Somewhere between being seriously concerned and very nervous seems about the right attitude to have toward the international economy as Toronto fortifies itself, literally, for the G20 summit.
The international economy is beset by at least three imbalances. First, growth is much faster in developing countries than in developed ones, where unemployment is stubbornly high and overall output weak.
Second, some of this imbalance in growth is caused by China manipulating its currency, piling up huge surpluses on trade and current accounts with slower-growing Europe and the United States. This obdurate Chinese attitude will be on display in Toronto.
Third, debt levels are astronomical in most European countries and the United States, with very grave doubts about the ability of those countries to reduce them appreciably, even over what is euphemistically called the "medium" term, which can mean a very long time.
Recovery is especially fragile in Europe, and it remains a work in progress in the U.S., with states cutting spending, housing foreclosures everywhere, unemployment very high and a political system that inspires absolutely no confidence whatsoever that it can come to grips with the country's fiscal mess.
The U.S., being the world's leading economy, is still being rewarded for its bad behaviour. Investors, believing the U.S. still to be the world's safest haven, keep pushing up the dollar and investing in markets, when by rights the dollar should be crashing and markets plunging.
This circumstance means the American public remains too complacent about the true state of the country's parlous finances, which in turn allows lawmakers to jawbone, point fingers but do nothing. When yesterday, in a letter to other G20 leaders, President Barack Obama wrote that his country would "reduce our fiscal deficit to 3 per cent of GDP by fiscal year 2015" (from 11 per cent today), he was, as Americans say, whistling Dixie.
It would not take much to make the U.S. fiscal situation considerably worse, including another growth slowdown. Or, as Harvard professor Kenneth Rogoff predicted in a speech a week ago in Ottawa, the U.S. national government might have to bail out the country's largest state, California, which is headed to insolvency.
Prof. Rogoff and his academic partner Carmen Reinhart have published a book, This Time is Different: Eight Centuries of Financial Folly, that makes what the developed world is experiencing utterly consistent with past experience.
Having examined financial, banking and currency crises since the 1300s, they conclude that following a financial crisis comes a solvency crisis. The "debt explosion" they describe (and we are now experiencing) comes less from the cost of bailing out and recapitalizing the banking system, but from the collapse of government revenues, automatic increases in government spending from such policies as unemployment insurance, and stimulus measures of the kind every country introduced in the recession.
They calibrated the historical average of increased debt to be 86 per cent. It takes many years to climb down from the debt mountain; that is, to get a country's debt-to-GDP ratio back to where it was before a financial meltdown followed by the debt buildup.
In the U.S, it is estimated that the country will amass another $9-trillion of debt in the next decade, unless radical changes are made to spending and taxation of the kind that are hard to imagine Americans understanding their country requires. In Canada, a more fiscally prudent place, the last Harper budget estimated deficits of $158-billion from 2009-2010 to 2014-2015.
In Europe, the fiscal situation continent-wide is dire, with Greece already having hit the debt wall, and Portugal not far away. Spain is in terrible shape, too. There is every chance in the next 18 months, or less, that some small European countries will leave the euro because the fiscal pain of staying in the currency zone will be too great. This Tuesday, the new British government will announce how it plans to reduce that country's staggering deficit, amounting to about 11 per cent of GDP.
Many are the reasons for the U.S. chronic trade and current account deficits, but one is the Chinese neo-mercantilist attitude. The Chinese essentially want to play by half the international rules. They were accepted into the World Trade Organization, pledging liberalized trade. They take every opportunity to oppose protectionism - elsewhere.
Then, they refuse to allow their currency to float, as other countries do, with the result that the yuan remains artificially low in order to stimulate Chinese exports and maintain an enormous trade surplus.
No wonder U.S. legislators are growing increasingly angry. In his letter to G20 leaders, Mr. Obama, obviously referring to the Chinese, said, "I want to underscore that market-determined exchange rates are essential to global economic vitality."
The Chinese, however, do not apparently believe in "market-determined" exchange rates, but rather in government-manipulated ones. If the Chinese manipulate their currency, do not be surprised if Americans begin to manipulate their tariffs, since it would appear the Chinese are deaf to exhortations.
The Toronto summit, like the world economy itself, will be a place of hopeful sounds masking serious tensions and extreme nervousness.