IMF predicts global recession when Greece defaults

Posted on 21 September 2011 with 1 comment from readers

With markets predicting a near 100 per cent certainty of Greece defaulting on its sovereign debt the warning from the International Monetary Fund that this will precipitate a crisis that will put the world back in recession is sobering but hardly a revelation.

Yesterday the IMF lowered its growth targets for all the major economies but said this assumed ‘business as usual’ with no default by Greece and President Obama’s $447 billion stimulus package being approved. Neither proposition is realistic: markets have Greece down for a default; and President Obama’s package will not emerge unscathed from Congress.

Recession distinct possibility

Even the understandably carefully worded IMF statement conceded the worst scenario was a ‘distinct possibility’. What else can you say in the face of the blindingly obvious that you wish was not true?

The IMF’s ‘downside scenario’ has the Greek sovereign debt crisis spreading to other eurozone nations. Yesterday Italian debt was downgraded by S&P, and the Portuguese Prime Minister warned his country will need help if Greece defaults along with Ireland.

Under the worst scenario there will be a systemic shock to eurozone banks leading to higher bad debts in the US and Asia and a slowdown in the global economy and ‘the US and the euro area would fall back into recession, with output in 2012 more than three per cent below projections’.

Calling on Europe to ‘get its act together’ the IMF urged policymakers to deal with the banking crisis by ‘injecting new capital and restructuring weak but viable banks while closing others…and injecting public funds’.

Indeed the IMF prescription sounds more like a capitulation than a solution. The broad sweep is to advise backing off from government cutbacks until economic growth rates improve and printing more money to throw into the system.

This is certainly not the sort of remedy the IMF would have proposed for mismanaged economies in the past. The contrast with its approach to the Asian Financial Crisis of the late 90s is stark. Then it bankrupted overstretched companies and individuals to knock back indebtedness with a fiscal squeeze and left countries to struggle. It was painful but worked.

Muddling through

Will the industrialized nations choose the alternative course now being suggested to them by the IMF? Most likely we will get some sort of corrupted version of the same script with political meddling stamped all over it. That seems unlikely to avoid the recession or eurozone banking crisis, and it risks fuelling up a bubble in government bonds in the smaller and small number of nations able to issue them at low coupons.

The IMF report does not even dare consider this, although past global financial crises have often climaxed with a crash in the bond markets. For unsustainable debts generally result in bankruptcy for the debtor and much higher interest rates for everybody else.

Will it be any different this time? Probably not and it is about time that IMF economists started to look further ahead that 15 months into the future. Where is this crisis taking us?