Danger of World Economy in 2010

The greatest danger to the global economy in 2010.

January 28 2010 : The greatest danger to the global economy in 2010 is the gargantuan and growing debt of nations, say the participants at the World Economic Forum in Davos that began yesterday.

Put bluntly, it's that whole countries could go bankrupt, so the mood among the roughly 2,500 participants at the conference is grim - but not as grim as in 2009.

Surveys commissioned by the Davos organizers found growing economic confidence after the fear and gloom of 2009. But more than half the participants at the annual conference in the Alps say concerns about debt are paramount, followed by worries about protectionism and heavy-handed regulation.

Regarding national debt, the situation in 2010 is much better than in 2008, says Kenneth Rogoff, an economics professor at Harvard - but any sense of normalcy is an illusion. He suspects that the crisis in banking will mutate into a full-blown sovereign debt crisis.

The history of financial crises shows that they're typically followed by a tremendous surge in public debt, Rogoff says, and he doesn't think it's going to be any different this time. The concept that the United States can simply grow its way out of crisis and that the debts will simply dissipate is voodoo economics, says Rogoff: Hard decisions have to be made.

Barney Frank, a congressman from Massachusetts, concurs. Too much has been squandered, he says. Washington has to curb its spending and procurement lest it drag down the whole country; America has too many weapons and not enough enemies, he quipped. Moreover, it has to moderate its ambitions and not try to solve all the problems at once. "A trillion dollars can be spread over 10 years," Frank advises.

America can cut back on subsidies for farming and on its space program, too. "We need that money," says Frank. He supports tax hikes, for instance on hedge-fund gains, which is grating music to the ears of the businessmen thronging Davos.

Where are the monsters?

It's a broad consensus that without the swift actions by governments as the global economic crisis developed in 2008, the situation would be a lot worse. At least some businessmen are grateful. Anand Mahindra, vice chairman and managing director of India's heavy machinery and engines corporation Mahindra & Mahindra, says so openly: Things would have been much harder. Unemployment would be worse.

But the visitors to Davos are less united about the merits of future regulation. Peter Levene, chairman of insurance giant Lloyd's of London, is not enamored of government intervention. "It doesn't always work." he says. "What has Sarbanes-Oxley done?" he adds, referring to U.S. laws enacted after the collapse of U.S. energy firm Enron in an accounting scandal.

What that achieved was to spur businesses to move from New York to London, Levene continued. If regulators overshoot, he warned, the global capitals stand to lose businesses. "Swiss cantons are doing roadshows," he says, warning that they are trying to lure businesses to move there. His prescription? Let industry handle the trouble alone.

Mahindra holds an opposite view: While the business world wailed in terror at over-regulation in 2009, what actually happened? Nothing. "Where are the monsters?" Mahindra asked. "President Obama didn't even say the word Glass-Steagall." The truth, says the Indian industrialist, is that somebody has to fix the problems.

Frank, representative of the arch-intervener, naturally seconded Anand: "Letting people drive without police, traffic lights or roads isn't a good idea," Frank said.

When Citigroup was asked why it was doing dodgy things off its balance sheet, the answer was that if it didn't, it would be at a competitive disadvantage vis-a-vis Goldman Sachs, says Frank: The idea of not having laws to govern the subprime-mortgage market has become ridiculous. But he agrees that not all laws work; sometimes the legislator itself doesn't believe in them.

Economists at Davos agree with that last notion. A number of them argue that over-regulation is a secondary danger to the global economy in 2010. The main one is the absence of appropriate regulation.

Protectionism, when countries shield their domestic markets from competition, is another grave concern at the conference.

None other than Jacob Frenkel, chairman of JPMorgan Chase and former governor of the Bank of Israel, gave voice to this concern. There's nothing like a horrible economic crisis to spawn horrible decisions, he explains. "If there's one clear thing in economics, it's that free trade is a win-win for all sides," Frenkel says. "Beware of protectionism, especially the protectionist attitude that people might adopt."

Roubini quakes before the dragon

Nouriel Roubini is one of the world's more esteemed economists. He's also a Davos regular and perennial pessimist. This year one of Roubini's concerns is the tidal wave of speculative capital flowing into China, which he fears could create an asset bubble of vast proportions. That, a la Roubini, could lead to the worst capital devaluation in history.

During the broad panel discussion, the deputy governor of the Bank of China, Zhu Min, chose to highlight another danger: the low rate of interest on the U.S. dollar. This leads investors to try their luck at carry-trade strategies: They borrow money in dollars, on which they pay low interest, and invest the money where they can get higher returns. But one upshot is to exacerbate volatility on the currency markets, which, says Zhu Min, confers a danger to world markets.

The Chinese currency remained stable during the crisis and afterwards, Zhu Min said, which led Massachusetts congressman Barney Frank to remark: Stability is fine, but perhaps Beijing might stabilize the yuan a tad higher