis meaneven countries that followthe guidebook will have tomoderate their expectationsfor reducing debt,” the IMFwarned. Even so, it stillurged countries to emulatethe successful examples ofreduction in debt, by imple-menting lasting mediumterm fiscal consolidationalongside structuralreforms to boost growth,rather than a series of tem-porary efforts to get deficitsdown.

However much thosereceiving IMF advice wouldlike a clean approach to fis-cal policy, the days whenthe fund could be countedupon to recommend a littletighter fiscal policy thanplanned in almost everycountry are now long gone.

With differential fiscalspace, countries are not inthe same boat even if theirdeficits appear similar.

‘One size fits all’ left formore tailored approachIMF and fiscal policy

The organisationnow suits its adviceto the nature of themember’s economy,says Chris Giles

200%Japan’s public sector debt asa percentage of nationalincome – the world’s highest

It is all change on 19th St NW inWashington: last year’s switch ofleadership at the InternationalMonetary Fund was followed thisyear by a similar move at its

sister institution over the road, theWorld Bank.

In both cases, a decades-oldstitch-up between Europe and the USover the appointments remained inplace. But the people in charge willhave to adapt their institutions to avery different world if they are toreturn to a central place in themanagement of international develop-ment and the world economy.

The IMF’s leadership changed lastsummer. The forced departure ofDominique Strauss-Kahn as managingdirector was followed by the swiftinstallation of Christine Lagarde inthe top job, maintaining the positionas a European fiefdom.

Earlier this year, the US continuedthe counterpart tradition of nominat-ing the president of the World Bank –in this case Jim Yong Kim, presidentof Dartmouth College, who formerlyran the World Health Organisation’s

HIV-Aids programme but whoseappointment was criticised by somedevelopment economists because ofhis narrowness of expertise.

With Dr Kim in the job only a fewmonths, it is hard to make a confidentassessment of what the bank will looklike under his presidency. Yet thehistory of the bank in recent decades– and Ms Lagarde’s experience at theIMF over the past year – suggest it isnot straightforward to retool theinternational financial institutions forthe realities of the modern worldeconomy.

For both institutions, the globalfinancial crisis was a chance to reas-sert their roles after several years inthe 2000s in which their influence hadwaned.

During that time there were plenti-ful private capital flows to developingcountries, and a new breed of aiddonor arrived in the form of Chinaand other big emerging markets, oftenwith rather different views from thebank’s on the role of the state in eco-nomic development. The bank’s rela-tive importance both as a provider of

finance and of advice to developingcountries shrank.

In the case of the fund, thebountiful liquidity and easy borrow-ing available in the years precedingthe global financial crisis meant therewere few debt-ridden countries facinga sudden stop in capital flows andneeding the IMF to fill the gap.

But both institutions swung intoaction when private capital dried upduring the global financial crisis –and since the biggest funding prob-lems have been in the rich world, spe-cifically western Europe, the IMF hasbeen more prominent than the bank.

The IMF more or less tripled itsfirepower in 2010 with a general pro-gramme of increases in contributionsfrom its member countries, and isadding nearly the same again with around of ad hoc pledges this year.

Some of the IMF’s early clients dur-

ing the crisis – the central and easternEuropean countries hit by contagionfrom the eurozone – have stabilised, ifnot fully recovered.

But the fund has found it muchharder to operate in the eurozone.

Even with the extra resources fromits shareholders, the IMF has beenable to play only a junior financingrole in the rescue programmes forIreland, Portugal and Greece,becoming just one member of the“troika” – the other two being theEuropean Central Bank and the Euro-pean Commission.

And the fund seems likely to pro-vide an even smaller share of themoney, or none at all, if Spain or Italy

ask for help. With the EuropeanUnion having to create institutions todeal with the crisis as it went along –usually painfully slowly, and withmuch public dissent between memberstates – the IMF has often found itselfat odds with both the pace and thecontent of the rescue effort.

In Greece, for example, as a recentinternal review of its activitiesacknowledged, fund staff were muchkeener than EU officials for a restruc-turing of Greece’s official debt stock.But their minority financing role gavethem relatively little influence

However, over the past year, underMs Lagarde’s leadership, the IMF hasbecome progressively bolder aboutpublicly disagreeing with the euro-zone authorities. Last summer MsLagarde provoked a storm of criticismby saying that European banksneeded more capital – with publicmoney involved if necessary.

