Meltdown appears unlikely, but getting rid of global economy's long-term stagnation is challenging

The fluctuating global financial market has made the market gun-shy since mid-August for several reasons: the currencies of several emerging economies have substantially depreciated against the US dollar, stock markets of developed and emerging economies have tumbled, and there has been a steep drop in global commodity prices. There are suggestions that, against such a backdrop, a financial crisis in some economies might be imminent.

There are other circumstances to consider: the US Federal Reserve will initiate a new interest-rate rise cycle and the Chinese economy is slowing down. Developed countries will not be immune to a financial crisis once it erupts. Therefore, scholars think that the Federal Reserve will not only raise the interest rate but might even introduce new quantitative easing measures, namely QE4.

I think otherwise. The Federal Reserve will raise the interest rate at least once this year. Second, the probability of a new international financial crisis in the short term is not that high.

The current turbulence in the global financial market might continue but it is unlikely to cause a large-scale crisis. The bigger question for the global economy is how to cope with the predicament of persistent stagnation in the medium term.

Domestic and international circumstances mean that even though the Federal Reserve will increase the interest rate, the market has already anticipated this move, thus minimizing the possibility of negative consequences.

In 2015, although the United States economy enjoyed an annual growth rate of 3.7 percent year-on-year in the second quarter, much higher than the initial rate of 2.3 percent, and its unemployment rate dipped to a relatively low level of 5.3 percent in July, concerns over its economic recovery still exist.

The labor force participation rate in the US employment market is still relatively low, which means there is still a severe problem with the labor force withdrawing in the long term from the labor market. Second, consumption and inventory adjustment is still the major driver for US economic recovery.

US corporations are still hoarding cash, as they are unwilling to make fixed investments. Third, in the past two years, the effective exchange rate of the US dollar has been increasing too fast, influencing its export and job market. In addition, the negative externality generated by the Federal Reserve's increase of its interest rate is affecting the US economy through multiple channels, including the growth rate of its exports and the revenue of overseas investment.

The Federal Reserve may need two years, or more, to return the federal funds rate to the average historical level. In other words, the impact of the Federal Reserve's increase in the interest rate, which has been overestimated by the market, is actually controllable in the short term.

China's economy is experiencing a downward trend in the short term. Slow economic growth in the first half of 2015 led the Chinese government to reinforce its macro policies. As for fiscal policies, a new round of domestic infrastructure construction, represented by the seven major national projects, and a new round of international infrastructure construction, represented by the Belt and Road Initiative, is creating momentum.

In monetary policies, there have been five rounds of reduction in the interest rate and three rounds of reduction in the benchmark rate since last November, with a future possibility of benchmark rate reduction. The decreased exchange rate of the yuan against the dollar since August has normalized the market. These policies will stabilize the Chinese economy in the second half of 2015 and reduce the international impact on China's economic downturn.

Also, compared with Southeast Asia during the financial crisis in the 1990s, emerging economies are more resilient when dealing with financial risks.

Emerging economies represented by Southeast Asian countries have learned their lessons from that financial crisis. The deficit of their current account in general is lower, and the scale of their foreign debt is smaller compared with the past. They now have a higher level of foreign exchange reserves and larger room for domestic expansionary policies.

As a result, they are more competent in coping with negative impact than before. It means also that there is a lower possibility for emerging economies to fall into large-scale crisis. Of course, there are sad stories. Latin American countries dependent upon resource exports perform better in a macro-economy and are less likely to encounter financial problems. Financial crisis in some countries is still possible.

Next, external aid for a country falling into crisis can be significantly improved in terms of timeliness and scale. Indeed, after the breakout of the financial crisis in Southeast Asia, the international community acted not only slowly but also with strict conditions in providing them with aid.

However, the world has changed. Currently, most developed countries are suffering from slow economic growth, which means that they are likely to be dragged into recession once large-scale crises in emerging markets occur. For their own sake, international organizations and even developed countries will act in a more timely fashion when there is a crisis in other parts of the world.

In addition, compared with the situation in the 1990s, emerging economies are arranging more regional and collective aid programs, such as the Chiang Mai Initiative and the Financial National Reserve. That is why the possibility of the crisis spreading from one country to the whole world is very low.

In conclusion, the current turmoil in the global financial market will not deteriorate into a new international financial meltdown. But it doesn't mean we have nothing to worry about.

Compared with a financial crisis, the challenge to get rid of the global economy's long-term stagnation is tougher, which not only requires governments to overcome domestic obstacles and push forward structural reforms, but also calls for strengthened policy coordination among different countries.

The author is senior research fellow and head of Department of International Investment, Institute of World Economics and Politics, Chinese Academy of Social Sciences. The views do not necessarily reflect those of China Daily.

(China Daily European Weekly 11/27/2015 page12)