Asian Growth Outlook for 2009-2010

Overview: Most of Asian economies released stronger-than-expected Q2 2009 GDP figures, showing a V-shaped recovery may be in the cards. Relatively strong macroeconomic fundamental and initial conditions, aggressive fiscal and monetary policies and surging capital inflows all support this argument. Despite some improvements, real economic conditions remain fragile. Exports are falling at double-digit rates for most of countries, though the contraction has eased somewhat thanks to inventory restocking. Consumption remains weak due to negative wealth effects amid worsening labor market condition. Investment is declining sharply, reflecting tight credit condition and still-weak demand at home and abroad. Government spending was largely insufficient to support growth. Therefore, economic activity is expected to remain weak in H2 2009 and 2010, considering stimulus effects begin to fade and private sector deleveraging in advanced economies will continue to keep both exports and investment weak. Asian economies will recover on a sustained basis, accompanied by any meaningful revival in external demand in the advanced economies.

Asia's Recovery Prospects Hinge on G3 Recovery?
* ADB: "Asia will lead the recovery from the global slowdown" on the back of aggressive monetary and fiscal stimulus measures, relatively strong financial systems, faster-than-expected rebounds in less-export dependent countries. However, the recovery might be hampered by a prolonged global recession or an earlier-than-expected withdrawal of stimulus measures. Developing Asia is expected to grow by 3.9% in 2009 and 6.4% in 2010. (Asian Development Outlook; September 22, 2009)
* IMF: The growth forecast of Emerging Asia has improved, driven by better prospects in both China and India and a faster-than-expected turnaround in capital flows. But the acceleration in growth hinges critically on the recovery in developed economies. Emerging Asia is forecast to grow 5.5% in 2009 and 7% in 2010. Japan will contract sharply at 6% in 2009 but will grow 1.7% in 2010 due to aggressive fiscal policies and strong performance in neighboring Asian economies. (IMF Outlook, July 8, 2009)
* World Bank: Despite aggressive government measures, growth in East Asia and the Pacific will slow to 5% in 2009 from 8% in 2008 due to weak exports and a slowdown in domestic demand. Yet the region will grow the fastest in the world, helped by China. Ultimate recovery depends on the pace of recovery in advanced economies. Growth in 2010 will be relatively subdued at 6.6%. An output gap will persist for several years because of weak labor markets and sluggish consumption. (World Bank Outlook, June 2009)
* FT: "Too early to declare a V-shaped victory." Much of the recovery in the region is created by base-period effect. Domestic demand is still-weak and fiscal stimulus cannot be rolled out as it would create risks of overcapacity, asset price inflation and damage to the financial system (July 26, 2009). In addition, Asia has flunked the longer-term economic rebalancing, evidenced by still-weak domestic demand. The current account surplus has widened as imports fall faster than exports. Central banks are intervening FX markets to prevent currency appreciation amid exports slump. (Lex, July 23, 2009)
* EIU: Asia's growth will slow sharply to 2.4% in 2009 due to high export dependence and risks to investment and employment. The recovery will be subdued in 2010, growing by a mere 4.6%. This will be due to weak demand in advanced economies, tight access to credit and risk of capital flight, despite some improvement in global risk appetite. Aggressive loosening of monetary and fiscal policies will support growth and ensure a U-shaped recovery in the region. (July 17, 2009)
* Analyst Tomo Kinoshita, Nomura: Asian economies will recover 2008 GDP levels in 2011. "As Asian economies reach full-employment conditions and thus close the output gap in 2011, the driver of investment growth should shift from public investment initiated by fiscal stimulus in 2009 to private investment in 2011." (August 7, 2009)
* Johanna Chau, Head of Asia Pacific, Citi: Asia's recovery is V-shaped, backed by aggressive policy stimulus, export inventory restocking cycle for tech, sharp inflation collapse and some help from incremental demand from China. But the upturn may not be strong as deleveraging in the advanced economies will reduce the region's potential growth, especially for countries more dependent to previously credit-fueled exports markets, including Singapore, Malaysia and Taiwan. (July 24, 2009)
* Paul Gruenwald, Chief Economist Asia, ANZ: Emerging Asia's recovery path will depend on a combination of demand momentum, export dependency and the likely effectiveness of fiscal policy. But Asia will be unable to recover without a resumption of external demand in the advanced economies. (July 3, 2009)
* Analyst David Carbon, DBS: A V-shaped recovery is taking place in Asia as the drivers of downturn were "one-off" in nature not the "fundamental weakness." (June 11, 2009)
* Analysts Chetan Ahya and Deti Tan, Morgan Stanley: Growth will bottom out in H1 2009, with muted recovery in H2 2009. (January 16, 2009)
* Analysts Bill Belchere and Rajeev Malik, Macquarie: The U.S. recession will have a greater impact on Asia than the 2001 recession, with Asian exports and countries with high external financing needs (South Korea, India and China) taking a big hit. (March 13, 2009)
* 2009 AXJ GDP Growth Forecasts: Nomura: 4.9% | Citi: 4.6%| ANZ: 3.8% | EIU: 2.4% | RGE Monitor: 4.3%
* 2010 AXJ GDP Growth Forecasts: Nomura: 7.7% | Citi: 7% | ANZ: 6.5% | EIU: 4.6% | RGE Monitor: 6.2%

What Are Risks to Growth?

* Domestic Demand: Consumer spending has improved in some countries because of stimulus measures. But in most Asian Tigers and ASEAN countries, consumption is contracting or slowing sharply due to negative wealth effects from large job losses in manufacturing and export-related sectors. Investment is contracting or slowing sharply in most Asian Tigers and ASEAN countries due to plunging foreign direct investment (FDI) and exports, lower corporate earnings and tight credit.
* Exports: Exports contracted sharply across Asia in H1 2009 due to lower demand from the G-3, though industrial production turned around in many Asian countries. China's stimulus spending in 2009 is mostly geared toward infrastructure. So most Asian countries that export parts and components to China for re-export to the G-3 countries will not benefit. Benefits to Malaysia, Indonesia and Vietnam will be limited as they export manufacturing-intensive commodities to China. Asia's exports will remain under pressure until final demand in advanced economies shows a strong and sustained improvement.
* Tight Financial Conditions: Despite aggressive monetary easing and improvement in liquidity conditions, private lending rates remain elevated, and banks see high credit risk lending to corporates and households. Capital-raising activity remains subdued. On the other hand, in countries like Vietnam and China, government stimulus measures are fueling asset bubbles.
* Capital Flows: Foreign institutional investor (FII) inflows are fueling market rallies but are still prone to global risk aversion and volatility in the U.S. markets. FDI will drop in most Asian economies in 2009. Debt inflows are already under pressure because of declining interest-rate differential with the U.S. and rising debt downgrades. A global liquidity crunch is sharply reducing Asia's access to foreign bank capital. Easing external balances and capital outflows may lead to currency depreciation in the region. (Nomura)
* Deflation: Excess capacity in manufacturing, rising unemployment and slowing or contracting domestic demand in many countries are causing deflationary pressures. China, Hong Kong, Malaysia, Singapore, Taiwan, Thailand and Japan are in technical deflation. Some impact is due to base effects as food and commodity prices are lower relative to 2008. Deflationary pressures might persist until late 2009 or early 2010 due to sluggish economic recovery and large output gaps.
* Fiscal Deficit: Increasing stimulus spending amid withering income-tax- and commodity-related revenues are raising fiscal deficits and public debt. Investor concerns over rising bond issuance and higher longer-end yields are posing risk to debt auctions. Debt ratings of many countries (Japan, India, Taiwan, Thailand, Malaysia, Pakistan and Vietnam) have been downgraded or are at risk.
* Political Risk: Political stability has strengthened after elections in India and Indonesia. Thailand and Japan are witnessing increasing political instability exacerbated by the economic downturn. China and Vietnam face the risk of greater social unrest from job losses among migrant and factory workers.