IMF staff have also tried to dig induring negotiations over the Greekrescue, saying that the debt sustaina-bility analyses produced by the othertroika members were too optimistic,and that Greece would need a biggerwritedown in its debt or more officialmoney to fill its financing gap.

The fund has also supported thecontention of Spain, the latest countryto come into the market’s line of fire,that an overly rapid fiscal tighteningwould merely send the economy fur-ther into recession and worsen thedebt burden rather than improve it.

On the face of it, the IMF has beengiven a vote of confidence by theEuropean Central Bank, with MarioDraghi, its president, saying that thefund must be involved in any rescueprogramme for countries such asSpain or Italy.

But critics are concerned that thefund, with little or no money of itsown on the table, will have even lesspower to determine the conditionsthat those countries must accept toget a bailout.

The fund and the bank face a worldin which they struggle to keep pacewith the rapid growth of privatecapital and the size and speed ofsovereign debt crises.

Even with tough and energetic lead-ership, their task is a daunting one.

Flush withcash, shorton influence

IMF and World Bank The two institutionsface new challenges, writes Alan Beattie

Leading lights: Christine Lagarde,managing director of the IMF andJim Yong Kim, president of theWorld Bank EPA, Bloomberg

The IMF has played onlya junior financing role inthe rescue programmesfor Ireland, Portugaland Greece

Olivier Blanchard: sympathy for slower fiscal consolidation

6 ★ FINANCIAL TIMES FRIDAY OCTOBER 12 2012

World Economy

If all you have is a hammer, everyproblem looks like a nail. For theworld’s central banks, thehammer is their ability to createmoney to buy up assets, and it is

pounding on every difficulty outthere.

The US Federal Reserve upgraded toa sledgehammer at its last meeting,turning its third round of quantitativeeasing from QE3 to QE∞ (or infinity)in an attempt to solve the problem ofunemployment. It plans to buy mort-gage bonds in the market until theeconomy starts creating jobs – andsays it will not tighten monetary pol-icy immediately even when it spots arecovery.

Switzerland long ago moved to an“unlimited” monetary policy, printingSwiss francs as though they grew ontrees in order to prevent the currencyrising against the euro. The EuropeanCentral Bank has also promisedunlimited intervention to protect thebond yields of struggling eurozonecountries against fears that theycould leave the euro.

Neither the Bank of England norBank of Japan has moved to infinitemoney printing yet, but the pair arepushing the limits of unconventionalmonetary policy, with the British try-ing credit easing and the Japanesebuying shares and property invest-ment vehicles.

For investors this sudden monetarybattering was great news, helping todrive up shares and other riskyassets. Global equities produced anextraordinary summer rally, jumping18 per cent from their lows at thestart of June to a mid-September high,with the eurozone periphery doing farbetter.

The question now is whether cen-tral bank liquidity has left financialmarkets disconnected from reality. Ifit has, the likely outcome is a repeatof 2010, 2011 and the start of this year,when the effects of monetary stimuluswore off and markets plunged, recov-ering only when central bankerspromised more action.

Since the equity rally petered out inmid-September, shares have donelittle in the US or Europe’s safercountries, although some strugglingcountries, particularly Spain andItaly, have seen bigger pullbacks.

Some investors argue that the side-ways move in shares is early evidenceof the market growing weary. Much ofthe effects of both the eurozone andUS action was priced in ahead ofofficial announcements, and not muchhas happened since.

“You’re not getting any flow [ofinvestments] through from realmoney or retail,” one hedge fundmanager points out, making it hardfor the rise to be sustained.

But the real test of the monetarypolicy experiments will be the effecton the credit cycle and the realeconomy. Central banks can create

money, but they cannot force peopleto spend it. If it is hoarded, withhouseholds paying down debt andcompanies refusing to invest, thenrecovery is unlikely.

