World economy in 'dangerous' phase, warns Lagarde

CHRISTINE LAGARDE, the new managing director of the International Monetary Fund (IMF), warned the world economy was in a “dangerous new phase” and that officials must take new steps to strengthen growth.

Ms Lagarde, speaking to international finance officials and economists in Jackson Hole, Wyoming, said the US should arrest a slide in house prices, while European banks must be required to boost capital to prevent the Continent’s debt crisis from affecting more countries.

The US and European Union should enforce long-term budget discipline to free up cash for short- term stimulus, she said.

“We risk seeing the fragile recovery derailed,” Ms Lagarde (55) said. “So we must act now.”

Ms Lagarde spoke near the end of a month when the value of global equities dropped by $5.7 trillion (€5.17 trillion) on concern global growth is slowing and governments will be unable to tackle sovereign debt burdens.

UBS AG and Citigroup Inc cut their forecasts for expansion of the world economy and predicted major central banks will leave interest rates on hold through 2012.

The slowdown provided the impetus for three days of debate at the conference, with Federal Reserve chairman Ben Bernanke saying the US central bank still has tools to boost its economy, without specifying what they were or whether they would be deployed.

“The stakes for the world economy are high,” said Allen Sinai, president of Decision Economics in New York, who put the likelihood of another global recession at 30 per cent.

Europe is struggling to contain a sovereign debt crisis that is nearing its third year and has left many banks from Spain to Greece in or close to insolvency.

Stress tests on 90 European banks published on July 15th showed eight lenders had a combined €2.5 billion capital shortfall, failing to ease concerns many of them remain vulnerable to a potential sovereign default.

Without an “urgent” recapitalisation, “we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis”, Ms Lagarde said. Bolstering banks’ balance sheets “is key to cutting the chains of contagion”.

The former French finance minister, who took the helm at the Washington-based IMF in July, said recapitalisation should be “substantial”, and called a mandatory move “the most efficient solution”. Banks should seek funds in financial markets first and later public money if necessary, including from the €440 billion European bailout fund, she said.

European Central Bank president Jean-Claude Trichet echoed Ms Lagarde’s call for banks to strengthen their balance sheets while saying any talk of a liquidity crisis was “plain wrong” because his institution had taken steps to aid banks, offering them unlimited cash for up to six months.

Attending his final Jackson Hole conference before retiring in October, Mr Trichet (68) avoided mentioning the debt crisis at length, preferring instead to defend the euro against critics who say its members are too diverse to unite under a single currency.

He used new research to show how the US has regional divergences similar to the euro area’s and noted how Europe has grown almost as quickly as the US and generated more jobs than it in the past decade.

While Ms Lagarde urged lawmakers to shrink budget deficits over time, she said they could still take steps now to stimulate expansion.

Making European budgets more sustainable “does not necessarily mean drastic upfront belt-tightening” because by addressing long-term risks such as rising pension costs, governments will have more leeway in the short term to fund policies that support job creation, she said. – (Bloomberg)