Lehman Anniversary: What's Different? What's Still the Same?

Lehman Anniversary: What's Different? What's Still the Same?

Overview: On the anniversary of the Lehman failure President Obama addresses Wall Street in order to build consensus for his administrations' regulatory reform plan. Banks are lobbying hard against the new consumer protection agency and Congress is slow in adapting proposed rules for a systemic risk regulator, or the regulatory regime for OTC derivatives, and a new non-bank resolution mechanism. At the international level, the G20 finance ministers reached a tentative agreement on September 5 (to be finalized by G20 leaders in Pittsburgh on September 24-25) on a review of capital requirements, the need for coordinated exit strategies, the adoption of macro-prudential policies, and eventually align remuneration incentives with the long-term performance of banks. There is also agreement international coordination with regard to OTC derivativesand hedge fund regulation as well as a consistent set of accounting rules.

What's Different?
* The Bank of International Settlements' comprehensive response to the global banking crisis which was formulated in response to the G20 finance ministers' agreement (September 7, 2009): Capital requirements will be strengthened across the board with systemic banks facing higher charges. A larger share of common equity will be mandated. Countercyclical reserve requirements will be mandated. A liquidity requirement will be considered, as will an overall leverage ratio. Risky trading activities will face higher capital charges as well as complex securities in order to minimize regulatory capital arbitrage.
* Moreover, the G20 finance ministers vowed to align remuneration incentives with the long-term performance of banks.
* OTC Derivatives Central Counterparties (CCP): There is new consensus that a central counterparty is necessary to reduce potential knock-on effects (systemic risk) from the failure of a large player. However, the riskiest products are not standardized enough for a clearinghouse and therefore remain exposed to bilateral counterparty risk which regulators want to mitigate by imposing higher capital charges and disclosure of aggregate position holdings.
* There is new recognition that derivatives can have an economic impact. Stanford Professor Darrell Duffie writes in a Pew research report that "at the bankruptcy of Lehman a large quantity of interest-rate swap hedges that had been provided by Lehman needed to be quickly replaced. Other dealers, themselves under financial stress, were willing to provide these hedges only at swap rates below government yields." (09/01/09) This led to the persisting negative swap spread phenomenon in the 30-year U.S. and other government bond markets, once considered a "mathematical impossibility" unless unsecured bilateral swaps were perceived as safer than government debt. A persistent negative basis was also observed in the corporate bond market. Analysts note that balance sheet constraints prevent market participants from arbitraging the price discrepancy away.
* Further transmission channels from derivatives to real economy include corporate credit lines which are increasingly based on CDS performance. This transmits counterparty risk inherent in the CDS premium to the corporate sector (cash spreads themselves measure credit and liquidity risk). This might systematically understate credit risk in normal times and overstate credit risk in times of stress, thus introducing procyclicality, according to an ECB report released in September 2009. Furthermore, there is the empty creditor phenomenon that provides "overhedged" bondholders with an incentive to push for bankruptcy instead of restructuring.
* A new paradigm of economic thought is voiced by economist Keiichiro Kobayash at VoxEU: "The existing theoretical structure of macroeconomics is incapable of addressing macroeconomic performance and the stability of the financial system in an integrated context." The author proposes a paradigm shift to explicitly include the financial sector, credit markets and asset/collateral prices in standard economic modeling.

What's Still the Same?
* Too big to fail banks are now even bigger and leverage has increased across the board. With the incorporation of insolvent competitors and the forced re-intermediation of formerly off-balance sheet vehicles, the leverage ratio of global banks has jumped to around 40-50 in the U.S., Europe, and the UK in 2008. (InvestorsInsight, 07/19/09) As of 2010, up to US$900 billion of remaining off-balance sheet vehicles will have to be consolidated.
* Meanwhile, systemic banks benefit from implicit and explicit government backstops, whereas a resolution regime for all systemically large and complex institutions a la Fannie and Freddie, for example--arguably one of the most important measures-- is stalling in Congress amid waning political support. (Dealbook, 09/08/09) There is strong lobbying against the Consumer Protection Agency, whose fate is unclear. It is not decided yet who will be the systemic risk regulator: the Fed or the Systemic Risk Council.
* The lack of any disciplining mechanism represents an incentive for large players to engage in risky trading activities with value-at-risk (VaR) measures back at record levels in Q2 2009 for the top five banks, with US$1.04 billion at risk to be lost at any given trading day. This "represents an 18% increase from a year earlier and is up 75% from the $592 million in the first half of 2007, according to regulatory filings." (WSJ, 09/09/09)
* August 2009 TARP Oversight Panel Report: Toxic assets are still on banks' books. They are likely to be found in the Level 3 accounting category (mark-to-model) due to valuation difficulties. As of Q1 2009, the large banks have US$657 billion of Level 3 assets on their books. Public-private investment program is poised to start in October 2009 but it is unclear if banks will want to sell despite the government subsidies, or if buyers will want to get involved in a government program.
* Commercial Real Estate (CRE) Risk: Fitch (via RiskCenter): "While CRE loans, excluding the more problematic construction and development portfolios, represent more than 125% of total equity for the 20 largest banks rated by Fitch, the risk is even higher for banks with less than $20 billion in assets, as average CRE exposure represents more than 200% of total equity for these institutions." (08/19/09) Fitch announces ratings review by September.
* Dependence on wholesale funding markets is likely to remain an issue. "In the year up to September 2009, Western banks have issued $645 billion of bonds without government guarantees, according to Dealogic, a research firm. But the idea that the banking system can improve its funding profile at the same time as it weans itself off explicit state guarantees looks wildly unrealistic. This partly reflects the sheer volumes of debt involved. As well as turning over existing short-term borrowings of some $18 trillion, Western banks have to refinance longer-term debts that are maturing at the rate of about $1.5 trillion a year. With securitization markets damaged (approximate funding hole of US$2 trillion) and confidence in banks battered, that will not be easy." (The Economist, 09/03/09)

Review

The large reliance on uninsured wholesale funding and the declining value of collateral led to immediate ripple effects in the already challenged repo market (see NBER report by Gary Gorton and Andrew Metrick), and in the money market funds invested in Lehman's commercial paper (e.g. the Reserve Primary Fund.) Similarly, in the off-balance sheet universe, counterparty risk is measured by the replacement cost of bilateral hedges with another counterparty, minus any collateral posted. For example, the European Central Bank (ECB) reports that "as participants sought to replace terminated positions, [credit-default swaps] spreads widened by up to 40 basis points for investment-grade CDS and by around 100 basis points for sub-investment grade CDS." Re-hypothecated collateral proved in many cases difficult to access. AIG's total US$372 billion net protection seller position in the bespoke market (according to an AIG release via the ECB report, not captured in Depository Trust & Clearing Corporation data) shows the perils of credit-risk concentration due to one-way bets as compared to balanced bilateral exposures as is the norm for dealer banks. (The latter is shown for example in US$5.2 billion payout on US$72 billion of contracts with Lehman as a reference entity registered in the DTCC data warehouse; see FT, 09/11/09.) CDS are different from interest-rate derivatives in that the former are subject to jump-to-default risk (heavy right tails) (ECB). Recent research in network theory shows that sound CDS risk management by a central counterparty requires liquidity reserves proportional to gross rather than net exposures. (Rama Cont, Andreaa Minca & Amal Moussa, Columbia University)

Lehman's total assets in 2007 were US$691 billion. Of these, long positions in trading assets (45%) and short-term collateralized lending (44%, e.g. reverse repos) were the main positions. On the liabilities side, long-term debt (18%), equity (3%) and other short-term debt (8%) complemented short positions in trading (22%) and collateralized borrowing (37%). The remaining 12% were "payables," including the cash deposits of Lehman’s customers, especially its hedge fund clientele. ("Receivables" on the asset side were 6%.) "Hedge fund customers’ deposits are subject to withdrawal on demand, and proved to be an important source of funding instability," noted Tobias Adrian and Hyun Song Shin in a September 2009 Bank of France stability report.

