The World Economy Is Far From Fixed

Anger in the land of Aphrodite.

Photographer: Angelos Tzortzinis/AFP/Getty Images

Global markets shuddered yesterday as China and Greece reminded investors that the world economy remains fragile. It was a timely warning: Growing optimism about the U.S. recovery mustn't be allowed to obscure the danger.

In different ways, China and Europe pose the biggest risks. In China's case, the hazards are mostly unavoidable and just have to be endured. In Europe, there's no such excuse. Better policy -- rather, any policy -- would lessen the peril.

The Chinese authorities are striving to contain an explosion of debt, notably in the form of risky borrowing by local governments. Lower-rated bonds will no longer be accepted as collateral for short-term loans, according to the country's clearing agency for exchanges. It's an attempt to make the use of opaque and lightly regulated so-called local-government financing vehicles less attractive, and it makes sense.

Europe's QE Quandary

The move took investors by surprise, though, and aroused fears that this year's spectacular rally in Chinese shares was at an end. The Shanghai stock market index fell more than 5 percent, the biggest drop since 2009.

The context is daunting: China's government faces the complex challenge of rebalancing its economy without crashing it. Every reminder of the difficulty -- and of how far financial excesses have been allowed to get out of hand -- is potentially cause for panic. There's nothing for it to do but press on with reform, step by step.

The worst of yesterday's global selloff can be more precisely timed, however, to the abrupt fall in Greek stocks. They dropped 13 percent, the biggest decline in almost 30 years. An early presidential election was called. If parliamentary elections follow, the country's grinding recession, massive unemployment and heavy debts might soon put the hard-left Syriza party in power.

That would destabilize not just Greece but the wider European Union as well. Unlike in the U.S., growth in the euro area has all but come to a stop. The risk that the EU might topple over into deflation and a third recession is real. A panic that starts in Greece and spreads throughout the system is frighteningly plausible.  

At least China's government is trying, albeit hesitantly, to address the country's economic problems. That would be too kind an assessment in Europe's case. For months, the European Central Bank has been declaring its readiness to do what's necessary (quantitative easing in the style of the U.S. Federal Reserve), but its divided governing council still hasn't gotten around to it.

While the ECB vacillates, the EU's political leaders seem powerless to act, fixated on irrelevant fiscal targets and paralyzed when it comes to orderly debt relief -- without which Greece cannot hope to return to any semblance of prosperity. Better policy doesn't guarantee a happy outcome, but it beats the alternative. Europe's protracted failure to get a grip is adding needlessly to the risk of a regional and global reversal.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.