Is the world heading for its third

global financial crisis?

The IMF annual meetings have been filled with a series of stark warnings, but
will a "triad" of challenges for the global economy trigger a fresh crisis?
It's another grey day in Lima. The sunless sky hangs over Perus capital as a mist forms
over the coastline. Across the city, there isnt a gap in the clouds for miles.
While storms almost never materialise, the weather during the International Monetary
Funds latest annual meeting captures the gloomy mood.
This week, the fund said global growth this year would be the slowest since the Great
Recession. A separate report by the fund warned that the world faced a triad of
challenges that meant policy missteps could wipe a massive 3pc off global growth.
Corporate borrowers in emerging markets could default en masse when the US raised
interest rates, it said. A new credit crunch, a fresh financial crisis: these were the risks
facing the global economy.

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For Andy Haldane, the Bank of Englands chief economist, recent market ructions and
concerns about the health of the Chinese economy could be the beginning of the latest
chapter in a three-part crisis trilogy.
As Chinas three-decade growth miracle comes to an end, the Anglo-Saxon crisis of
2008, which was followed by the eurozones meltdown in 2011, now threatens to
metastasise in emerging markets.
But while its clear that Chinas double-digit growth rates have come to an end, how low
can growth go? And who will be the biggest losers from the end of the commodity
boom?

Parallels with yesteryear

While its been almost 50 years since the IMF held an annual meeting in South America,
some things dont change.
In 1967, when members convened in Rio de Janeiro, Brazil, the fund was led by PierrePaul Schweitzer, a French lawyer who took the helm at a time of expansion and
creation of the special drawing rights (SDR) club of elite currencies.

The new world is lower commodity prices which are going to stay low for
the foreseeable future"
Mauricio Crdenas, Colombian finance minister
Christine Lagarde, also a French lawyer, leads the fund at another critical juncture,
where quota reform is badly needed and the IMFs advice on Greece for example
has not always been heeded.
Pessimists point out parallels between todays ructions and the Asian crisis of the
1990s. A stronger dollar has sucked money out of emerging economies and back into
the rich world, pushing down the value of emerging market currencies.
Optimists say flexible exchange rates have helped to cushion the impact of the
downturn, not hinder it, while stockpiles of foreign reserves also provide ammunition to
fight off a full-blown crisis.
Those who insist the glass is half full also highlight that past crises had a relatively small
impact on advanced economies. But pessimists point out that emerging markets now
make up the lions share of global growth, driving 80pc of world output since 2010, and
a much larger slice of global trade
But one thing that everyone accepts is that lower growth is on the way.
Jose Uribe, Colombias central bank governor, says it is time to face facts: We cannot
keep trying to grow at the rates of the past.
Mauricio Crdenas, the countrys finance minister, describes the situation facing Latin
America and other emerging market economies as a simple one: accept reality or deny
it.

Were in a new world, he says. The new world is lower commodity prices which are
going to stay low for the foreseeable future. At the same time there is going to be less
global liquidity. The US is going to start raising rates in the near future so were not
making any expectations that we will go back to where we were five or six years ago.
Colombia has taken difficult decisions as its oil revenues have dwindled. The country
announced $2.4bn (1.6bn) of budget cuts earlier this year and has warned of more belt
tightening in the coming months.
Crdenas believes the currency is reaching a new equilibrium of about 3,000 pesos to
the dollar. A year ago, it was 2,000. As the currency depreciated, Colombias central
bank raised interest rates in September in a signal that it takes its 2pc to 4pc inflation
target seriously, despite flagging growth.
For Crdenas, credibility has been hard won and he believes keeping Colombias house
in order will pay off in the long run. We thought in advance about this situation. We
thought: as oil prices have been falling, we will be investing more in infrastructure so
this expansion is offsetting from an aggregate demand point of view the decline in oil
rates, he says.
Crdenas remains confident that Colombia can still flourish without relying on others.
Whether we succeed is going to be less about the tailwinds from China and from global
liquidity, its more about us.
Previously all countries were surfing on the same wave at the same pace. Now its
about who is the better swimmer, who has less weight, who has a better sense of
direction. Those abilities are going to reflect differences from country to country.
If Colombia shows how an economy can weather a storm, then the current situation in
Brazil serves as a cautionary tale for those who choose profligacy over prudence.
The IMF expects the economy to contract by 3pc this year, and 1pc in 2016 as the
economy buckles under the strain of falling commodity prices, high inflation and
unemployment.
Brazils credit rating was cut to junk status by Standard & Poors in September, taking
away the investment grade it had enjoyed for seven years.

Its economic troubles have been compounded by political turmoil. A corruption scandal
involving state-run energy firm Petrobras has led to a call for the impeachment of
president Dilma Rousseff and left her popularity in tatters.
Amid all this, the unpopular government is trying to introduce measures to balance the
books.

You have to adapt to the new reality or end up like Brazil

Ilan Goldfein, former deputy of Brazil's central bank
For Ilan Goldfajn, chief economist at Itau, Brazils largest private bank, and a former
deputy governor of the countrys central bank, sorting out the budget deficit will be
crucial to bring investment back into the country.

