Robert J. Samuelson: Repeating the same mistakes of the 1930s?

Published: Tuesday, Sept. 27 2011 12:00 a.m. MDT

John Poole, president of the Federal American National Bank in Washington in 1933, spoke from a window ledge of the Perpetual Building Loan Association to assure worried shareholders that the Perpetual was a sound bank and that the rumor was caused by false and unfounded rumors.

Associated Press

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WASHINGTON — "We are back in a danger zone," says a top economist at the International Monetary Fund. Though an understatement, it captures the central paradox of this year's annual meeting of the IMF and World Bank. Everyone is alarmed at the swift deterioration of the economic outlook, but there is no leadership — no consensus on what to do or, even when crude agreement exists, little conviction that practical politics will permit action. There is a hazardous vacuum of ideas and power.

Europe is now the flash point of global concern. Most of its major countries are indebted. The economy has slowed to a crawl; the latest IMF forecast (perhaps optimistic) puts next year's growth at about 1 percent. Banks are threatened by their exposure to depreciating government bonds. What looms is a vicious circle: Slower growth makes it harder to cut budget deficits; this causes investors to dump European government bonds; interest rates rise, banks weaken and the economy gets worse.

One possible way to break this cycle is to create a new global lending facility that would buy European debt and, in the process, lengthen maturities and charge modest (non-panic-driven) interest rates. This would provide time for Europe to make gradual changes — reducing spending, raising taxes — to bring budgets under control.

Call it a "bailout," a "rescue" or a "refinancing." It probably couldn't work without China. It has the money to become, in effect, Europe's lead banker. Its foreign exchange reserves total $3.2 trillion and are growing by hundreds of billions of dollars a year. But the United States and Europe don't want to call China, and the Chinese don't seem to want to be called.

Americans and Europeans don't want to cede power to China. China might seek a new world order based on China's interests, while ditching the existing system of "open, rules-based trade," writes economist Arvind Subramanian in his book, "Eclipse." China's involvement would probably trigger an uproar in the United States and Europe. Similarly, China apparently disdains the choices it would face.

Political paralysis meets economic drift. We are flirting with a renewed global recession. With 44 million already unemployed in advanced countries, the social and political implications are fearsome. Worse, a new recession might snowball into an even deeper and longer downturn.

The alternative is that Europe muddles through. Though possible, the odds seem increasingly against it. The Europeans' assumption that they can handle their debt problems smacks of wishful thinking.

There's too much debt. In the spring of 2010, the interest rates demanded by financial markets indicated that only about 5 percent of the eurozone's debt was considered highly risky, says the IMF. That represented only Greece. By late summer 2011, the portion judged risky was 46 percent and included Ireland, Portugal, Spain, Italy and Belgium. If financial markets added France to this group — a possibility — the share of threatened debt would rise to 66 percent.

It's implausible that the strong half or third of the eurozone (the 17 nations using the euro) could rescue all the weaker members, in part because "strong" countries also have high debts.

Europe is hostage to financial markets because maturing loans and ongoing deficits mean many countries must regularly borrow huge amounts. Already, Greece, Ireland and Portugal have been excluded from private markets; lenders demanded crushing interest rates. Some countries face staggering 2012 borrowing needs. The IMF estimates that Italy requires new loans equal to one-fourth of its GDP; for Spain and France, the amounts are about one-fifth of GDP.

Europe is caught in an economic pincer: slow-growth assaults from one side; fickle financial markets from the other. One obvious way out — the China option — seems barred by geopolitics. There is precedent. Historians blame the Great Depression's severity in part on poor international cooperation. Economist Charles Kindleberger found a vacuum of power: Great Britain, the old economic leader, could no longer lead alone; and the United States — a replacement — wasn't ready to help. Is there a parallel today between the U.S. and China? Are we repeating the mistakes of the 1930s? Unsettling questions.

Robert J. Samuelson is a Washington Post columnist.

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