The risk of a double-dip recession is rising

The risk of a double-dip recession is rising

By Nouriel Roubini

Published: August 23 2009 18:55 | Last updated: August 23 2009 18:55

T  he global economy is starting to bottom out from the worst recession and financial crisis since the Great Depression. In the fourth quarter of 2008 and first quarter of 2009 the rate at which most advanced economies were contracting was similar to the gross domestic product free-fall in the early stage of the Depression. Then, late last year, policymakers who had been behind the curve finally started to use most of the weapons in their arsenal.

That effort worked and the free-fall of economic activity eased. There are three open questions now on the outlook. When will the global recession be over? What will be the shape of the economic recovery? Are there risks of a relapse?

On the first question it looks like the global economy will bottom out in the second half of 2009. In many advanced economies (the US, UK, Spain, Italy and other eurozone members) and some emerging market economies (mostly in Europe) the recession will not be formally over before the end of the year, as green shoots are still mixed with weeds. In some other advanced economies (Australia, Germany, France and Japan) and most emerging markets (China, India, Brazil and other parts of Asia and Latin America) the recovery has already started.

On the second issue the debate is between those – most of the economic consensus – who expect a V-shaped recovery with a rapid return to growth and those – like myself – who believe it will be U-shaped, anaemic and below trend for at least a couple of years, after a couple of quarters of rapid growth driven by the restocking of inventories and a recovery of production from near Depression levels.

There are several arguments for a weak U-shaped recovery . Employment is still falling sharply in the US and elsewhere – in advanced economies, unemployment will be above 10 per cent by 2010. This is bad news for demand and bank losses, but also for workers’ skills, a key factor behind long-term labour productivity growth.

Second, this is a crisis of solvency, not just liquidity, but true deleveraging has not begun yet because the losses of financial institutions have been socialised and put on government balance sheets. This limits the ability of banks to lend, households to spend and companies to invest.

Third, in countries running current account deficits, consumers need to cut spending and save much more, yet debt-burdened consumers face a wealth shock from falling home prices and stock markets and shrinking incomes and employment.

Fourth, the financial system – despite the policy support – is still severely damaged. Most of the shadow banking system has disappeared, and traditional banks are saddled with trillions of dollars in expected losses on loans and securities while still being seriously undercapitalised.

Fifth, weak profitability – owing to high debts and default risks, low growth and persistent deflationary pressures on corporate margins – will constrain companies’ willingness to produce, hire workers and invest.

Sixth, the releveraging of the public sector through its build-up of large fiscal deficits risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth.

Seventh, the reduction of global imbalances implies that the current account deficits of profligate economies, such as the US, will narrow the surpluses of countries that over-save (China and other emerging markets, Germany and Japan). But if domestic demand does not grow fast enough in surplus countries, this will lead to a weaker recovery in global growth.

There are also now two reasons why there is a rising risk of a double-dip W-shaped recession. For a start, there are risks associated with exit strategies from the massive monetary and fiscal easing: policymakers are damned if they do and damned if they don’t. If they take large fiscal deficits seriously and raise taxes, cut spending and mop up excess liquidity soon, they would undermine recovery and tip the economy back into stag-deflation (recession and deflation).

But if they maintain large budget deficits, bond market vigilantes will punish policymakers. Then, inflationary expectations will increase, long-term government bond yields would rise and borrowing rates will go up sharply, leading to stagflation.

Another reason to fear a double-dip recession is that oil, energy and food prices are now rising faster than economic fundamentals warrant, and could be driven higher by excessive liquidity chasing assets and by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy, as it created negative terms of trade and a disposable income shock for oil importing economies. The global economy could not withstand another contractionary shock if similar speculation drives oil rapidly towards $100 a barrel.

In summary, the recovery is likely to be anaemic and below trend in advanced economies and there is a big risk of a double-dip recession.

The writer is professor of economics at the Stern School of Business, NYU

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羅比尼專欄／新興經濟體 底子硬復甦快

【經濟日報╱羅比尼（Nouriel Roubini）／編譯劉道捷】 2009.08.24 04:15 am

上周我評估那些國家最能熬過全球經濟衰退和信用危機，發現所有國家都受到信用危機影響，但若干國家配合堅強基本面，推動因應危機政策，獲得相對優勢，若干新興經濟體尤其如此。這種優勢可能促使我強調的下列國家，在全球經濟復甦中表現優異。 這些國家有什麼共通之處？重點之一是金融風險較低，國內市場比較大、比較強勁。此外，這些國家有能力推動財政與貨幣政策，對抗景氣衰退，和大肆舉債消費的國家大相逕庭。不過這些國家雖然地位優越，能否恢復永續成長，還是要看他們能否推動結構改革而定。 亞太國家──中國大陸 中國靠著強力財政與貨幣刺激，促使去年底幾乎停滯不前的經濟恢復加速成長，但政府的反應是否只是爭取時間，現在還不清楚。中國的振興措施自有風險，包括資 產泡沫、產能過剩和呆帳問題，但跡象顯示國內需求比預期有力。振興經濟措施以基礎建設為主，下半年或明年仍有繼續刺激經濟的空間，如此應可為其他國家提供 更多支撐，否則，中國和全球經濟成長可能大為不振。 澳洲 澳洲靠著運氣與政策，驚險逃過衰退。全球製造業低迷情勢，但中國和其他新興市場國家繼續利用澳洲豐富的天然資源，使澳洲今年淨出口得以成長。同時澳洲財政支出大增、政策利率下降，阻止消費者支出與房價急劇下跌。 澳洲靠著出口與國內需求兩大經濟支柱支撐，今年第一季就恢復經濟成長，但仍然處在實質衰退中。 全球生產觸底對澳洲是好消息，顯示澳洲今年可以避免衰退、實質衰退期間也會很短。 印度 印度今年可以創造接近6%的經濟成長。印度國內儲蓄、企業保留盈餘與消費基礎龐大，出口依賴程度低落，鄉村就業與所得所占比率居高不下等因素，都有助於印 度維持消費水準。政府及時推出因應危機對策、金融體系大致與外國隔絕、資訊出口大致能夠維持、外匯存底雄厚、投資報酬率優厚等條件，使印度可以繼續吸引外 資。 印尼 全球衰退與商品修正打擊印尼出口，幸好出口占國內生產毛額比率低落，經濟相當依賴國內消費，中國振興經濟，使印尼得以增加商品出口。 政府推動財政刺激政策、推行貨幣、信用與外匯措施，都有助於維持民間需求與融資需要。 印尼金融情勢相當穩定、改革繼續推動、資源部門仍有投資機會，是印尼能夠繼續吸引外資的原因。 北美──加拿大 加拿大財政健全，去年與今年初經濟表現領先七大工業國，但貿易與投資依賴美國，因此經濟復甦可能比美國慢。但金融部門比較有力、借貸水準與違約比率較低、國內需求重振，應可促使加拿大經濟從2010年開始復甦。 歐洲──法國 法國去年逃過經濟衰退，今年經濟表現可望領先歐盟四大經濟體。法國國內需求主導的成長模式比較平衡，對法國躲過全球經濟衰退相當有幫助。龐大的社會安全網充分支持法國的對抗衰退措施，銀行部門相當健全，地位優越，可以充分支撐歐元區經濟復甦。 挪威 去年第四季挪威經濟陷入負成長，但在先進經濟體中，表現仍然列在中段班，分析師預測挪威經濟今年還會萎縮1至2%，明年可以恢復成長。挪威與眾不同，多年 來一直享有巨額經常帳與預算剩餘，政府應用財政與貨幣政策因應衰退的能力綽綽有餘。因此可能是先進國家中最先復甦、最早提高利率的國家，預期2010年第 二季就會提高利率。 拉丁美洲──巴西 和其他開發中國家相比，巴西經濟頗有彈性，早在今年第一季，消費彈性就展露無遺，但製造業仍然疲弱不振。零售業繼續緩慢因應大為不利的環境，銷售成長率繼 續縮減，不過消費者信心幾乎已經回到危機前的水準，可以支撐消費。央行的貨幣與財政刺激應可協助經濟復甦，基礎建設與住宅興建計畫、汽車工業與資本財銷售 稅務優惠應可支撐勞動市場、擴大國內生產。

Charting the U.S. Economic Recovery: V, U or W?

