World economic recovery or is it all just talk?

By Larry Elliott and Mark Milner

LONDON: Rome seemed to agree with the G7 finance ministers at the weekend. Just ahead of the talks, financial markets were on the slide amid a fresh bout of nervousness.

There were signs, too, of fractiousness among the big players. U.S. treasury secretary Paul O'Neill had dropped a strong hint that Europe wasn't pulling its weight. France's finance minister, Laurent Fabius, had hinted equally strongly that when it came to the blame game, people in glass houses shouldn't throw stones.

But, warmed perhaps by the Roman sunshine, the finance ministers cobbled together a surprisingly upbeat message.

Things might have been worse than initially expected, but the worst could soon be over. The American economy would pick up in the last three months of the year and turn in a relatively respectable 3 percent improvement in 2002. There was support for Japan's latest blueprint aimed at dragging the country's moribund economy out of recessionary mire. Europe, struggling with its "one size fits all" monetary policy, barely rated a mention -- even though its largest economy, Germany, is in big trouble.

They have a case. The United States has had six cuts in interest rates this year. American taxpayers are about to get a hefty cut in their annual bills from the internal revenue service. Europe's central bank has been less accommodating than the Federal Reserve, but several governments are promising their voters tax cuts. A strong bounce-back in American consumer demand along with an export-led recovery in Europe on the back of a weak currency plus structural reform in Japan equals better times ahead.

But some finance ministers may have thought their colleagues were whistling to keep up their spirits. The British finance minister, Gordon Brown, for instance, injected a typically prudent note. "The downturn in the world economy has not yet reached its bottom. No country and no continent can be insulated from global economic developments."

So what could go wrong? Plenty. Whichever country you choose, the corporate sector is hurting. Profits warnings pile upon profits warnings. For many, the immediate response is to shed jobs -- look no further than the telcom Marconi. Last week the company warned profits would halve and that it was slashing its payroll. Nortel, Ericsson, Philips and Siemens have all announced job losses.

Even Nokia, for long the darling of the telecoms sector, finally succumbed to the downturn. Last month it warned that profits would not match expectations and jobs would have to go.

As firms cut their inventories and their payrolls, confidence among corporates, investors and consumers is dented with a knock- on effect on the real economy.

The key to recovery, particularly in the United States, is whether the boost to consumer demand caused by cheaper money and lower taxes will boost corporate earnings sufficiently to stop the rot in both corporate profitability and the performance of the stock market -- in itself in the U.S. an important factor in consumer confidence.

Bears of the U.S. worry that Federal Reserve chairman Alan Greenspan's aggressive monetary policy will only delay the inevitable. Pumping the economy full of cheap credit simply buys the U.S. a breathing space before an even more pronounced downturn takes hold.

The U.S. investment bank, Bear Stearns, puts it this way. "Despite occasional signs of U.S. economic resilience, we think the world is falling into a long recession under the pressure of the ever-strengthening US dollar and crude oil rationing. Debt burdens in Argentina, Brazil and Turkey are crunch points in the global slowdown."

The risks of a fresh emerging market crisis are high and increasing all the time. Turkey is still wrangling with the International Monetary Fund over a rescue package tied to a restructuring program. Brazil is waiting for Argentina, which has the potential to be the Thailand of 2001.

The country is heavily in debt, its currency -- tied to that ever-rising dollar -- is under severe strain, its economy is buckling under austerity measures endorsed by the IMF. Prices are falling, so are tax revenues. Interest rates are 11 percentage points higher than in the states. Unemployment is around 16 percent, sales of big ticket consumer goods like cars have slumped. To make matters worse, squabbling politicians appear reluctant to agree the sacrifices required -- although with a congressional election looming, that is hardly a surprise.

The country's finance minister, Domingo Cavallo, who steered Argentina out of a previous crisis a decade ago, refuses to be downhearted. Argentina won't devalue, he insists, and the country will pull its way out of recession later this year.

Not everyone agrees. Bear Stearns argues that "default or a forced debt restructuring" is a likely outcome of Argentina's problems.

"We think the current situation -- no default, no devaluation, no dollarisation and no growth -- is unsustainable."

The Bear Stearns analysis concludes that the slowdown this time, if it happens, will be different from that of 1997-1998, when markets crashed but the real economy in the west remained firm. "We expect more contagion through the real economy than through financial markets. An Argentine default, with related difficulties in Brazil and other emerging markets, would heighten current world trends toward limited growth and investment in developing countries; and deflation as more countries push their goods on to shrinking world markets."

Even the Panglossian view of the world economy which prevailed in Rome at the weekend implicitly acknowledges that one of the most serious problems facing the global economy will not go away -- the strength of the dollar. If, as expected by the G7, U.S. growth does recover and begin to outpace that of euroland in the second half of this year and into next, the dollar will continue to seem more attractive to international investors than the single currency.

That would add to inflationary pressure in Europe, making it harder for the European Central Bank to cut rates, but increase the squeeze on profits for the U.S. corporate sector, which is already suffering dearer energy costs. The stronger dollar would also compound the problems of countries like Argentina. Compared to G7 countries it may be a relatively small fry but as previous crises have shown, size does not always matter.

-- Guardian News Service