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. Last Updated: 07/27/2016

The EU Lifesaver

The crisis is not over. There are three economic indicators that demonstrate this. The first is the continuing growth of foreign exchange reserves in China and the corresponding increase in U.S. budget deficits. China consumes far less than it could in relation to its economic potential, while Americans consume too much and beyond their means. Thus, the main macroeconomic imbalance at the heart of the crisis remains unchanged. This has led to prolonged low interest rates and bubbles in selected markets.

The second indicator is the high level of unemployment in the countries hardest hit by the crisis. The absence of new jobs means that the private sectors in those countries bear no short-term prospects for growth in demand. The result is that privately held companies continue to cut costs. The third indicator is the declining level of private debt. The desire of private companies to reduce their debt and the reluctance of banks to extend credit testify to the high risks still facing the global economy and the threat of a further weakening of the financial situation of the world’s leading credit and financial institutions.

The key question is how the world will overcome these problems.

There is a real possibility that over the next few years more countries will resort to protectionist policies in an attempt to save their domestic economies. Developed economies will be forced to continue their policies of low interest rates and high fiscal deficits. Meanwhile, government spending will be less effective in stimulating economies. All of these factors will prolong the global stagnation.

One potential solution is if Chinese families increase consumption. The refusal by Chinese authorities to restructure their economy in favor of increased consumption or to be more flexible regarding the yuan exchange rate to maintain a high rate of economic growth and employment levels makes it impossible for the United States to eliminate its trade deficit through standard market mechanisms. The United States needs to increase exports, reduce consumption per household, increase the rate of national savings, invest more in industry and reduce its deficits. Without those measures, the Federal Reserve cannot step in to raise the abnormally low base rate and keep bubbles out of the stock market. That situation will likely push the United States toward increased protectionist trade policies, which will reduce overall demand and slow down the global recovery.

The Russian economy, which remains extremely sensitive to external factors, has fared worse during the crisis than any other Group of 20 economy. The country should use the crisis to draw the necessary conclusions. Russia must bring its head back down out of the clouds regarding fiscal policy. Even when oil prices remain at $70 per barrel, the country’s deficit is projected to be 5 percent of gross domestic product. Runaway spending during the pre-crisis period of rapid growth in commodity prices and the unprecedented influx of foreign capital sent budget spending through the roof. One serious problem is that ballooning state subsidies and cash infusions for favored domestic industries are crowding out the more effective private investments. Finally, the capital inflows that boosted the economy in the 2000s were largely a form of repatriation of Russian capital. Unfortunately, many misguided steps were taken that have turned that inflow into an outflow.

The government’s continued support of state-owned companies is fraught with the risk of running up deficits. It would be wrong to assume that there are more people in the government and state-owned companies with Russia’s best interests at heart than there are in the ordinary business community. It would make more economic sense to have state policies that win the trust of citizens and investors than to continue the unchecked growth of government spending and the sinking of budgetary funds into an economy fraught with corruption.

The European Union may be the best stabilizer. With its diversified and highly competitive industries, its balance between the industrial and financial sectors and its reasonable and prudent regulatory policies for the financial sector, it will serve as the best anchor as the crisis unfolds, the guarantor against further drops in GDP. Germany and France are best positioned to lead this stabilization, although their decrease in exports has already caused concerns.

The EU’s aggregate economy would be stronger if it weren’t for its weak links: above all, Greece, Portugal, Ireland, Spain and Latvia. Addressing the weaknesses in these countries is perhaps the most important challenge facing Europe’s largest economies.

Oleg Vyugin is the chairman of the board of directors of MDM Bank. This comment appeared in Vedomosti.