Charting the U.S. Economic Recovery: V, U or W?

Overview: There are growing debates about the shape of the economic recovery, how long will it take to close the output gap and if the economy will grow above or below potential during the recovery. Some analysts expect policy measures and pent-up demand to drive a V-shaped recovery like the one witnessed after the 1981-82 recession. Others expect sluggish recovery in private demand and structural weaknesses in the economy to lead to a U-shaped recovery. Some analysts forecast that as impact of policy measures fade and inventory adjustments finish, growth might slow again if private demand remains weak, leading to a "double-dip" or a W-shaped recession.

Will Fundamentals Support a V-Shaped Recovery?
* Several economists expect the Zarnowitz rule, which says that deeper recessions are followed by steeper recoveries, to hold during this recovery. As economic variables plunged to record lows during late 2008/early 2009, a pent-up demand can boost growth even of these variables don't go back to their pre-boom levels in the near-term. Under this scenario, GDP growth will revive in H2 2009, posting above-potential growth (3%-5%) for some quarters with the economy slowly moving toward potential growth.
* Economists expect this pent-up demand to come from consumption, home prices, autos, industrial activity and investment. They assume the recession will have no impact on consumer behavior, bank-lending or excess capacity. Despite wealth erosion, households will consume as long as they have positive net worth, rising incomes and debt-restructuring/forgiveness opportunities. Firms low on headcount will begin hiring and investing immediately. Residential investment will rebound.
* Senior Economist James Glassman, JPMorgan: The economy might bounce back quickly growing 3%-4% in the coming quarters due to "pent-up" consumer demand as the equity rally will have positive wealth effects. Fed actions might prevent long periods of high unemployment. (via Bloomberg, August 14, 2009)
* Professor Alan Blinder, Princeton University: Lower potential growth going forward is based on the assumption of slower productivity growth, which might not be true. The economy will grow “closer, but not quite, to 3 percent” ahead. (via Bloomberg, August 14, 2009)
* Vice Chairman Laurence Meyer, Macroeconomic Advisers: There is no evidence that the structural unemployment rate has increased. The economy will grow 3.6% in 2010 and 3.9% in 2011 due to pent-up demand from stabilization in home prices. (via Bloomberg, August 14, 2009)
* Chief Economist Stephen Stanley, RBS: Since housing and auto sales are at “very depressed levels,” they will contribute to growth even if they don’t reach their pre-recession peaks. “There is a lot of pent-up demand [as] consumers are holding off on practically all of their discretionary purchases.” The economy might grow 2.9% in 2010, 4.4% in 2011 and 3.5% in 2012. (via Bloomberg, August 14, 2009)
* Michael Mussa, Senior Fellow, Peterson Institute for International Economics: Policy measures will counter economic shocks and the downturn and will lead to a vigorous recovery. The cyclical turning point will occur in mid-2009 with modest growth in summer 2009 and firm recovery in autumn 2009. Growth will be over 4% (Q4-over-Q4) in 2010. (April 8, 2009)


Will Sluggish Private Demand Lead to a U or W Shaped Recovery?
* Many economists believe that structural constraints to private demand will lead to a sluggish U-shaped recovery.These include: 1) slower credit growth; 2) lower household consumption/higher savings (due to jobless recovery, slower wealth and income growth, deleveraging, subdued home prices and higher taxes); 3) high government debt monetization raising real rates; 4) labor market woes (high structural unemployment, aging population); 4) low possibility of export-led growth due to global recession; 5) high taxes, greater regulation, more protectionism; 6) deleveraging in financial and corporate sector; 7) impact of slower capex, innovation and aging population on total factor productivity.
* Other economists expect policy measures and inventories to temporarily boost growth but believe the economy will fall back into slower growth in late 2010/early 2011 due to fading impact of fiscal stimulus, sluggish private demand, higher commodity prices during recovery, high government debt, less room for fiscal/monetary stimulus, lower credit growth and early withdrawal of stimulus measures. This might lead to a double-dip or a W-shaped recession.
* Under these scenarios, growth is forecast to remain below-potential for some quarters/years at around 1%-2% and it might take several years to close the output gap. The economy grew 3.4% during 1929-2008 and 2.8% during 1997-2008. Some of these economists see the risk of potential growth rate also declining.
* Dr. Roubini: "We are in a deep U-shaped recession [which is] three times longer than the previous two and five times deeper–in terms of cumulative GDP contraction–than the previous two. [A recovery will only begin in 2010] and will be weak given the debt overhang in the household sector, the financial system and the corporate sector...[There is] also a massive releveraging of the public sector with unsustainable fiscal deficits and public debt accumulation...[There will be] a shallow, below-par and below-trend recovery where growth will average about 1% in the next couple of years when potential is probably closer to 2.75%...[T]here is a risk of a double-dip W-shaped recession toward the end of 2010 due to the challenge of getting right the timing and size of the exit strategy for monetary and fiscal policy easing." (May 19, 2009)
* Rischard Berner, managing director, co-head of global economics and Chief U.S. Economist and David Greenlaw, managing director and chief U.S. fixed income economist, Morgan Stanley: "The recovery likely will be bumpy, with surges in output followed by slower growth. Longer term, the recovery will be relatively slow, as financial and economic headwinds are only gradually giving way to tailwinds...Yet the recovery will be sustainable... Neither a ‘W' nor a double-dip are the most likely outcome." (August 13, 2009)
* CEO Mohammad El Erian, PIMCO: Excessive regulation, higher taxation, lower consumption and existence of zombie institutions will constrain the growth of potential output to a "new normal" of 2% or below with an eventual inflationary bias down the road. (May 12, 2009)
* Professor Martin Feldstein, Harvard University: "[T]here is a risk the economy may experience a double-dip contraction." The economy could flatten out or be positive in Q3 2009 and contract again in Q4 2009 as the stimulus' impact wears off and companies finish rebuilding inventories. "There isn’t going to be enough to sustain a really solid recovery." (via The Big Picture, WSJ, July 21, 2009)
* Economists Jan Hatzius and Ed McKelvey, Goldman Sachs: Growth will be below trend in 2010 due to fading stimulus impact, rising savings, tight lending conditions and excess capacity in housing and the rest of the economy. Another shock, such as early withdrawal of stimulus, might pose risk of a double-dip. (July 31, 2009, Report: A Stronger Economy in the Near Term, But)
* Economists Drew T. Matus et al, BoA/Merrill Lynch: A 'square-root' type of recovery looks likely as boost from fiscal stimulus will be muted by constraints on consumer spending. The economy will settle to a new trend growth of 2.5%. (In the Report 'The Shape of Things to Come', May 21, 2009)
* IMF: Financial turmoil characterized by banking crisis are associated with severe and longer downturns with larger impact on growth. The U.S. will grow 0.8% in 2010 (below potential) with a sluggish recovery. Growth will turn sustainably positive only in Q2 2010. Potential output will be weak in the medium term due to higher financing costs. (IMF 2009 Article IV, July 2009)
* Professor Kenneth Rogoff, Harvard University: "[The] next five to seven years won't be like the boom years before the financial crisis. With housing prices likely to be soft for years, credit much tougher to come by [and] unemployment stubbornly high, consumers are likely to remain cautious." Taxes will have to be raised to finance debt and entitlements. (via Washington Post, August 13, 2009)
* Gary Shilling: "The recession will extend into early 2010. Only by then fiscal stimulus will stabilize [consumption and] global financial woes [and] excess home inventories may be absorbed." GDP is forecast to grow 2% in the next decade with growth coming from government spending while growth of consumption, investment and trade will slow. Consumption's share in GDP will fall to 66.5% in 2018 from 71% in 2008 while share of other components in GDP will increase, especially that of government spending. (Via Investors Insight, August 10, 2009)
* Douglas Holtz-Easin, Brookings: Despite better economic data, consumers will take longer to recover as they re-build their wealth, pay higher taxes and face high unemployment and inflation. (via Washington Post, August 13, 2009)
* Congressional Budget Office (CBO): "Many factors will temper the strength of the recovery: the loss of household wealth, the fragility of financial institutions, persistently weak growth in the rest of the world, a surplus of housing units on the market and low utilization of manufac­turing capacity... Even if the economy returns to positive growth in 2009, the loss in output, income and employment during the recession and the next few years will be huge.... The gap in output (7% in 2009-10) will not close until 2013 due to large shortfalls in output over the next few years." (May 21, 2009)
* Bridgewater Associates: "Government actions...are not sufficiently directed at the root problem of excessive indebtedness to produce permanent healing." Labor cost cutting by companies will undermine demand and keep up the pressure on banks because of loan losses. (via Thoughts from the Frontline's May 15, 2009, Issue)