On the other hand, shares are aleading indicator of the economy, aswell as having an influence on it. Fedchairman Ben Bernanke’s stated goalis to push up shares and house pricesto make people feel richer and spend.This is trickle-down economics writlarge: by making those with wealtheven better off, he hopes to create jobsfor the poor. The danger many inves-tors are focused on is not that the

policy fails, but that it works too well.“We have entered the asset price

targeting era in monetary policy,”says Yves Bonzon, chief investmentofficer at Pictet, the Swiss privatebank. “Policy makers have killed theshorts [short sellers].”

This round of Fed intervention isdifferent from other interventionssince the crisis. The first round camewhen bond markets were expectingdeflation, and prompted investors toexpect something like normal infla-tion in future. QE2 came when infla-tion forecasts had dropped sharply,although not to the point of disinfla-

tion. The third, last autumn’s Opera-tion Twist, had seen a smaller fall ininflation expectations, but there wasstill a fall.

But this time inflation was expectedto be perfectly normal before the Fedintervened. Increasingly investorsthink the Fed has moved fromworrying about inflation to pushingfor faster growth, and that makesthem fear higher inflation.

Gold is up more than 17 per centfrom its May low on the back of QE3,and emerging markets are braced fora repeat of the flood of cash that leftthe US after QE1 and QE2.

Guido Mantega, Brazil’s financeminister, said last month that the Fedwas acting only because political grid-lock made fiscal measures impossible.“The last resort is to pursue QE meas-ures, which in my view have verylittle effect because in the US there’sno lack of liquidity, unlike in theEuropean market,” he said.

Historically, shareholders have notgrown concerned about inflation untilit reaches 4 per cent, double thetargets of the Fed, ECB and Bank ofEngland. But even as it looks like theFed, at least, has set its inflationtarget to one side to focus on jobs,there are plenty of deflationary forceswhich could upset an investmentstrategy based on the reflation of theworld economy.

Quite apart from the risks from arecession-bound European economyadding austerity to its problems,investors face the danger that US poli-ticians could plunge the country intorecession in January if they cannotagree a compromise to stop automatictax rises and spending cuts – thefiscal cliff – going ahead.

The change in Chinese leadershipdue to start in November adds to thepolicy uncertainty amid the currentslowdown in its economy and thestalled effort to switch from invest-ment to consumption.

The good news is that the problemsahead leave lots of room for reliefrallies when, and if, they are solved.

The bad news is that shares lookexpensive on long-term valuationmeasures. Cheap or expensive, withbond yields held close to record lowsby central banks, many investors feelthey have to buy them anyway.

Risks ahead for investors if QE continuesFinancial markets The true test of the monetary policy experiments will be their effect on the real economy, writes James Mackintosh

Happy days: hascentral bankliquidity leftfinancial marketsdisconnectedfrom reality?

Bloomberg

The “flight to safety” trig-gered by the financial melt-down has continued una-bated this year, as concernsover the eurozone’s crisisand the faltering global eco-nomic recovery have pro-pelled investors towards therelative shelter of govern-ment bonds.

As a result, the govern-ment borrowing costs of theUS, the UK and Germanyhave ground lower andlower, touching multi-cen-tury record lows this year.The benchmark 10-year gov-ernment bond yields ofthese three countries arenegative in real terms, orwhen inflation is accountedfor. In other words, inves-tors expect to lose moneywhen they buy them.

“You now have to pay forthe privilege of puttingyour money in a safeplace,” observes Elie ElHayek, global head of gov-ernment bond trading atHSBC. “The only thing youcan hope for is that every-thing else loses even morevalue.”

Government interestrates are particularly low inlarge parts of Europe. Whilea handful of embattledeurozone countries are suf-fering from a crisis of inves-tor confidence, others haveseen their bond yields tum-ble as a result of the samecrisis.

Indeed, the two-year bor-rowing costs of Denmarkand Switzerland are pres-ently negative even in nom-inal terms, and haverecently been negative forFinland, the Netherlands,Austria and Germany. Ger-many, the largest and mostrobust economy in the euro-zone, is one of the mainbeneficiaries, with yields ofGerman “Bunds” belowthose of US Treasuries.

“Bunds have becomepaper safety deposit boxes,”says Stewart Cowley, headof fixed income at Old

Mutual Asset Managers.“They only have value as arepository of money, not asan investment.”

