Shutdown Raises Global Recession Risk as Lagarde Lambastes U.S.

Global finance chiefs chastised the U.S. for the political gridlock they identified as the biggest threat to the world’s economy and financial markets.

Arriving in Washington for the annual meetings of the International Monetary Fund and World Bank, policy makers expressed concern that failure by U.S. lawmakers to end a government shutdown and raise the nation’s debt ceiling could trigger default and recession, imperiling already historically sluggish growth around the globe.

The lack of resolution would have “very negative consequences for the U.S. economy and spillover effects which mean negative consequences for the rest of the world,” IMF Managing Director Christine Lagarde told Bloomberg Television’s “Surveillance” with Tom Keene today. “It could precipitate another crisis if it was to last longer.”

Ten days into the shutdown, lawmakers have a week remaining to lift the U.S.’s $16.7 trillion borrowing limit or risk a default that would potentially sound echoes of the 2008 collapse of Lehman Brothers Holdings Inc. U.S. stocks and the dollar climbed today while Treasury bill rates tumbled amid signs that lawmakers could strike a deal.

“Politicians are playing with fire here, are playing with the credibility of the economy, are playing with the sustainability of the recovery,” Chilean Finance Minister Felipe Larrain said in an interview. “It’s a major effect on U.S. markets, on global markets.”

 

Political Impasse

Both Lagarde and U.S. Treasury Secretary Jacob J. Lew warned that the political impasse could sap the safe haven status of U.S. assets.

“The world actually counts on us being responsible,” Lew told the Senate Finance Committee, as he cautioned that the spat is “beginning to stress the financial markets.”

Lagarde said the U.S. should be wary that it is “not damaged because of what is going on.”

The potential fallout was enough for the IMF to warn this week that a default could “seriously” harm global activity as it cut its economic forecasts for this year and next to 2.9 percent and 3.6 percent respectively. Even with stabilization, recent expansion is still averaging half the pace it did before the 2008 financial crisis, leaving it vulnerable to shocks.

 

Global Performance

The four-year moving average of global growth when measured by nominal gross domestic product is just 2.2 percent, compared with about 6 percent prior to 2008. Deutsche Bank AG strategists estimated last month that the five-year average is the weakest since the 1930s, and that even in recovery, the world is $41 trillion poorer, when its performance is compared to the pre-crisis trend.

Avoiding a breach of the cap by pulling back government spending to ensure the Treasury can meet its interest payments would still force the world’s largest economy into recession, according to economists at Goldman Sachs Group Inc. and IHS Inc. (IHS)

Even just the worry that the U.S. might default prompted Hong Kong’s futures and options market operator today to demand traders put up more collateral when using some Treasury bills to back up their positions.

Premier Li Keqiang yesterday told Secretary of State John Kerry that China was paying “great attention” to the U.S. debt ceiling, the official Xinhua News Agency reported today. China is the largest foreign owner of U.S. Treasuries, with $1.28 trillion worth of them at the end of July.

 

‘Acute’ Uncertainty

The shutdown has already provoked Bank of America Merrill Lynch economists to slice their forecast for U.S growth this quarter to 2 percent from 2.5 percent. A month-long impasse could cut activity more deeply and undermine financial markets, hurting trade partners such as the U.K., Mexico and Canada, according to Gustavo Reis, a senior international economist at BofA Merrill Lynch.

“A fiscal hit to the U.S. could suck much needed air from the global upturn,” he said. “With political uncertainty remaining acute in the U.S., we continue to see risks to global growth biased to the downside.”

At JPMorgan Chase & Co. (JPM), Senior Global Economist Joseph Lupton in New York still bets there will be a pact and that a pickup in global manufacturing against a backdrop of easy monetary policy is enough to expect a “period of lift” in the world economy into next year.

Other Threats

Other threats to recovery lie outside the U.S. too. Emerging markets, the locomotive of expansion in the post-crisis years, have weakened. Performance also remains lackluster in the euro area where some banks still struggle to lend and Germany has yet to form a coalition government.

“There is a big risk that shocks will disturb the European environment,” Axel Weber, chairman of UBS AG (UBSN) and a former Bundesbank president, told Bloomberg Television in Washington. “Politics has to get its act together to provide leadership globally.”

While the subject of ire for the collapse of Lehman Brothers in 2008, the U.S. typically uses the annual IMF and World Bank meetings as a bully pulpit to press others on the need to improve economic policy, be it China to revalue its currency or Japan to reflate its economy.

Just two years ago, then-Treasury Secretary Timothy F. Geithner warned euro-area counterparts that they threatened “cascading default, bank runs and catastrophic risk” unless they tackled their own fiscal crisis.

 

Fed Tapering

The U.S. may face further pressure from foreign officials to clarify its monetary-policy plans after the Federal Reserve signaled this summer that it may unwind its $85 billion asset-purchase program, before deciding last month to leave it unchanged.

“We all understand that there needs to be better communication, there needs to be greater predictability and better coordination among all of us at the G-20 so that we can minimize turbulence,” South African Finance Minister Pravin Gordhan said in an interview.

President Barack Obama’s nomination of Janet Yellen to run the Fed did find international favor with Bank of Korea Governor Kim Choong-Soo, who said she may keep policy consistent with that of Ben S. Bernanke, the current Fed chief.

 

(Bloomberg)

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Date Posted

October 10 2013