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You have to adapt to the new reality, and the new reality is that terms of trade are
different. Commodities are very different. You can either accept or deny this. If you
accept it then you have to tailor your budget to different prices. Oil in Colombia, copper
in Chile, iron ore in Brazil: all the commodity producers just have to realise its a different
business now.
While attempting to spend your way out of trouble is not recommended, targeted
infrastructure investment that could raise growth in the short and medium term, is.
Peru declared a public holiday on Friday to coincide with the IMF annual meeting. The
main reason? To keep cars moving in a city where traffic jams are notorious. "I think the
traffic in Lima is even worse than Bogota," jokes Crdenas.
So what lies in store for the countries that do not adjust? They will end up like Brazil,
says Goldfajn. Brazil basically denied the reality for four years. The diagnosis was:
something is happening, the government is not stimulating enough, we are not spending
enough, there is not enough credit, there are not enough public subsidies so we should
just push, push, push.
But in the same way Brazil benefited from the boom, it now has to deal with the bust.

'Holy Grail' of global growth

The dilemma now facing emerging markets has posed a bigger question: where is
growth going to come from now that the emerging market engine is stalling?
Maurice Obstfeld, the IMFs new chief economist, said last week that the holy grail of
robust global growth remained elusive six years on from the Great Recession.

The IMF said the risk of recession had increased in many regions since April Photo: IMF

Central banks around the world have cut interest rates more than 600 times since
Lehman Brothers collapsed, yet this has not been enough to secure the recovery.
Obstfelds predecessor, Olivier Blanchard, who retired from the post at the end of last
month, is more upbeat than the tone of the latest IMF health checks suggest.

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Blanchard is used to hearing the Financial Stability Report forecasting the end of the
world every six months. At this stage, Im not very worried. Sure, the baseline is
unexciting. Sure, there are risks, coming from the real economy or the financial sector.

The nature of the risks keeps changing. But I dont think at this stage the risks are larger
than they have been in the recent past, he says.
Blanchard is particularly calm about China, and says claims that economic growth could
be slowing to an annual pace of between 2pc and 3pc are not based in fact. He says
the IMF spent a lot of time talking to Chinese policymakers over the summer.

"Over time, China growth will slow down, but the probability that it will
suddenly collapse to 3pc to 4pc or less is small."
Olivier Blanchard
Consumer spending remains strong, he says, while housing investment, which has
already fallen sharply, is no longer in danger of collapse. The problem is state
investment he says, and while preventing Schumpeters gale from blowing unproductive
companies down is not ideal, he believes the state could ensure that a hard landing
stemming from this sector is avoided.
Over time, China growth will slow down, but the probability that it will suddenly collapse
to 3pc to 4pc or less is small, he says.
Gentle slowdown or not. China remains one to watch.
"The management of China's slowdown is something we've been worried about and it's
starting to manifest - so that makes you worry that the downside risk could be greater,"
says one UK policymaker.
"But we're not in the sky is falling mode. I would say that's the way people are leaving
here, with that mindset."
"China has got massive issues - they've had those for 30 years and have managed
them.
"I think this will weigh on Chinese growth for most of the next decade. Are they locked in
a world of 6pc, stepping down to 5pc growth? I think so. A big middle-income country
growing at 5pc is a lot - but it's not what it was."

Blanchard is now looking for ways to avoid what Lagarde has described as a new
mediocre. One way to ensure monetary policy remains potent in times of low growth
would be to set a higher inflation target, says Blanchard, in an idea he put forward a few
years ago.
A higher inflation target implies that rates can fall further, making it more likely that
policymakers can support employment and fight off recessions.
However, the Bank of England's Haldane says this policy would probably prove
unpopular with the public. People in Britain at least already believe prices are rising
faster than official data show.
When the public are asked directly about the inflation target, they suggest, on average,
that it may if anything be a little too high, he said recently.
The Banks latest inflation attitudes survey shows the public thought prices rose by
2.1pc in the year to August, when inflation was in fact zero.
The survey also showed more than half of people believe the Banks current target of
2pc inflation was about right. Just 7pc said it was too low, while 45pc said a higher
inflation target would make the economy weaker.
Negative interest rates are an alternative to a higher inflation target, but again this has
its pitfalls. Negative deposit rates at banks could end up slowing the economy unless
policymakers banned cash so customers couldnt withdraw their savings and hoard
them under the mattress. This seems like a long way off. Its unlikely we will be buying
bananas with bitcoin just yet.
But the challenge facing policymakers is serious. If a really bad shock happened and
I have no clue as to what form it would take the room for fiscal or monetary policy
response would be limited, says Blanchard.
Goldfajn believes many emerging market economies will also join in the quest for higher
growth.
I think this debate on low productivity and growth will spread from the US and other
advanced economies all over the globe. Countries wont boom any more, theyll just
grow.

People will think 1pc, 1.5pc growth? I need much more than that to become rich as an
emerging market. Well be having these conversations over the next five years.
For now Limas clouds continue to obscure the horizon, as uncertainty about Chinas
slowdown clouds the outlook. The suns not ready to come out. Not yet, anyway.