Some money managersargue that the governmentbond yields of the “safehaven” states cannot gomuch lower, and warn thatsovereign debt will prove tobe a bad investment onceinterest rates start to rise.

For example, Germany’screditworthiness isexpected to be impaired bythe rescues of the strug-gling periphery, weighingon German Bunds. Someinvestors are also avoidingUS Treasuries, fretting thatthe US’s political stasis andinability to tackle itsbudget deficit could lead toa debt crisis in the world’sbiggest economy at somepoint.

Nonetheless, many inves-tors and economists aremore concerned that thewest could be facing a sce-nario similar to that ofJapan after its bubbleburst, in which economicgrowth stays stubbornlyweak for much longer thanexpected. In that case, thebond yields of these “core”governments could alsostay subdued for muchlonger than expected.

“People have been short-ing Japanese governmentbonds for decades, and lostmoney,” Mr El Hayekpoints out. “If growthdoesn’t return soon wecould be facing a similar sit-uation to Japan, with lowyields for a long time.”

This possibility poses amajor problem for assetmanagers. Although thetorrent of money gushinginto government bondshas ensured healthy capi-tal gains for investors sofar – sovereign debt isone of the best performingasset classes since thefinancial crisis – thereturns on offer now aredismally low.

This can have far-reach-ing consequences, particu-larly for investors that needa certain rate of returns tomeet their fiscal obliga-

tions, such as insurancecompanies and pensionfunds.

Martin Senn, chief execu-tive of Zurich InsuranceGroup, argues that low gov-ernment bond yields areone of the reasons whylisted insurance companiestrade at such low valua-tions. “Interest rates willremain low for some time,which is a huge challengefor long-term investors thathave fixed liabilities thatthey have to meet,” he says.

Investors seeking higherreturns but wary of equitymarkets and other riskyassets have largely settledon two alternatives – corpo-

rate debt and emergingmarket bonds.

Highly rated companiesnow also enjoy rock-bottomborrowing costs, but emerg-ing market governmentshave arguably been theprime beneficiaries of the“hunt for yield” in recentyears.

These developing coun-tries can for the most partboast robust economicgrowth rates and govern-ment finances in decentshape – attractive proposi-

tions for westerni n v e s t o r s

confrontedby a lackof bothin theird o m e s -tic mar-kets.

T h edevelop-i n g

w o r l d ’ sborrowing

costs have tumbled as aresult. After shooting up toa peak of 12.2 per cent inOctober 2008, the blendedyield of the developingcountry government bondsin JPMorgan’s benchmarkEMBI index has plunged toa record low of about 4.7per cent this year.

Some of the moreadvanced emerging econo-mies now enjoy decidedlywestern borrowing costs.Mexico, for example,recently issued a 100-yeardollar bond that trades at ayield of just under 4.7 percent. Its benchmark 10-yearissue yields 2.4 per cent,just above the comparablebonds of France.

But it is not just the toptier emerging markets thathave seen their borrowingcosts decline markedly.JPMorgan’s “Nexgen” indexof the average bond yield ofmore esoteric countries hasalso fallen to a record low,partly thanks to a rally inAfrican sovereign debt.

Developing countrieshave responded to theresurgent appetite for theirdebt with a bond sale binge.The volume of internationalemerging market debt issu-ance has touched almost$350bn already this year, arecord for the period and upnearly 50 per cent, accord-ing to Dealogic, the dataprovider.

In fact, some analysts andinvestors say emergingmarket debt is beginning tobehave as a “safe haven”asset itself – rallying whenglobal financial markets areturbulent. Emerging marketbonds still tend to gethit hard when marketstresses become exception-ally severe, as they did inthe second half of last year,but for the most part theyhave proven unusuallyresilient to turmoil.

“Increasingly the debtflows are becoming counter-cyclical,” Bhanu Baweja,head of emerging marketfixed income and currencystrategy at UBS, noted in arecent report. “Now wheninvestors are worried

about global or EMgrowth they are sellingEM equities, but hold-i n g o n t oEM debt. In fact, theymay well be addingto it.”

