IMF Warns of Deepening Debt-Crisis Recession

News Brief – January 24, 2012

The International Monetary Fund cut its forecasts for growth in 2012 on Tuesday and warned of a possible deepening downturn in Europe.

Revising an earlier forecast, the IMF predicted that the global economy will expand 3.3%, this year, down from 3.8% last year and lower than the 4% growth it had forecast last September.

“The world recovery, which was weak in the first place, is in danger of stalling,” IMF chief economist Olivier Blanchard said. “But there is an even greater danger, namely that the European crisis intensifies. In this case, the world could be plunged into another recession,” he said.

Oliver Blanchard is spot on in identifying a serious threat to the world economy. His only error is from where he sees the threat coming and how bad it is.

On Monday IMF chief Christine Lagarde warned of a worst case scenario in the form of a possible Depression-era collapse in the global economy. If however Europe follows IMF recommendations, she said, the fund expects the euro zone to face a mild recession this year.

Nonetheless, it should be emphasised that this is still a “best case scenario.”   

Economists are increasingly concerned that Greece will default within weeks. Even worse, the larger economies of Spain and Italy are now under threat, pushing up the cost for Rome and Madrid to borrow to cover the risk of default.

The IMF 2012 forecasts that the economies of both countries will contract, with Italy facing a contraction of 2.2% and Spain a fall of 1.7%.

Neither is expected to recover economically until 2014, at least.

Meanwhile bigger economies such as the U.S., Japan, the U.K, France and Germany are expected to expand by only 1.5% on average next year, a growth rate too slow to curb rising unemployment levels.

Moreover, the IMF forecast of slowing global economic growth is based on the assumption that the world will not see a dramatic rise in the price of oil. If that were to happen then the IMF’s most optimistic forecast would be null and void, making its worst case scenario seem optimistic.

Iran’s recent rhetoric about “closing the Straits of Hormuz” seems intended to play on such concerns; with growing fears that a dramatic rise in the oil price could completely undermine prospects for global economic recovery.   

Although Tehran’s ambassador to the U.N. may have only been bluffing when he spoke recently about the “option” of closing the Straits, he seems to have hit a raw nerve.

Within days Western powers despatched naval vessels to the Straits of Hormuz – assuming, of course, that they had not planned this some time ago and were merely using his threats as an excuse.

Either way, as the European Union voted to impose harsher sanctions on Iran’s oil – and Iran responded by suggesting it could close the waterway through which 35% of the world’s oil is shipped – French, British and American warships were all sailing toward the gulf.

In response Iran declared defiantly that sanctions would provide it with an economic stimulous and repeated threats to close the straits.

Between claim and counter-claim and trading threats the West and Iran seem to be on a course for a confrontation. If it erupts into armed conflict then the world may not only face a slowdown in growth and financial meltdown. For both Russia and China have warned that they view the prospect of conflict with Iran with grave concern.

In fact Russia has repeated these warnings recently, as if to emphasise how seriously it views the situation. While China signalled a clear rejection of any new sanctions on Iranian oil.

We live in dangerous times. They could be about to become even more perilous.