金融回暖，經濟猶寒

金融回暖，經濟猶寒

by Nouriel Roubini

紐約——近三個月，全球資產價格強勁回升：發達經濟體股票市值漲幅已超30%，大多數新興市場漲幅更大。大宗商品——石油、能源和礦產的價格飆升；政府債收益迅速攀升，導致企業信用利差（企業債與政府債收益之差）急劇縮小；振盪（所謂“恐慌指標”）減緩了；美元走弱，表明市場對避險性美元資產的需求減弱了。

然而資產價格的這一波回升是不是由經濟基本面驅動的呢？它是可持續的嗎？這一波股價回升究竟是一輪牛市的開始，還是漫漫熊市里的一輪反彈？

雖然一些經濟資料表明基本面的確有所改善，至少一場蕭條來臨的風險已有所降低，全球衰退在年末觸底的可能性有所加大，風險情緒也有所緩和，但是一些不可持續因素也在發揮顯著的作用。何況，某些資產價格的迅速回升會對全球經濟復蘇構成威脅。所以說，市場向下調整的許多風險因素猶存。

首先，信心和風險厭惡心理都是善變的，新一輪振盪很容易出現，只要宏觀經濟和金融資料意外出現下行苗頭的話——許多人覺得，剛剛露頭的全球復蘇儘管生機勃勃，卻還沒有成熟。

第二，極端寬鬆的貨幣政策（零利率、量化寬鬆、新的信貸供應、新發政府債以及購買缺乏流動性的風險私人資產等措施），連同用來穩定金融系統的巨額開支，會在金融和大宗商品市場吹起新一輪流動性驅動型資產價格泡沫。例如，中國的國有企業輕易獲得大量資金和信貸，正在到處收購股權，囤積大宗商品，遠遠超過其生產所必須。

宏觀經濟基本面差於預期引發調整的風險是明顯存在的。實際上，美國和其他發達經濟體最近的資料意味著，衰退將持續到今年年底。更糟的是，未來的一輪復蘇很可能是有氣無力、極不充分的——實際增長遠低於潛在增長率，持續幾年甚至更久——而私人部門的債務和杠杆負擔，連同激增的公共部門債務，會限制家庭、金融公司及企業放貸、借款、支出、消費和投資的能力。

疲弱的復蘇這一情景令人不安，低增長率和通縮壓力限制了收入和利潤空間，大多數發達經濟體的失業率高達10%，可能導致銀行和金融機構的資產組合中大量累積壞賬和有毒資產，從而引發新的金融休克，這一切都在挑戰V形復蘇的希望。與此同時，若干新興市場已經爆發的金融危機可能會傳染給其他經濟體，進而給全球金融市場造成額外壓力。

有些資產的漲價還會導致經濟形勢二次探底，走出W形。尤其是流動性洪水推高能源價格的速度過快、幅度過大。2008年夏天高油價在促發全球經濟衰退中所扮演的角色不容低估。當時油價超過了140美元/桶，是房價崩盤和金融休克之後壓垮全球經濟的最後一根稻草——它給美國、歐洲、日本、中國和其他石油淨進口國帶來了猛烈的供應衝擊。

與此同時，大多數經濟體的財政赤字不斷擴大，推高了長期政府債的收益。鑒於投資者對全球復蘇有所預期，長期利率上升是一種必然的調整。但還是有一些導致利率上升的因素令人擔憂：大規模預算赤字和債務對主權風險及實際利率會有何種影響；當全球經濟於2010~2011年間復蘇，且通縮壓力消失之時，大規模赤字的貨幣化會不會導致嚴重通脹？政府債收益走高，按揭利率和其他私人證券收益也會隨之走高，從而擠壓私人需求，這反過來也可能對經濟復蘇構成威脅。

所以我的結論是，不能排除2010年下半年或2011年出現這樣的情形：一場100美元/桶以上的油價完美風暴、高企的政府債收益和各國政府為了避免債務再融資而增加稅收，三種因素共同導致一輪新的經濟下行，甚至是二次探底。資產價格從今年3月份的低位回升這一輪有一定的基本面基礎，因為全球金融崩潰和經濟進入蕭條的風險減弱了，信心也得到了恢復。但是這輪回升也有相當大的一部分是缺乏支撐的，因為它的驅動力是“經濟會迅速復蘇到潛在增長水平”這種過度樂觀的預期和過快過猛地推高了油價和股價的流動性泡沫。負面的油價衝擊和過高的政府債收益有可能剪斷復蘇的翅膀，導致資產價格和實體經濟出現新一輪較嚴重的下挫。

A Phantom Economic Recovery

Roubini Project Syndicate Op-Ed: A Phantom Economic Recovery

Nouriel Roubini | Aug 16, 2009

Where is the US and global economy headed? Last year, there were two sides to the debate. One camp argued that the recession in the US would be V-shaped—short and shallow. It would last only eight months, like the two previous recessions of 1990-1991 and 2001, and the world would decouple from the US contraction.

Others, including me, argued that given the excesses of private sector leverage (in households, financial institutions and corporate firms), this would be a U-shaped recession—long and deep. It would last about 24 months, and the world would not decouple from the US contraction.

Today, 20 months into the US recession—a recession that became global in the summer of 2008 with a massive recoupling—the V-shaped decoupling view is out the window. This is the worst US and global recession in 60 years. If the US recession were—as is most likely—to be over at the end of the year, it will have been three times as long and about fives times as deep—in terms of the cumulative decline in output—as the previous two.

Today’s consensus among economists is that the recession is already over, that the US and global economy will rapidly return to growth and that there is no risk of a relapse. Unfortunately, this new consensus could be as wrong now as the defenders of the V-shaped scenario were for the past three years.

Data from the US—rising unemployment, falling household consumption, still declining industrial production and a weak housing market—suggests that the US recession is not over yet. A similar analysis of many other advanced economies suggests that, as in the US, the bottom is quite close, but it has not yet been reached. Most emerging economies may be returning to growth, but they are performing well below their potential.