On the hunt for yield in morerobust emerging markets

StewartCowley: Bundsonly havevalueas ‘repositoryof money’

As policy makers gather inTokyo this weekend for theannual meeting of the Inter-national Monetary Fund,they will ask for the firsttime in a decade whetherthe rise in commoditiesprices that started in 2002has finally come to an end.

The slowdown in Chineseeconomic growth, togetherwith the eurozone sovereigndebt crisis, high unemploy-ment in the US and thearrival of fresh raw materi-als supplies after a decadeof investment in new pro-duction has certainlystarted to damp prices forcommodities from crude oilto iron ore.

The IMF index of com-modities prices is downnearly 15 per cent from anominal record high set inmid-2008. As the IMF says inits semi-annual World Eco-nomic Outlook, the “spillo-vers” from weaker economicgrowth “have lowered com-modity prices and weighedon activity in many com-modity exporters”.

Yet, commodities traders,natural resources execu-tives, policy makers andanalysts are almost unani-mous in warning that theso-called “commoditiessupercycle” that developedon the back of the industri-alisation and urbanisationof China and other emerg-ing countries in Asia,Africa and Latin America isnot over – at least not yet.

The IMF commoditiesindex, one of the broadestand more complete meas-ures of raw materials costs,may have fallen from itsrecord high of four yearsago, but it is still up 32 per

cent over the past five yearsand a hefty 220 per centsince 2000.

The supercycle’s demisehas been pronounced –wrongly – before.

In the 2008-09 globalfinancial crisis, the WorldBank said it was “bestunderstood as yet anothercycle in a long history ofcommodity price cycles”.The boom and bust theoryfailed as prices recoveredsharply in 2010 after eco-nomic growth gatheredmomentum.

Looking forward, itmakes more sense to thinkof the commodities supercy-cle not so much as like theboom and bust periods ofthe 1950s and 1970s, but asless “super” and less “cycli-cal”. Raw materials pricesare likely to settle at ahigher level than previ-ously, with ups and downstracking swings in eco-nomic activity.

If economic growth inemerging countries, fromIndia to Brazil, gatherssteam in early 2013, pricesare likely to rise again, ana-lysts and traders say.

The commodities marketis also likely to be moreprone than in the 1980s and1990s to supply shocks.

This is because, on theone hand, inventories ofmost commodities – with afew exceptions such as alu-minium – are at the lowestlevel in decades, providinglittle cushion.

On the other hand, spareproduction capacity hasbeen mostly exhausted.Thus, the adjustment toany drop in production is

almost always comingthrough high prices dentingeconomic growth and, thus,consumption.

For the next few months,however, the key will beeconomic growth in China.

“If you believe that thenew Chinese leadershipwould boost fiscal spendingand growth would acceler-ate, just buy copper andoil,” says a senior commodi-ties banker to explain howdependent the outlook is onthe once-a-decade leader-ship change in Beijing. “Butif you do not, then I wouldstart selling,” he adds.

The IMF forecast that theworld’s second-largest econ-omy would expand a rela-tively modest 8.2 per cent in2013, somewhat higher thanthe 7.8 per cent projectedfor this year, but certainlymuch slower than theplus-10 per cent typical ofthe 2000s.

But even if Chinese eco-nomic growth remainsweaker than during thepast decade, other countriesin Asia, notably India, aregoing to demand greaterand greater quantities ofraw materials.

Moreover, naturalresources groups areresponding to the drop inprices by curtailing their

expansion projects. In duecourse, lower capital expen-ditures would translate intoless supply growth, forcingprices higher.

The cost of producing rawmaterials, particularlycrude oil but also some met-als and minerals, hasincreased significantly overthe past decade. If commod-ities prices drop muchbelow current levels, somehigh-cost producers wouldstart losing money, forcingthem to shut down produc-tion and, thus, supportingprices.

For example, analystsestimate that the highestcost Canadian heavy-oilproducers need Brent crudeto be trading at least atUS$85 a barrel to covertheir costs. Brent crude hasbeen trading around$110-$115 in October, but inSeptember prices fell closeto the $85 level, triggeringtalk in the market of immi-nent output cuts.

The role of high-cost pro-ducers is also evident in theiron ore market. About athird of Chinese minersneed prices to stay above$100 a tonne to remain prof-itable, but prices this yearfell as low as $90.75 a tonne,forcing some miners to shutdown production.

