The IMF has made another call for austerity in spending, particularly in Europe. The agency has also put restated its belief that growth in GDP is Europe’s only path to financial viability. The two approaches are almost certainly mutually exclusive. Budget cuts are likely to be regressive along with the taxes that usually accompany them. And the cuts often bring civil unrest, particularly in Europe.

Naoyuki Shinohara a Deputy Managing Director of the IMF told an audience in Singapore that unsettling movements in the global markets, brought on to a large extent by the budget crisis that is roiling Europe could spread to other regions.

Developments in financial markets pose a major downside risk to the global economy. They could have negative effects on private and sovereign funding rates, bank balance sheets and credit conditions, and capital flows and portfolio allocations. The ability of banking sectors to withstand funding shocks is of particular concern. This risk is heightened by market doubts about political effectiveness and the ability of governments to deliver on needed policy measures.

Shinohara believe that government policy should err on the side of budget cuts at the expense of stimulus if necessary. That almost certainly means a slower recovery in the US and EU markets. President Obama tried to push a “second stimulus” package though Congress. It was eviscerated and only some provisions for unemployment insurance survived. EU nation’s, some of which are still in recession, will not emerge from economic difficulties without some government aid to improve liquidity and the availability of credit.

Asia, he argued, is likely to be the engine of global financial expansion during the foreseeable future, but its growth many not be enough to offset lagging economies in other parts of the world.

This owes much to the extensive financial reforms following the Asian crisis of the 1990s, as well as the role of traditional virtues—maintaining adequate capital, avoiding excessive reliance on short-term funding, ensuring proper loan underwriting, and following sound risk management.

That leave the global capital and credit markets with a thin line of defence. China’s export increases continue to improve–up 50% in May. But so do its labor costs, and with that there is the potential of substantial inflation.

The IMF has plans for reform and improvement of the capital markets, but they rest on uncertain foundations.

Douglas A. McIntyre

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