Moreover, for a number of reasons, growth in the advanced economies is likely to remain anaemic and well below trend for at least a couple of years.

The first reason is likely to create a long-term drag on growth: Households need to deleverage and save more, which will constrain consumption for years.

Second, the financial system— both banks and non-bank institutions—is severely damaged. Lack of robust credit growth will hamper private consumption and investment spending.

Third, the corporate sector faces a glut of capacity, and a weak recovery of profitability is likely if growth is anaemic and deflationary pressures still persist. As a result, businesses are not likely to increase capital spending.

Fourth, the releveraging of the public sector through large fiscal deficits and debt accumulation risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth.

Domestic private demand, especially consumption, is now weak or falling in over-spending countries (the US, UK, Spain, Ireland, Australia and New Zealand, etc.), while not increasing fast enough in over-saving countries (China, other Asian countries, Germany and Japan, etc.) to compensate for the reduction in these countries’ net exports. Thus, there is a global slackening of aggregate demand relative to the glut of supply capacity, which will impede a robust global economic recovery.

There are also now two reasons to fear a double-dip recession. First, the exit strategy from monetary and fiscal easing could be botched, because policymakers are damned if they do and damned if they don’t. If they take their fiscal deficits (and a potential monetization of these deficits) seriously and raise taxes, reduce spending and mop up excess liquidity, they could undermine the already weak recovery.

But if they maintain large budget deficits and continue to monetize them, at some point—after the current deflationary forces become more subdued—bond markets will revolt. At this point, inflationary expectations will increase, long-term government bond yields will rise and recovery will be crowded out.

A second reason to fear a double-dip recession concerns the fact that oil, energy and food prices may be rising faster than economic fundamentals warrant, and could be driven higher by the wall of liquidity chasing assets, as well as by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy, as it created a major income shock for the US, Europe, Japan, China, India and other oil-importing economies. The global economy, barely rising from its knees, could not withstand the contractionary shock if similar speculative forces were to drive oil rapidly towards $100 a barrel.

So, the end of this severe global recession will be closer at the end of this year than it is now, the recovery will be anaemic rather than robust in advanced economies, and there is a rising risk of a double-dip recession. The recent market rallies in stocks, commodities and credit may have gotten ahead of the improvement in the real economy. If so, a correction cannot be too far behind.

©2009 / PROJECT SYNDICATE

Nouriel Roubini is chairman of Roubini Global Economics and a professor at the Stern School of Business, New York University.

Nouriel Roubini - Article summarizing the US and global economic outlook

Nouriel Roubini - Article summarizing the US and global economic outlook

Article summarizing the US and global economic outlook

Nouriel Roubini | Mar 22, 2009

Here is below an English translation of an article in the Italian financial newspaper Il Sole 24 Ore that summarized a presentation about the US and global economy and financial markets that I recently made in Italy:

The economist Nouriel Roubini: "There may be light at the end of the tunnel” by Isabella Bufacchi, Il Sole 24 Ore

Whoever dares to ask Dr. Doom- Nouriel Roubini - if the crisis has reached its bottom, if the worst is behind us, must also have the courage to hear his answer that can be summed up in two letters, an predictably "no". According to the professor of economics at New York University, which now enjoys an undisputed reputation worldwide for having predicted well in advance and with an accurate analysis the crisis that has brought the world to its knees, the markets have yet to discount other bad news: he is of the view - in truth he is not the only - that the rise in stock markets in the last few days are a temporary "bear market rally” with more contraction ahead. However, in an intense presentation held yesterday in Milan at a meeting organized behind closed doors by Calyon Crédit Agricole, Dr. Doom gave a glimmer of hope: "there is possibly light at the end of the tunnel," he said, although with close teeth. That bottoming out however requires a number of conditions: it requires governments and central banks of the countries most affected by the worst recession since the Great Depression of 1929 – the United States, European Union, China and Japan in the first place - "to adopt anti-crisis measures that very aggressive and front loaded". What has been implemented so far, in terms of fiscal stimulus and monetary policies, including unconventional policies, is not enough. The severity of the crisis is such – “the world economy in danger of falling into the abyss of a near depression" to put it as Roubini says it - that resolving this crisis requires major policy efforts and timely and bold decisions by the governments. Here is a summary of the Doom-thinking on the major open questions that are most relevant to the markets as of 20 March 2009.

Banks The "good news" for Dr. Doom is that after the failure of Lehman Brothers the systemic risk associated with further disorderly bankruptcies of major financial institutions has been reduced: the countries of the G7 and the European Union have admitted that letting Lehman in a disorderly way was a mistake "and promised that they will do everything possible to prevent an event of this scale happening again”. According to Roubini guarantees for deposits and for new borrowing of banks and the recapitalization of banks with public capital are positive developments. However, according to Roubini, much more remains to be done: many American and British banks are still unstable, near insolvent and many institutions will have to temporarily "nationalized"; this will be the proper way to "clean up their balance sheets." Roubini recommends that the State takes the task of cleaning up the balance sheets of insolvent banks, by taking them over and then separating good and bad assets. You can also expect more bad financial news from banks, insurance companies, hedge funds and even by countries that have committed similar policy mistakes as in Iceland: highly leveraged and troubled institutions will be forced to sell illiquid assets into illiquid markets, thus triggering new lows in global stock markets.

Speaking of toxic securities, Roubini said, because its estimates on the losses of the banking system worldwide (3,600 billion dollars) are worse than those of the IMF (2,200 billion) because the IMF estimated the losses based on current delinquencies and charge off rates while Roubini forecasts are based on projections of what losses will be at the peak in a year from now in a reasonable macro scenario. Dr. Doom prefers the Swedish model of cleaning up banks because the Japanese model, "keeping alive zombie banks," turned out a failure that prolong the depression. Finally, among the short-term initiatives that can help to resolve the crisis Roubini discussed appropriate forms of a suspension of mark-to-market accounting and the temporary easing of capital requirements of banks.

Recession: V or U or L Dr. Doom had already foreseen a long and protracted U-shaped recession for the world economy when the prevailing view was of a short and shallow V-shaped recession for the US. Roubini yesterday made it clear that his estimate for the length of the recession in the U.S. is moving from 24 to 36 months, with an unemployment rate in the U.S. that is heading towards 10%. Its "U" in the meantime is worsening day by day. "If the Obama Administration and the rest of the world will not intervene in drastic manner, with anti-crisis fiscal and other policies even stronger than those announced, the" U "is likely to turn into a" L ", i.e into a near-depression." The forecasts by Roubini about the global economy are bleak. "Do you remember the saying that when the U.S. sneezes, the world catches a cold. Well now the United States have a severe chronic case of pneumonia." Why does Roubini sees a gloom on a global scale and does not believe in "decoupling" (according to which Europe and other economies can grow without following the U.S. in its recession)? Yesterday, he argued that excesses of leverage also existed in many countries outside the US: the "too much" leverage (excessive borrowing of households to purchase homes and/or auto loans, student loans, and broader consumer credit) was prevalent also in the UK, Spain, Ireland, Iceland, some Baltic states, Emerging, Europe, Dubai, etc. According to Roubini, if the growth in China slows from 10% to 5% as likely this year that is a "hard landing" for China.

Another source of vulnerability for the world – according to Roubini - is the risk of financial and currency crisis that is affecting a number of emerging countries in Europe: Latvia, Estonia and Lithuania, Pakistan, Korea, Indonesia, Venezuela and Ecuador were all been mentioned yesterday. For all these reasons the forecasts of Dr. Doom on the likely contraction of the global economy in 2009 have deteriorated from -0.5 to -1.2 percent. "In other times the world growth below the threshold of +2.5% was bad news as that is the signal of a global recession."