Price is rightfor supercycleto continue,say tradersCommodities

It may be less ‘super’and less ‘cyclical’ butmuch will depend onthe pace of Chineseeconomic growth,says Javier Blas

Natural resourcesgroups areresponding to thedrop in prices bycurtailing theirexpansion projects

Government bonds

Robin Wigglesworthfinds the developingworld is benefitingfrom weak growthin western nations

‘You now haveto pay for theprivilege of puttingyour money in asafe place’

FTSE All-WorldIndex

Jan Oct2012

190

200

210

220

230

Gold$ per troy ounce

Jan Oct2012

1500

1600

1700

1800

European stocks

Source: Thomson Reuters Datastream

Indices (rebased)

Jan Oct201260

70

80

90

100

110

Ibex 35 MSCIFTSE Europe

Bond yieldsRedemption yield on 10-yeargovernment bonds (%)

Jan Oct1.0

1.5

2.0

2.5

UK

US

Germany

Cost challenge: Canada’s heavy oil producers need highprices to avoid losing money Rezac/Greenpeace

FINANCIAL TIMES FRIDAY OCTOBER 12 2012 ★ 7

World Economy

Marunouchi has rarelylooked this pretty. Themain financial district ofTokyo, which provides thebackdrop to the 2012 meet-ings of the InternationalMonetary Fund and theWorld Bank Group, hasbeen buffed and polishedfor months.

Tokyo station, just behindthe main conference venue,has a gleaming new façade.A construction site near theA-listers’ hotel has becomea mini eco-park. Lightsadorn trees lining the mainstreet of Nakadori, whichtomorrow will host a grandparade featuring drums,flutes, bells and demons.

All this pageantry has apoint. Last year the worldassociated Japan withscenes of panic and suffer-ing, as the nation experi-enced its biggest ever earth-quake, its most deadly tsu-nami in more than a cen-tury and its worst nuclearaccident.

This year, the world’sthird-largest economy hasrebounded – and this week,thousands of attendees ofthe world’s most importantfinancial summit have hadthe chance to see it forthemselves.

Delegates have takenrickshaw rides aroundNihonbashi, the Edo-periodcentre of mercantilism, andsampled sake from each ofthe country’s 47 prefec-tures. Others have opted forthe kimono fittings inGinza, or the geisha cruisein Tokyo Bay.

“The world got theimpression that this archi-pelago had been fried byradiation and it wasn’t safeto go,” says Paul Blustein,Japan-based senior fellow atthe Centre for InternationalGovernance Innovation(CIGI), a think-tank basedin Waterloo, Canada. “Peo-ple landing in Tokyo maybe shocked to see just how

comfortable and well-to-dothis place really is.”

Japan’s economic growththis year should be amongthe highest of developednations, thanks largely to aresurgence of consumerspending in the first half ofthe year, and ongoingefforts to rebuild thetsunami-hit north-east.

Hence the special field-trips this week to the boom-town of Sendai, capital ofMiyagi prefecture, whichhas been boosted by thearrival of thousands of con-struction workers. Hencethe gift from the Ministry ofFinance to each delegate: asmall ornamental doll fromFukushima prefecture,which rights itself whenknocked over.

“The major message thegovernment wants to sendout is that life and the econ-omy in Japan is back tonormal,” says DaisukeKotegawa, research directorat the Canon Institute forGlobal Studies, and aformer executive directorfor Japan at the IMF.

Task number two forTokyo, at a time of tensionswith China and Korea overterritorial claims, is toimpress on delegates theidea of Japan as a matureand responsible world citi-zen.

Tokyo, after all, had notbeen scheduled to host the2012 autumn meetings,which are held every threeyears outside Washington.That honour was supposed

to fall to the Egyptian cityof Sharm El-Sheik.

But as the IMF castaround for a replacementafter the toppling of HosniMubarak, Japan acceptedthe call. Stepping in, inJune, not long after thequake, was seen as a way toremind finance ministersand central bank governorsof 188 member states of thenation’s commitment tomultilateralism, even in itsown moment of crisis.

