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World Economic Forum: Governments losing battle against global deflation

The character of responses to the recession augurs badly for a sustained recovery. The right sort of domestic consumption stimulus has not been put in place in China – the country is racing for exports again. Other regions are ill-equipped to cope; a Japan-style stasis of deflation and growth looks to be just around the corner, writes Charles Dumas of Lombard Street Research.

THE IMBALANCES THAT spawned the global financial crisis and so-called Great Recession are mostly acknowledged now – in contrast to mid-2008 – but the fallout from the crisis is that recovery depends on the policies of the surplus countries. A healthy recovery could ensue if they reduce their net saving, which means either structural policies to lower the private sector’s excessive saving or willing adoption of structural government deficits.

An alternative equilibrium might be achieved were the imbalances to continue but be offset by steadily lower relative prices of surplus countries’ exports – lessening the real burden of imports by deficit countries – and a willing acceptance of low to negative real rates of return on the resultant net export surpluses. But this is an inherently unlikely programme. While surplus countries putting their net exports into deficit countries’ equities and real estate would be a valid alternative to accepting low to negative real returns, it would be psychologically at odds with the natural caution that underlies the high savings in the first place.

Failing such an optimal or modestly sub-optimal mode of economic recovery, the global recovery depends on huge increases in government deficits, concentrated in the same deficit countries that have just over-utilized their private-sector debt capacity to stimulate demand and offset the need for private debt reduction.

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