Thursday, 29 January 2009

It is still downhill from here

IMF's most recent revision of the global growth estimate came as a surprise to many. However, it was largely in line with our position in December – namely that the market consensus regarding economic growth in 2009 was way too optimistic. IMF has now confirmed this view with a strong downwards revision of the global growth from the previously expected 2.2% to 0.5%. We believe that this view will have to be revised downwards once again.

There were, however, several interesting points. One is that the UK economy is now considered basketcase #1 in the industrialised world. Household debts to mortgage institutions (-banks) and credit card companies are worse than is the case in the US. The housing market is probably even more inflated than elsewhere, and adding insult to injury, both current account and public sector were heavily in deficit as the crisis struck. Forecasting a contraction of 2.8% in 2009 still appears a bit on the positive side, but rightfully places UK among the hardest hit economies.

The forecast for USA of a modest 1.6% negative growth in 2009 followed by positive growth of the same magnitude in 2010, however, indicates some kind of heavy meddling from political circles. A number of respected US economists have estimated that the accumulated contraction in output would end up anywhere between 5 and 10% over a three year period. We know that 3rd quarter 2008 was bad for the US economy and that 4th quarter was even worse. But probably they did not add up to anything that would bring the combined fall in output anywhere near 5% in 2008 and 2009. US consumers have already redressed their savings rate considerably, as fears for the future have driven many away from spending on holidays, new cars and so on. But it is not enough to save the economy from a severe downturn. The overhang of bad debt is worse than in the UK, so even a hike in households' savings rates, a period of sub-par growth is highly likely.

Germany also finds a place among the laggards, with an expected contraction in output of no less than 2.5% per cent in 2009 and almost zero in 2010. Main driver for this collapse is of course the exports, which are being hit hard by the rapidly shrinking international trade flows.

China and other east Asian nations have been held out by many as the best hope for a growth pole, able to pull the global economy. This idea is also being reviewed now, and the result is not nice. China and India will both see significant slowing in 2009. Even if the growth numbers for these countries are dodgy, the hope that the domestic demand in those two countries would "replace" falling consumption in the developed economies is now off the table.

While all of this is interesting, there are a couple of things that deserve mention. The noble art of making growth forecasts always implies making a number of heroic assumptions regarding the behaviour of governments and other background variables. In this case, these variables deserve some extra assumptions. IMF is in commendably clear about some background variables. It assumes that political efforts to solve the banking crisis will eventually bear fruit. And that the various stimulus packages in fact arrive on time and have the desired effects on domestic demand.

It is probably exactly on this point where the IMF report has its weakest point. For political reasons, IMF cannot at this point in time begin to publicly vent doubts that the various programmes or policy packages will not work. With the most recent near-panic in the UK banking sector and the slow deterioration of credits worldwide, it appears we are entering a phase where it will be clear that the good money so far thrown after the bad money will not have the desired effect. The stimulus packages so far are far from being enough to lift the economies out of the slump, but IMF cannot make a blanket criticism of the programs.

In this way, the IMF forecast is an important statement to politicians that things are continuing to go downhill, but as regards the actual forecasts it is very likely to be more politically correct than anything else.

Thursday, 22 January 2009

Barack Obama – a one-term president?

About this time of the year 8 years ago I prophesised that George W Bush would live to regret having been elected president because of the impending downturn arriving hot on the heels of the Dot-com bubble. Of course it went differently, with W setting out for higher goals and leaving the economy to a Treasury Secretaries almost anonymous enough that they are already forgotten (O'Neill and Snow, just in case). In the Federal Reserve they were matched by a self-declared ideological crusader, who saw it as one of his life's missions to keep state intervention in the economy to a minimum in the belief that human greed would engender the necessary caution and stability in the markets.

In the aftermath of the Dot-Com bubble, Greenspan did what he had done in earlier cases of economic turmoil: he lowered the interest rates. However, in 2001 profound liberalisations had been introduced by the Clinton administration. And everybody went on a lending or borrowing spree. In the US, the accumulation of debt relative to GDP rose to an all time high. And then last summer, this bubble also burst. George W had in the meantime replaced John Snow in the Treasury by Henry (Hank) Paulson. A former star athlete, White House insider, and Government Sachs CEO, Paulson demonstrated great energy in his attempts to avert the crisis.

As Barack Obama was sworn in as the 44th President of the United States, the economic crisis was as deep as ever, and worsening. Judged by early data, the US economy could have shrunk by as much as 5 per cent annualised in the last quarter of 2008. Lay-offs continue faster than any time since World War II. World trade is nosediving, hitting a nascent American export boom. The economy needs between $850bn and $1000bn as a stimulus package, and counting for every day. Paulson's ill-formulated TARP programme to salvage the US banking system is gradually proving as ineffectual as critics believed it would be, while largely leaving untouched the very individuals who were responsible for reckless lending and underwriting activities. Abroad – in the export markets - things have not been much better with demand falling off a cliff.

Obviously, the markets are looking to Obama and his team to take decisive action. I am just afraid that they may be too optimistic. Obama and his team are probably fully aware that they need to take painful action now in order for it to be forgotten when re-election is up in 2012. There is just a snag here. This crisis is no normal bump-in-the-well-paved road economic crisis. The root lies with what one could call the American Way of Lending. And it will take a while to fix.

Let me be precise about the use of words here. By American Way of Lending I refer to a culture of easy credit, lax regulatory standards, banks underwriting securities instead of lending, generous rules for personal bankruptcies, and so on. Roughly since the Reagan era, the US economy has been gradually liberalised. There is no doubt that the positive side of this that the US economy has been as vibrant and innovating as it is the case. But the negative side has been a household sector which has gradually – and over the time span of a whole generation – learnt the consume first and pay later. This culture, paired with a low-interest rate policy and financial innovation has created not only the biggest housing bubble in history. It has also created the biggest current account deficit in history.

I have on earlier occasions written that it takes time to get out of a situation like this. First, the households have to increase their savings rate. To pay off debts. Given that a lot of private debt is mortgage debt, and given that the employment situation will not improve until maybe sometime in 2010, many consumers will experience negative equity and perceive of their economic situation to be more insecure than just 6 months ago. This leads to an even sharper economic downturn. It is therefore unlikely that the US consumer will begin to consume at a rapid clip again until debts have been worked off and the negative equity have been removed. Other countries have made experiments with the same combination, and invariably it has taken a period of 4-5 years until the decks have been cleared. Typically, the economy shrinks sharply in the beginning of the period as the savings rate is pushed up, and the economy grows slower than potential for a while, because of a slow growth in private consumption.

Barack Obama was elected on a promise of change. Probably it was not supposed to be a change for the worse, economically speaking, and for a longer period of subpar economic growth. Bill Clinton famously beat George HW Bush on a simplistic "It's the economy, Stupid" message. For all his compelling rhetoric, I am afraid that Barack Obama in 2011 may find himself open to exactly the same criticism, as the economy may still be subdued. Even if he and his economics team arrive at just the right actions. Life is tough, but unfair...