This week’s discussionson restarting internationallending to Myanmar –inserted into the IMF/WorldBank’s programme at

Tokyo’s behest – were alsoaimed at bolstering thatimpression.

“If we can start providingsubstantial assistance,including through theWorld Bank and the AsianDevelopment Bank, Myan-mar can be another Viet-nam,” explained TakehikoNakao, Japan’s top finan-cial diplomat, at a briefingto journalists last week.

The IMF itself has lav-ished praise on its second-

largest shareholder. Whenthe fund went cap-in-handto its member countries ear-lier this year to boost itsfirepower, for example,Tokyo was first to chip in.Its $60bn pledge was alsothe largest from any coun-try, helping to lift the totalloans available to the IMFabove $1tn.

And in November 2008, inthe wake of the Lehmancollapse, then prime minis-ter Taro Aso offered theIMF up to $100bn in tempo-rary funds, while calling onother member countries toinject additional permanentcapital.

“When the global econ-omy faced its darkesthours, you stood by yourfellow global citizens,” IMFmanaging director Chris-tine Lagarde told a TokyoIMF forum in July, a cur-tainraiser to the mainevent.

Japan’s actions, she said,had helped “stave off aneven more dire global eco-nomic collapse”.

Beyond these two broadaims, Tokyo wants whatevery host nation wants: toteach the world a thing ortwo.

The last time Japanthrew open its doors to theIMF/World Bank, in 1964, ithad real economic growthof 11.2 per cent, unemploy-ment at one-quarter oftoday’s levels and a tradeaccount about to embark onmore than four decades ofalmost unbroken surpluses.Now, real gross domesticproduct has shrunk in threeof the past four years, andthose trade surpluses havevanished.

But the country’s bigproblems – energy con-straints, the ageing of soci-ety and massive fiscal defi-cits – are by no meansunique to Japan.

“There is a great senseamong Japanese of Japanbeing disregarded, and con-sidered irrelevant,” saysTakatoshi Ito, dean of thegraduate school of publicpolicy at the University ofTokyo, and a former IMFresearcher.

“Yes, we are declining,relatively speaking, but it ismuch too early to dismissus. We want to be put backon the map.”

Pageantry replaces panic ashost nation pulls out the stopsJapan

The world’s thirdlargest economy hasrebounded after theearthquake, writesBen McLannahan

‘Yes, we aredeclining, relativelyspeaking, but it ismuch too earlyto dismiss us’

Posters for the IMF­World Bank Tokyo meetings Bloomberg

The year is 1986. The venue, asweltering Estadio Azteca inMexico City. The occasion,England vs Argentina in theWorld Cup quarter final. Just

under 10 minutes into the second half,Diego Maradona, Argentina’s brilliantplaymaker, picks up the ball near thehalfway line and beats five players toscore a goal often hailed as the great-est of all time.

Sir Mervyn King, Bank of Englandgovernor, believes Maradona’s goaltells us something about the nature ofmonetary policy. “The truly remarka-ble thing is that Maradona ran virtu-ally in a straight line. How can youbeat five players by running in astraight line? The answer is that theEnglish defenders reacted to whatthey expected Maradona to do.Because they expected Maradona tomove either left or right, he was ableto go straight on,” Sir Mervyn said in2005.

Similarly, by convincing marketsthat they will shift monetary policy in

one direction or the other, centralbanks can let expectations that theywill act – rather than action itself – dothe work for them.

Sir Mervyn made the commentsseven years ago. But the Maradonatheory of monetary policy is one thatthe world’s two most important cen-tral banks, the Federal Reserve andthe European Central Bank, havedeployed in recent months.

With interest rates close to zero, theFed has resorted to verbal commit-ments, in September pledging to keepinterest rates near to their currentrecord lows until 2015. The hope isthat this commitment is credibleenough to lower borrowing costs forbusinesses and households taking outlonger-term loans. The Fed and theECB have also attempted to counterthe mood of economic gloom by com-mitting to expand their alreadybloated balance sheets until condi-tions improve.

ECB president Mario Draghihas said the central bank will do

“whatever it takes” within its man-date to counter expectations of abreak-up of the eurozone. Thatincludes buying a potentially unlim-ited amount of eurozone governmentbonds, so long as ailing sovereignsagree to economic reforms.