Break the vicious circle There may be light at the end of the tunnel according to Roubini if the right policies are undertaken. Governments and central banks should commit to "break the vicious circle", the lack of confidence that is hindering real investment spending by companies that are solvent and that is leading sound households not to spend. What must be avoided is a situation where small, medium and large-sized solvent firms fail because of the lack of credit, i.e. the liquidity and credit crunch that hurts even sound enterprises unable to roll over their debts. Firms are reacting to the falling demand by investing less and reducing production and unemployment as their goal is to survive the crisis by saving cash. But the loss of jobs or the risk of becoming unemployed restrains the consumption of households. In this scenario, Roubini points out that banks that are under-capitalized, as many are, are being forced to reduce their risks and thus provide even less credit. And it is in this area, the NYU professor, that governments and central banks can play a crucial role with interventions to assist small and medium sized enterprises and households at risk of going bankrupt because of the lack of credit; therefore, government guarantees of lending and recapitalizations of banks can help. In short, governments and central bank are the only agents who take actions to prevent a worse recession. “Partially socializing the losses of banks, firms and households, transferring to the public sector the losses of the private sector will be very expensive public debt-wise; but it is the policy medicine that can help an L-shaped near depression" in the words of Roubini.

Deflation and inflation Roubini argues that one should not be concerned about future high inflation. As he explains. "If a patient comes into the emergency room and is in a coma fighting to survive, I simply don’t believe that doctors in such a situation should be concerned about the diet of the patient and tell him to first exercise, go on a diet and lose weight if he is overweight, or first to convince him to stop smoking: first of all you need to do something immediate to prevent the patient from dying." Well, a recession that threatens to turn into a depression that is like a near death experience for the global economy: and that is why Dr. Doom (who during the conference yesterday he spoke of a small but rising risk of collapse of the global economy and the risk of a global depressionary catastrophe) urges governments and central banks to focus on the risk of deflation. Prices will fall because firms have an over-supply of unsold good that they will try to dispose of by reducing prices. Roubini also argues that commodities prices, despite recent decreases (even by 60% for oil), may drop further, fueling the deflationary pressures. He sees "more downside risk" for oil and gold prices. As demand and consumption falls below production, prices fall and firms cut back production and employment leading to another round of falling demand; this is the vicious circle that governments need to prevent.

The role of central banks Having mentioned the specter of a "liquidity trap," Roubini argued yesterday that policy rates dow to zero and quantitative easing (creating base money through the purchase of securities in the market) is necessary but not sufficient. According to Dr. Doom central banks must do more. So far they have done too little too late. Their goal should be to reduce market credit spreads that right now are so high that they are pricing the risk of a depression. The fact high yield spreads of corporate bonds are 2,000 basis points above Treasuries is likely excessive. According to Roubini, given the likely rate of defaults and recovery rates in case of bankruptcy short of a depression outcome, a 2,000 basis points spread implies that high yield corporate bonds are cheap. But the high yield bond market is frozen. That is why central banks consider buying some private assets with greater credit risk; "while this would increase the risks on the central banks balance sheet this is necessary to reduce the excessively high market spreads." As for the ECB, Roubini is critical of this central bank as it has done too little too late to reduce its policy rate (that is still a long way from the zero bound in the Eurozone) and is still behind the curve in considering and implementing quantitative easing. The objective should be to ease the credit crunch with unconventional monetary policy actions and new tools. The risk of inflation from such aggressive easing is so far minimal: in spite of aggressive base money increases the money and credit multiplier has sharply fallen and the quantitative easing has not – so far – increased credit significantly.

The dollar and Treasury bondsRoubini yesterday expressed aloud what everyone thinks: that the United States would like a weak dollar, the Eurozone a weak euro, Japan a weak yen, China a weak yuan, and Switzerland a weak Swiss franc, each as a way to boost their sagging exports and growth. But this is not possible as all currencies cannot be weak relative to each other. So, what is the prediction of Dr. Doom for exchange rates? Without going into much detail, the argument was this: the only true "AAA" assets in the real world at the moment are US Treasurie. Many previous "AAA" securities issued by banks, industrial companies, as well as those in securitized products, and even those of sovereign states that are shaky like some in the Eurozone, are not true AAA or have been massively downgraded. And if risk-averse investors are still looking for really safe investments, with the highest rating "AAA" they have little choice but that of U.S. Treasuries. Also, even if the Administration Obama fiscal deficits floods the market for government bonds denominated in U.S. dollars, a large proportion of this issuance will be purchased by the Federal Reserve thus keeping rates low. All this means that the U.S. dollar is – in relative terms – still a safer choice for risk averse investors. In the medium term, the dollar will need to depreciate - according to Roubini – but it will not experience an outright collapse because "this weakness is not a trend."

Global Current Account Imbalances The ideal scenario for the future of the global economy is – according to Roubini - is a more balanced global economy where the US consumes less and exports more reducing its trade deficit, while the Chinese, Japanese and German economies reduce their trade surpluses and rely more on domestic demand as a source of growth. Also, although it will take time governments that have increased their fiscal deficit to GDP ratio and their debt to GDP ratio with draconian anti-crisis stimulus packages will have to restore fiscal discipline to ensure medium terms fiscal sustainability. Roubini argued that saving the world and preventing a depression will have a high fiscal cost:"there is no free lunch”. The cost of the rescue will be steep and fiscal deficit bill will come eventually due when governments will have to increase taxes and/or reduce government spending to service their higher stock of public debt. But, according to Dr. Doom, there is no alternative: "in the long run we may all be dead – to paraphrase Keynes – but in the short run it is more important to avoid by any means an early near-death of the global economy."

http://www.rgemonitor.com/roubini-monitor/256108/article_summarizing_the_us_and_global_economic_outlook

HELICOPTER BEN GOES ZIRP, QE, AND MORE... WHILE THE GLOBAL ECONOMY ENTERS STAG-DEFLATION

HELICOPTER BEN GOES ZIRP, QE, AND MORE... WHILE THE GLOBAL ECONOMY ENTERS STAG-DEFLATION

By Nouriel Roubini

REG Monitor

December 17, 2008

Original source: RGEM Monitor

The Fed decision yesterday to cut the Fed Funds range to 0-0.25% formalized the fact that, over the last month, the Fed had already moved to a ZIRP (zero-interest-rate-policy) -- as the effective Fed Funds rate was already close to zero -- and started a policy of QE (quantitative easing) as its balance sheet has surged over the last few months from $800 billion to over $2 trillion. And -- as discussed below -- the Fed is now undertaking even more unorthodox policy actions.

These Fed policy actions are occurring while the U.S. and the global economy is now risking a protracted bout of stag-deflation, a disease that I first discussed as early as January 2008 when I warned about the risk of a global deflation and stag-deflation. While it is now fashionable to talk about such deflationary risks –- and the latest U.S. CPI figures confirm that we are entering into deflation -– some of us were worrying about the coming deflation well before the mainstream –- concerned with short-run and unsustainable increases in commodity prices –- discovered the deflationary risks in the global economy.

It was clear to those of us that saw early on the risks of a severe U.S. and global recession that, once that recession would emerge, deflationary rather than inflationary pressures would emerge as slack in goods markets, slack in labor markets, and slack in commodity markets would emerge. So now we need to worry about stag-deflation, deflation, liquidity traps, and debt deflation. Welcome to the world of stag-deflation or, as Krugman would put it, to the world of “depression economics.”

