Three years after the credit crunch that triggered the international recession of 2008-9, the world economy is on the brink of another major crisis. Amid growing evidence that the US recovery is faltering, the unresolved problems of debt and dysfunctional markets are coming back to haunt the decision-makers of leading economic powers.
The national debt of euro zone members, notably Greece, Portugal, Italy and Spain, is at the heart of the crisis. According to Nouriel Roubini, the economist dubbed "Dr Doom" for predicting the recent financial crash, soaring sovereign debt and slowing growth pose fresh threats to global stability. This, coupled with economic deceleration in China and contraction in Japan, is reducing the demand for oil and putting pressure on the economies of the GCC.
Thanks to the powerhouses of India and China, the world economy can withstand the continued uncertainty over debt in the US and Europe - for now. But if there is a Greek debt default or America's economy stagnates, then the world faces a second financial crisis in three years.
Amid growing concern over higher debt and slower growth, global stock markets have lost more than $3.3 trillion (Dh12.1 trillion) since early May. The IMF has already cut its growth forecast for the US and the UK. Confirmation that the US is stalling or China's economic expansion is significantly slowing down will send shock waves through the world's financial centres. That would transform growing nervousness into panic.
The euro zone sovereign debt crisis remains the most acute problem. With more than $130 billion, European banks are the largest holders of Greek debt. If Greece defaults, then Europe's banking system will require another massive bailout. Injecting capital into banks using taxpayers' money would push indebted countries like Spain and Italy over the edge.
Friday's agreement between Germany and France on a new aid package for Athens provides a temporary reprieve. But over the past 18 months since Greece first struggled to avoid default, euro zone leaders have merely treated the symptoms of crisis - not the fundamental causes such as diverging productivity between surplus and deficit countries. The absence of a proper growth strategy for the euro members has exacerbated such and similar problems.
Likewise, the US economy is heading for a crisis, as the Republican-controlled House of Representatives and the Obama White House cannot agree on raising the national debt ceiling in exchange for a credible, long-term deficit reduction plan. Political stalemate until the next elections in November 2012 may paralyse the US when a transformation of big government and business is needed.
The trouble is that growth of US output risks dropping below the so-called "stall speed". That is the rate of economic growth at which expansion slows dangerously and the recovery stutters. Once the engine stalls, the economy descends into a double-dip recession. America's Achilles heel remains the falling value of residential and commercial real estate in which much of US private and corporate wealth is tied up. If prices continue to fall, then falling consumer and investor confidence will turn cautious optimism into gloom.
Dr Roubini's "doomsday" scenario can be averted on two conditions. First, advanced economies, notably the US and the euro zone countries, need to get a handle on sovereign and corporate debt. Second, emerging markets, above all China, have to avoid overheating and reduce the bubbles in credit and real estate before they burst.
But much more needs to be done to restore strong, sustainable growth. One urgent task is to restructure banking conglomerates and reform financial markets. Both US and European banks are in a triple bind. They have to deleverage, increase their capital reserves and reduce their exposure to western sovereign debt. But instead of tackling these problems, the investment banking arms have engaged in short-term speculation to generate profits for their institutional shareholders and pay bonuses to executives.
Some more regulation of financial instruments like derivative-trading in essential commodities such as energy or food is surely required. But public authorities should also consider incentivising and rewarding more virtuous behaviour, for instance banks that combine profitmaking with some social purpose like investment in green technologies or social housing.
The other pressing task is to boost growth through more strategic investment. Emerging markets like the GCC can help by channelling money into activities that promote long-term growth and reduce financial speculation.
Investing in large-scale infrastructure projects is no less important. Examples include the old Silk Road in Central Asia or new trading routes connecting emerging economies in the wider Middle East to those in Asia, Africa and Latin America, notably shipping or communication networks.
Focusing on long-term productive activities rather than short-term speculative profit will raise overall growth and economic benefits. The economy becomes more stable and less vulnerable to the volatility and destabilising fluctuations of purely financial transactions that make money out of money but are uncommitted to any specific place or sector.
As the global recovery continues to stutter, governments and the financial sector are running out of time to agree on real reform. Another crisis would cause economic and social costs that no country can afford.
Adrian Pabst is a lecturer in politics at the University of Kent, UK, and a visiting professor at the Institut d'Etudes Politiques de Lille (Sciences Po), France
