Global Crisis: Where do We Stand?

The latest fluctuations in Wall Street and the disclosure of new information about the economy in the United States as well as other countries, has raised doubts over the level of optimism reigning a few days ago, bringing to the table disturbing questions about the evolution of the crisis, its consequences and, basically, about the strategy for, and the nature of, the way out.The latest fluctuations in Wall Street and the disclosure of new information about the economy in the United States as well as other countries, has raised doubts over the level of optimism reigning a few days ago, bringing to the table disturbing questions about the evolution of the crisis, its consequences and, basically, about the strategy for, and the nature of, the way out. In this article, we seek to rank these questions in hierarchical order, and arrange the evidence on which they are grounded with a view to determining where we stand. First, let’s take a look at the evidence over which there exists a certain consensus:

1.In the first place, there are already more voices claiming that the risk for the US economy to enter a depression has diminished. Which, in turn, indicates that there exists a certain agreement that the foundations of the US economy have improved during the course of this year in relation to last year. In addition, asset prices rose by 30%, volatility decreased, and the price of raw materials soared spectacularly, the spread between the yields of corporate bonds and those of public bonds fell significantly as the latter’s yield increased greatly, and the dollar weakened as a result of a lower demand for safe assets.

2.In particular, the US financial system (globalized and the epicenter of the global crisis, to a great extent) has strengthened in relation to its situation one year ago, as a result of the huge liquidity injections it has received from the Fed and the Central Government. We might say we have definitely moved away from the risk of reproducing another case like the Lehman Brothers one. Yet, and in spite of the bank stress test, no one knows with accuracy the magnitude of the credit default and, hence, the future financial needs of the US financial system, let alone the global financial system.

3.Despite the enormous financial backing received, in part thanks to the sacrifice of US taxpayers, credit (or more precisely, the acquisition of risk) has not been restored, which restrains consumption, investment and the level of economic activity.

4.The housing sector, driver of the US economic growth and the ultimate originator of the global crisis, does not show consistent and sustainable recovery symptoms. Home values have continued to deteriorate.

5.The monthly figures of workers losing their jobs diminish month after month; the same thing happens with those applying for unemployment insurance. However, the monthly figure of workers joining the army of unemployed is in excess of half a million, and the aggregate exceeds 8 million. Consequently, every month the unemployment rate rises in its irreversible road to the two-digit figure.

6.The confidence index, as well as the spending level, of the US consumer have been improving, both reaching record levels in the month of May. The stimulus plan of the Obama administration, the improvements in Wall Street stock prices, the drop in mortgage rates, the perception that the fall in home prices might seem to have hit the floor, and that the job market will recover, have slightly increased household wealth and reduced the “fear” effect. This is both good and risky at the same time since, if no clear indicators appear showing that the economy in the short term starts a sustainable recovery, hope may turn into greater mistrust. On the other hand, this slight increase in consumer spending is threatened by a rise in the saving rate, which shows unprecedented levels in the last 15 years. In previous articles we stated that the change in the US consumers’ spending-saving ratio constitutes a structural change that will characterize for years the level and structure of domestic demand (75% if the GDP) and, hence, the level of economic activity, as well as that of its production structure.

7.A large portion of the US and global political systems have admitted that the financial system does not self-regulate. The proposal submitted to Congress by Obama some days ago starts a process of legislative debate in relation to the supervision and regulation of the US financial system (the same process might be initiated within the EEC), including banks, hedge funds, private equity firms and any new financial product being offered to consumers, creating a new Federal Agency to such ends.

8.This week, the World Bank reaffirmed its pessimism about the world economy, which, according to its estimates, will decline by 2.9% in 2009. As from the next year, the organization expects a global growth rebound that will translate into a 2% growth in 2010, and a 3.2% rise in 2011. According to this report, the US economy will shrink by 3% in 2009, Japan will fall by 6.8%, and the Euro Zone, by 4.5%. In contrast, underdeveloped countries and emerging economies will grow by 1.2% in 2009, a deceitful figure because, if China and India are excluded, the underdeveloped world will experience a contraction of 1.6% in 2009. In Latin America, recession will be more profound, with its GDP shrinking by 2.3% in 2009, and rebounding positively by 2% in 2010. In Latin America, Peru stands out as the leader, with a forecasted growth of 3%, while at the opposite end is Mexico, whose economy has been directly affected due to its exposure to the United States, whose GDP will decline, according to the World Bank, by 5.8% this year. If this set of predictions happens to be confirmed, a warning would consolidate implying a geopolitical shift with foreseeable consequences over the world monetary system: China, due to the size of its GDP, will become the world’s second largest economy, thus outperforming Japan.

