Davos Forum Looks For Key To Economic Revival

As the economic news from around the world got bleaker this week, economists around the world have been discussing possible solutions to the crisis at the world economic forum in Davos. They're pinning big hopes on emerging market nations, and a healthy dose of liquidity.

A monster from the past (the liquidity trap) is back, for the first time since the Depression of the 1930s. With lenders keeping their cash holdings rather than investing, the world economy is grinding to a halt.

President Obama has brought out an $800 Billion plus stimulus package against the backdrop of the worst economic data in generations, with poor corporate results cutting across business sentiment, and mass unemployment data that indicates could rise to 7.5% with another 500,000 jobs being lost in January.

“Most of the money that we are investing will go out of the door and go directly to job creation, generating or saving from 3-4 million new jobs. But even as this plan puts Americans back to work, it would also make the critical investments in alternative energy, safer roads, better health care and modern school that will lay foundation for long term growth and prosperity.”

On Thursday, Federal Reserve officials warned of a prolonged global slowdown which could push the US to the brink of deflation. That warning followed a forecast on Wednesday by the IMF that the world economy would slow to a near standstill this year.

The package – dubbed the ‘Recovery and reinvestment’ plan – provided plenty for those at Davos to think about.

Managing Director of The World Bank says rebuilding confidence is key to restoring capital flows.

"If you put in place these 2 measures that I talked about, which is one doing the cleaning of the financial system and two, continuing with the fiscal stimulus in these counties and trying to create jobs, confidence will start to come back. Banks will begin to lend again and that is oil that greases the wheel."

But stimulating the financial sector is not a total solution. Jacko Maree, CEO Standard Group believes the world may have to look to emerging nations as the driving force that stimulates demand.

"The kick start is going to come from the emerging markets and the recovery in those rather than from the developed world. When we look at countries like Brazil and even Russia – there's been a tremendous change in values of stock prices but many of the underlying companies are doing well – so there's almost seems to be an overreaction."

Sharp interest rate cuts and fiscal stimulus packages have been the standard medicine dished out so far around the world, but whether it will work is as yet unclear. The consensus is that the world has to brace itself for a best case scenario of at least one year of recession, and a subsequent decade of low growth. Just how to get things back on track is harder to agree on.

With the U.S. government already involved in bailouts of the banking sector, auto industry and housing, most of the fiscal stimulus comes after 2011. That's led to a muted response from those looking for something more immediate.

Other concerns about the fiscal stimulus range from wariness about preferential treatment for US companies in accessing support, to a possible change towards protectionist sentiment. But having passed the House of representatives without the support of Republicans, who wanted a more targeted plan, the biggest question as it goes to the senate is whether it is big enough, and how soon it will work. And with economic and corporate data indicating a continued collapse, its timing and size may yet become bigger issues still.

Wen Jiabao used his speech to the World Economic Forum in Switzerland to call on the US to improve its economic relations with China, but also heaped the blame for the current crisis on the West.

“Even before Obama walked through the White House door, there were plans for $1 trillion of new debt,” said Niall Ferguson, a Harvard historian who has studied borrowing and its impact on national power. He now estimates that some $2.2 trillion in new government debt will be issued this year, assuming the stimulus plan is approved.

“You either crowd out other borrowers or you print money,” Mr. Ferguson added. “There is no way you can have $2.2 trillion in borrowing without influencing interest rates or inflation in the long-term.” Struck by the new borrowing because the roots of the current crisis lay in an excess of American debt at all levels, from homeowners to Wall Street banks. “This is a crisis of excessive debt, which reached 355 percent of American gross domestic product,” he said. “It cannot be solved with more debt.”

While Mr. Ferguson is a skeptic of the Keynesian thinking behind President Obama’s plan — rather than borrowing and spending to stimulate the economy, he favors corporate tax cuts — even supporters of the plan like Mr. Zedillo and Stephen Roach of Morgan Stanley have called on the White House to quickly address how it will pay for the spending in the long-term.

Even as Congress looks for ways to expand President Obama's $819 billion stimulus package the rest of the world is wondering how Washington will pay for it all.