PART II - Demand deficiency threatens world order

PART I -World braces for crucial summit
PART III-Streets heat up as world faces tough choices
PART IV -The 25 sentries take on the global turmoil
PART V -Financial stability a must for healing

The G20 summit in London on April 2 will focus on finding a way for the world to emerge from the economic crisis, the worst since the Great Depression of the 1930s. But to solve a problem one has to find what it is first, and that seems to be one tough job.Â

As credit lines freeze, global demand dips and millions of jobs are lost, one question inevitably lingers: How did it come to this?

Speaking to the Hürriyet Daily News & Economic Review, global experts underlined a "collapse in global demand," which implies that the real issue is much more complex than the collapse of stock markets. In the words of Neil Shearing, an emerging Europe economist at Capital Economics in London, we are living in a time of "deficient global demand."

"Consumers in the United States, Britain, Australia and parts of Europe borrowed far more than they could afford," said Christopher Low, chief economist at FTN Financial in New York. "They used their homes as collateral, and as long as they had home equity, they could borrow more, which they used to service the debt and to buy consumer goods."

As soon as the value of their homes fell, however, they were cut off from further credit, and there was an immediate drop in spending, said Low, adding that the drop in borrowing - lost spending power - constitutes "several trillion dollars a year" in the United States alone. Thus, "even the $787 billion U.S. stimulus package cannot offset" that lost power, Low told the Daily News.

"The loss of buying by the biggest consumer economies has hurt every country around the world, due to weakened exports," Low said.

More bad news on the way

Charles W. Calomiris, professor of financial institutions at Columbia Business School, pointed to the "difficulty in assessing the value of subprime-related securities held by institutional investors," a must if the credit markets are to be unfrozen.

Marco Annunziata, chief economist at UniCredit in London, agreed. "The efforts deployed by policymakers globally have not yet been sufficient to restore confidence in the financial sector," he said. "This is because the total amount of toxic assets in the system was so large and their complexity so high, that it is taking much longer than expected to restore transparency in the banks’ balance sheets." Â

The global economy has entered into a "deep, coordinated recession," according to Annunziata. "Central banks have reacted by cutting rates almost to zero and in some cases initiating quantitative easing, while many governments launch fiscal stimulus programs. But it takes time for these measures to have an impact on the real economy, and in the coming months we will still see contractions in economic activity and increases in unemployment."

"The demand generated by the housing bubble has disappeared," said Dean Baker, co-director at the Center for Economic and Policy Research in the U.S. "The contraction in the U.S. housing sector has directly reduced annual demand by about $450 billion, due to lost construction and home sales."

The loss of $6 trillion in housing bubble wealth, with "at least another $2 trillion on the way, coupled with a loss of $8 trillion in stock wealth" is translating into a "decline in annual consumption of around $800 billion a year," he said. "In addition, the collapse of a bubble in non-residential real estate will be reducing annual demand by another $150 billion to $200 billion," Baker said, also implying that the current stimulus packages are far from providing a cure.

The solution to the crisis lies in the United States and Western Europe, according to Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley. "The U.S. has not taken concerted steps to stop the bleeding in its banking system. Until that is done, its economy won't stabilize," he told the Daily News.

"Europe has not done enough to stabilize Eastern Europe, where capital inflows have halted, or in Greece and Ireland where there is deep financial trouble. Problems there are now beginning to severely undermine confidence in Western Europe's own economy and financial system."

To undo the damage, much needs to be done, all agree. But to do what is necessary might be so "painful" for the billions of people already angry and hurt that there is, inevitably, a political side to this economic story.

"The real obstacle is political," Charles W. Calomiris, a professor of financial institutions at New York’s Columbia University, said. "Banks are so unpopular that politicians lack the will to ... end the crisis, which would require governments to absorb the extreme downside risk held by banks," he said. "Helping the banks would be the beginning of recovery, and should be supported by everyone, but the banks are so unpopular that helping them exposes a politician to attack from his opponents."

PAIN IN EASTERN EUROPE

The woes of Central and Eastern Europe have formed the latest wave in the crisis, and Michal Musak, an economist from Slovakia, is witnessing the pain first-hand.

"The slowdown in the eurozone and elsewhere means there is much lower demand for products made in Central and Eastern Europe," he told the Daily News.

"Eeconomic growth is set to slow down considerably. In Slovakia, we saw double-digit growth in 2007, while next year's growth now seems to be close to zero. Some investors lost faith in the region and regional currencies have weakened significantly."

This weakness excludes Slovakia, which adopted the euro in January. But in Hungary and, to a lesser degree, Poland, the rapid devaluation means "higher cost of servicing debt, as local firms and households borrowed a lot in foreign currencies," Musak said. "Now they feel the pain of a weaker currency. Growth will stay mute until there is a better mood in the eurozone."

*Taylan Bilgiç is the managing editor of the Economic Review. Write him at taylan.bilgic@tdn.com.tr