9.The level of indebtedness and currency issuing in the US economy has begun to heighten inflation fears, which are still offset by the low level of consumption and economic activity. These fears, coupled with the unemployment level, weaken the “energy” that the recovery may have and, hence, depress the level of expectation, affecting, in turn, consumption and investment. Alan Greenspan very recently remarked that “Excess capacity is temporarily suppressing global prices. But I see inflation as the greater future challenge”.

This evidence, based on objective information, leads us to draw some conclusions in an attempt to understand where we stand in the worst global crisis in the last eight decades:

1. It is difficult to know with certainty at what instance of the recession-recovery cycle we are. It might seem we have left behind the worst part of the crisis (even a skeptical Soros has made comments in this respect); there is no evidence, however, that we are heading in the short term (this year) toward the recovery phase. Having analyzed and crossed data, the only thing we can positively assert is that recession is tempering and, equally emphatically, that it has not ended yet. But we cannot assert with equal emphasis that the world economy has hit bottom, or that it is close to doing so. What happens with Wall Street’s growth and spasms of optimism is that risk asset prices have long been moving up and down the entire range, depending on the latest macro-economic report published.

2. The transition toward the recovery phase will be complex, full of ups-and-downs and difficulties; and recovery, when it comes, will be fragile as a result of, among other things, high unemployment levels that will persist for many years and the recessive impulses originating from fiscal and tax policies aimed at reducing the huge deficit that the US economy has generated. According to Nouriel Roubini, “the recovery is likely to be anemic and sub-par — well below potential for a couple of years, if not longer — as the burden of debts and leverage of the private sector combine with rising public sector debts to limit the ability of households, financial firms and corporations to lend, borrow, spend, consume and invest. This more challenging scenario of anemic recovery undermines hopes for a V-shaped recovery, as low growth and deflationary pressures constrain earnings and profit margins and as unemployment rates above 10 percent.” And he concludes by saying that “As a result, one cannot rule out that by late next year or 2011, a perfect storm of oil above US$100 a barrel, rising government-bond yields and tax increases (as governments seek to avoid debt-refinancing risks) may lead to a renewed growth slowdown, if not an outright double-dip (W-shaped) recession.” Paul Krugman stated that “Some of the measures that have been taken to deal with the crisis seem to be predicated on the belief that this is going to be a short, short recession. However, everything says that’s wrong, that this is going to be a sustained period of weakness.”

3. According to the latest World Trade Organization (WTO) report, world trade is expected to fall by 9% this year, although later on the World Bank downgraded this forecast. On account of this plunge, its recovery will lag well behind the recovery of the economic activity in the United States and Europe; it will be threatened by long-lasting protectionist policies.

4. The impact of the recovery of the US economy will have a delayed effect on the Euro Zone and the most industrialized emerging economies, much of them located in Asia. Economic recovery in China and raw material ─ mainly food ─ exporting countries will accompany the timing and pace of the US recovery.

5. The strategy to come out of the crisis and the making of headway toward recovery will entail new balances of power at global level, starting with the monetary sphere. Recently the BRIC Group (Brazil, Russia, India, and China), and now the Central Bank of China officially reiterated that worldwide commercial and financial transactions should be made in a worldwide currency, instead of the US dollar.

Therefore, to the initial question (Where do we stand?) we can only answer by pointing out with moderate certainty that we have definitely moved away from the risk of depression, that the contraction has slowed down, that the US economy has not hit bottom yet, that the transition period remaining until recovery begins is complex and full of vicissitudes and ups-and-downs, and that recovery, once it begins, will be fragile and prolonged.

Carlos Garramón
July, 2009

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