The Fed has said it will purchaseboth mortgage-backed securitiesissued by the government-sponsoredenterprises Fannie Mae and FreddieMac along with government debt untilthere is a sustained improvement inthe US labour market.

The ECB and the Fed will hope that,as with Maradona’s goal, this expecta-tion of open-ended bond purchaseswill mean that their actual buyingsprees are far smaller than they other-wise would have been.

Paul Mortimer-Lee, economist atBNP Paribas, said in September afterthe announcement of the details ofthe ECB’s new bond-buying OutrightMonetary Transactions programme:“If the central bank commits to inter-vening with unlimited firepower andis credible, then it might not actually

need to do anything at all. So far, therally in peripheral debt and the dropin volatility would suggest it appearsto be working – and working verywell.”

Mr Draghi’s credibility has beenstrengthened not just because therewas only one dissenting vote againstthe OMT – from Bundesbank presi-dent Jens Weidmann – but also by thefact that he split the German elite.The ECB president received thebacking of Angela Merkel, Germany’schancellor, and Wolfgang Schäuble,Germany’s finance ministerin August. Jörg Asmussen, a Germanmember of the ECB’s executive board,did not participate in the governingcouncil’s August meeting, where theOMT was first approved.

Yields on Spanish and Italian gov-ernment debt, for now, remain atmanageable levels. But the Maradonatheory of monetary policy alone couldprove insufficient. “The Spanish pre-mier Mariano Rajoy may become a bit

like those England defenders – immo-bile and loath to ask for support. Themarket will then question whetherthe strategy is working,” Mr Mortim-er-Lee said, adding that Maradonacould only get away with running in astraight line because defenders wereused to his twists and turns.

Mr Draghi might have to master thecentral banking equivalent of Dutchfootballer Johann Cruyff’s bewilder-ing signature move – that is, buyinglarge amounts of government bonds –if the OMT is to work.

In the Fed’s case, its open-endedcommitment to expand its balancesheet is more credible; a measure ofUS inflation expectations rose to itshighest level since 2005 in the daysfollowing the announcement of QE3.But it is unclear whether the Fed canconvince businesses to add jobs aseasily as they can influence financialmarket sentiment, or whether bankswill pass on the benefits of the bondpurchases to consumers.

In the UK, the Bank of England andthe Treasury have tacitly acknowl-edged the limits of government bondpurchases, unveiling in June theFunding for Lending scheme, whichcame into operation in August. Unlikequantitative easing, which works bybypassing the banks, Funding forLending was set up to encourage lend-ers to offer more and cheaper credit tothe UK’s businesses and householdsby lowering banks’ funding costs. Themore banks extend credit, the morebenefit they will get from Funding forLending.

Cheaper funding will help. But amore pressing concern for lenders isthe need to raise capital to meet regu-latory requirements and provide somesuccour to concerned investors. Inthese circumstances, deleveraging –not extending credit – remains themore obvious course of action.

Other, more radical, options remain.Central banks could buy riskier, lessliquid assets. Or they could offervouchers to households, to be spentby a set date, to boost consumption.But many already believe their exist-ing policy responses have stretchedmonetary authorities’ mandates andcredibility as guardians of price stabil-ity to the limit.

If the effectiveness of the latestround of measures proves limited,central banks could have to breakthe rules and adopt policies thatowe more to Maradona’s first goalagainst England – which sawthe Argentine use what he laterdescribed as the “hand of God” topump the ball into the net with hisfist – than his brilliant second.“He was lucky to get away with it,”Sir Mervyn King has said of Mara-dona’s gambit.

Central bankers, too, might soonhave to ride their luck.

Maradonalends handon centralbank policy

Monetary options Policymakers hopeexpectations of bond purchases will reducethe need for action, writes Claire Jones

Forward­looking policy move:Diego Maradona of Argentina onhis way to scoring against Englandin the quarter­final at the 1986World Cup in Mexico Getty

The Fed and the ECB aimto counter the mood ofeconomic gloom bycommitting to expandtheir balance sheetsuntil conditions improve

8 ★ FINANCIAL TIMES FRIDAY OCTOBER 12 2012