PART III - Streets heat up as world faces tough choices

PART I -World braces for crucial summit
PART II -Demand deficiency threatens world order
PART IV -The 25 sentries take on the global turmoil
PART V -Financial stability a must for healing

This lack of political will in governments to solve the crisis is the main issue for Charles W. Calomiris, a professor of financial institutions at New York’s Columbia University, who said the aggressive approach requires “the political will to absorb downside risk.”

Calomiris also told the Hürriyet Daily News & Economic Review of an additional problem in Europe. "The lack of a framework for coordinating loss-sharing across countries [is the issue]," he said. "That political coordination problem could threaten the European economic and monetary union, if financial protectionism leads countries into open conflict over their financial systems' resources, which is conceivable."

Explaining why the current U.S. stimulus packages are not enough, Dean Baker, co-director at the Center for Economic and Policy Research in the U.S., said the loss in annual demand from the collapse of the residential and non-residential real estate bubble is "on the order of $1.4 trillion."

"The stimulus package comes to about $350 billion a year," he said. "This is nowhere near large enough to fill the gap. Until the U.S. government spends far more in stimulus, or the dollar declines enough to bring the trade deficit close to balancing, the downturn will not come to an end."

The ideological side of things:

Kevin H. O'Rourke, an economics professor at Trinity College in Dublin, Ireland, a country that is among the worst-hit, also said the governments have not done enough. "The stimulus packages announced to date have been grossly insufficient," he said. “In Europe there is an ideological resistance to doing the right thing that is becoming quite alarming."

So, when they meet at the roundtable in a few days, how can G20 leaders make sure April 3 will not be "another day in the crisis?"
O'Rourke said the first thing the G20 should do is "to announce that there is not a trade-off between reforming the global financial system and stopping this depression from becoming a Great Depression."

"The G20 should announce a coordinated and ambitious macroeconomic stimulus package and any central banks who have not yet cut interest rates to zero should do so immediately," he told the Daily News. "All central banks should also be ready to embark on large-scale quantitative easing measures. They should also greatly expand the resources available to the IMF to deal with countries in particular difficulties. In that context, calls to keep international trade open would be a lot more credible."

Baker agreed with such an aggressive approach. "The best thing the G20 can do is to be aggressive about pushing stimulus. It should also demand that the central banks that have room to cut rates do so," he echoed O'Rourke.

But his other proposals were definitely not in line with the prevailing "free market" thinking. "The best and quickest form of stimulus right now would be tax credits for employers to offer paid time off, such as shorter workweeks and longer vacations," he said. "This can immediately get more money into the economy and lead to a situation in which there are more people employed at every level of gross domestic product. For example, in the U.S., if the average work year was reduced by 3 percent, this would create 4.2 million more jobs at the same level of GDP."

Stepping up coordination:

Coordination is the key word for Marco Annunziata, chief economist at UniCredit in London. "The G20 should step up coordinated fiscal stimulus programs, as a coordinated expansion of fiscal policy would have a stronger impact on the global economy and help revive global trade," he said. Still he warned of a transatlantic rift: "Some key eurozone countries do not seem convinced that more stimulus is necessary. This, in my view, creates the risk that the recession in Europe might be even longer than in the U.S."

"The best the G20 could do is to show a steady hand," said Rainer Singer, an analyst overseeing Central and Eastern Europe at the Erste Group Bank. "We support further measures to stabilize the financial sector as this is a prerequisite for a global recovery. Economic stimulus should be decided on a by-country basis as the macro situation differs strongly among G20 members," he told the Daily News.

"The best thing the G20 could do would be to commit to sizeable fiscal stimulus packages," said Neil Shearing of Capital Economics. "There remain significant political hurdles to overcome, however, which makes this unlikely. More generally, the crisis is only likely to abate once the problems in the U.S. and European banking sectors are fixed – that means coming clean about the true extent of losses, and may ultimately not be possible until housing markets have stabilized."

To heal emerging markets, a sizeable injection of funds into the IMF would be "most welcome," Shearing said. "This would help countries that are struggling to roll over large amounts of debt against a backdrop of weaker global risk appetite. In Emerging Europe, a pan-regional bailout fund might be the best way to stop the current rot in markets."

WORST-CASE SCENARIOS

Christopher Low (FTN Financial): "The worst case is a debt deflation spiral, which is what caused the Great Depression in the 1930s to drag on for so many years. Deflation occurs when the value of assets, the price of goods and services and income all fall for an extended period."

Barry Eichengreen (University of California, Berkeley): "If nothing is done, this turns into a lost decade like Japan in the 1990s."

Charles Calomiris (Columbia University): "My worst-case scenario is one of continuing financial meltdown, which would entail significant worsening of unemployment in developed countries, spreading to the rest of the world. This scenario would also entail some sort of unravelling of the European economic and monetary union, or at least the postponement of new members' involvement in the eurozone."

Dean Baker (Center for Economic and Policy Research): "In my worst-case scenario, concerns on deficits obstruct sufficient stimulus in the U.S. and elsewhere. This causes the economy to continue to spiral downward in 2009 and 2010. The downturn could continue almost indefinitely. That is the same mistake that political leaders made in the 1930s, thereby causing the depression to last a decade."

Marco Annunziata (UniCredit): "The worst-case scenario is one where the financial sector remains dysfunctional for the rest of the year, with zombie banks unable to lend, and the contraction in real GDP intensifies and extends into 2010. We might end in a multi-year depression."

Kevin H. O'Rourke (Trinity College): "If policy makers do too little, too late, the slump worsens, populist politics are strengthened everywhere and the world sees a wholesale return to protectionism, with unpredictable consequences for international relations."

BEST-CASE SCENARIOS

Christopher Low: "This relies on several things working together: the Chinese stimulus boosting demand, jobs and income; the U.S. stimulus stabilizing jobs and income and a housing rescue which stabilizes home values and reduces the debt load. If other nations were able to use stimulus, the odds of success would be even better."

Barry Eichengreen: "If the real problems are addressed, the world economy will begin to recover in the second half of 2010."

Charles Calomiris: "The G20 governments adopt a credible, effective plan for ending the financial crisis by agreeing on measures to eliminate the extreme possibilities of loss in the financial system, and find ways to coordinate the costs of doing so across borders. I view the chance of this happening at the upcoming G20 meetings as remote."

Dean Baker: "The best scenario would to see all the major economies to offer aggressive stimulus packages, averaging 4 to 6 percent of gross domestic product, which could begin to boost the world economy by the end of the year.

Marco Annunziata: "In this scenario, we may see the beginning of normalization in the financial sector by the middle of this year, with growth bottoming out and then recovering in the second half, opening the way for positive world growth in 2010. Such a scenario depends largely on the success of efforts to stabilize the banking system, especially in the U.S."

Kevin H. O'Rourke: "If the correct macroeconomic policies are pursued, we may start getting out of the slump in a year or two."

* Taylan Bilgiç is the managing editor of the Economic Review. Write him at taylan.bilgic@tdn.com.tr
Tomorrow:  Buck Rogers and the 25 sentries