So what is the outlook for the U.S. and the global economy in 2009? And what is the likely policy response to the risks of a global stag-deflation? Let us discuss next these two questions…

The outlook for the U.S. and the global economy is now very bleak and getting worse as the global economy is experiencing its worst recession in decades. In the U.S., recession started last December, and will last at least 24 months until next December -- the longest and deepest U.S. recession since World War II, with the cumulative fall in GDP possibly exceeding 5 percent. In comparison, the last two recessions in 1990-91 and 2001 lasted only 8 months each and in 2001 (1990-91) the cumulative fall in GDP was only 0.4% (1.3%). There is also a risk that this deep and protracted U-shaped recession (the mainstream consensus view of a V-shaped short and shallow recession is now out of the window) may morph into a more severe Japanese style L-shaped recession unless aggressive fiscal policy and recapitalization of the financial system is enacted.

The recession in other advanced economies (the euro zone, the U.K., other European economies, Canada, Japan, Australia, and New Zealand) started in the second quarter of this year, before the financial turmoil in September and October further aggravated the global credit crunch. This contraction has become even more severe since then. I don’t expect growth in the advanced economies to recover before the end of 2009.

There is now also the beginning of a hard landing in emerging markets as the recession in advanced economies, falling commodity prices, and capital flight take their toll on growth. Indeed, the world should expect a recession (growth in the -1 to -2% range) in Russia and a near recession (growth close to zero) in Brazil next year, owing to low commodity prices. There will also be a very sharp slowdown in China and India that will be the equivalent of a hard landing (growth well below potential) for these countries. In China the latest figures for electricity use, export[s,] and imports suggest that the economy is already close to the hard landing scenario of a growth rate of 5%. The deceleration of growth in China is much more rapid than expected.

Other emerging markets in Asia, Africa, Latin America, and Europe will not fare better, and some may experience full-fledged financial crises. More than a dozen emerging-market economies now face severe financial pressures: Belarus, Bulgaria, Estonia, Hungary, Latvia, Lithuania, Romania, Turkey, and Ukraine in Europe; Indonesia, South Korea, and Pakistan in Asia; and Argentina, Venezuela, and Ecuador (a country that has just defaulted on its sovereign debt) in Latin America.

How is the policy response in the U.S. and other countries to this risk of a global stag-deflation?

The Fed decision yesterday to cut the target for the Fed Funds rate to a 0% to 0.25% range is just underwriting what was already obvious and happening in reality: while the target Fed Funds was -- until yesterday -- still 1% in the last few weeks -- following the massive increase in liquidity by the Fed -- the actual Fed Funds was already trading at a level literally close to 0%.

So the Fed just formalized what was already happening for weeks now, i.e. that the Fed Funds rate was already zero and that the Fed had already moved to quantitative and qualitative easing (QE) in the form of massive increase in the monetary base and aggressive use of monetary policy -- via a range of new facilities and tools -- to reduce short term and long term market rates that are stubbornly high in a sign that the credit crunch is severe and worsening.

I predicted early in 2008 that the Fed Funds rate "would be closer to 0% than to 1%" in the midst of a severe recession. Now 12 months into this severe recession (that officially started in December 2007) -- a recession that will last at least another 12 months (if not, as possible, much longer) -- the Fed Funds rate is already down to 0% (the beginning of the zero-interest-rate-policy or ZIRP for the U.S.) and the Fed has moved into uncharted unorthodox monetary policy as a severe stag-deflation is taking place.

And, as predicted here over a month ago, the Fed is now committed to keep the Fed Funds rate close to zero for a long time (as a way to push lower long term Treasury yields), is purchasing agency debt and agency MBS in massive amount; and is even considering purchasing long-term Treasuries as a way to push lower long term government bond yields that are already falling sharply.

More aggressive policy actions may be undertaken by the Fed as a severe credit crunch shows no signs of relenting. In his 2002 speech on deflation the Bernanke spoke even of helicopter drops of money, monetizing fiscal deficits, and even buying equities. The latter actions have already been partially undertaken: the Fed is effectively already monetizing the U.S. fiscal deficits as the purchase of markets assets (agency debt and MBS and other facilities) is financed with the Fed printing presses rather than the TARP program; and now with the Fed considering the purchase of long-term Treasuries, such monetization of deficits will be made more formal. Also, since the TARP has been turned into a program to recapitalize financial institutions (and thus boost their capital and market value), the U.S. has already effectively intervened indirectly in the equity market (by partially nationalizing a good part of the U.S. financial system); once the Fed starts to buy the U.S. long-term Treasuries financing the TARP program, this indirect Fed purchase of U.S. equities will be even more clear.

While Fed actions to reduce mortgage rates -- via purchases of agency debt and agency MBS -- are partially successful, as long-term mortgage rates are falling, most of Fed purchases of private assets have been so far limited to very high-grade securities. Thus, the gap between the yield on high-grade commercial paper purchased by the Fed and the one that the Fed is not purchasing is sharply rising; ditto for the gap between agency MBS and private label MBS; also, while long-term Treasury yields are sharply falling, the spread of corporate bonds -- both high-yield and high-grade -- relative to Treasuries remains huge, as a sign of a severe credit crunch. Thus as a next step the Fed may be soon forced to walk down the credit curve and start buying private short-term and long-term securities with lower credit rating. That would mean that the Fed will take on even more credit risk than is already taking on today while purchasing illiquid private assets. But desperate times lead to desperate actions by desperate policymakers.

In the rest of the world, monetary and fiscal easing is also occurring as global policymakers are trying to prevent a global stag-deflation; but the policy response in most countries is more limited and constrained than the aggressive one of the U.S. monetary and fiscal authorities.

In the Eurozone the policy response has been extremely slow. First, the ECB is behind the curve and cutting rates too little and too late. Second, the ECB has been much less creative and aggressive than the Fed in creating new facilities to unclog the liquidity and credit crunch that is becoming as severe in Europe as in the U.S. Third, the fiscal policy stimulus in the E.U. is weak: those countries that need a stimulus the most (Italy, Portugal, Greece, Spain, U.K.) are the ones that can afford it the least given their large fiscal deficits and debts; and those who can afford it the most -- Germany -- are least willing to have it. Fourth, the recapitalization of financial institutions in Europe is occurring more slowly than in the U.S. and some of the financial firms rescue plans have been partly botched. Also, cross-border financial activities and the lack of cross-border burden sharing in the E.U. limit the ability of the E.U. to rescue large financial firms with cross-border activities. Add to this the fact that many banks in Europe are too big to fail but also too big to be rescued (large relative to the fiscal resources of their country’s government). Fifth, the structural rigidities of Eurozone (labor markets in particular) may cause the Eurozone contraction to be as severe as the U.S. one even if the initial economic and financial imbalances were less severe in this region.

While the U.S. and Japan are already into a ZIRP policy, other advanced economies’ central banks will in 2009 get very close to it, starting with those in Switzerland and the U.K. And more unorthodox monetary policies, such as QE and the other ones adopted by the Fed, may become more popular in a number of advanced economies.

In the many emerging-market economies at the risk of a financial crisis, aggressive monetary easing and fiscal easing are not likely. Indeed, many of these countries start with large fiscal deficits and debt, thus requiring fiscal discipline rather than easing. Moreover, many of these countries have large stocks of foreign currency liabilities whose real value would sharply increase if easy monetary policy leads to a sharp depreciation of their currency. Thus, there is less room for monetary easing. Also, many of these countries don’t have the fiscal resources to provide liquidity and capital to their financial institutions that are now facing a sudden stop of capital inflows. The international community -- IMF programs, World Bank [and] other IFIs' financial support, and the Fed/ECB with their swap lines -- can help countries under distress as long as they implement appropriate policy changes, but the risks of outright financial crises remain in some of the weakest economies.

In China -- which is now at risk of a severe hard landing -- it is not clear whether the aggressive fiscal and monetary/credit easing will be able to prevent a hard landing. Can aggressive monetary/credit and fiscal policy easing prevent this hard landing? Not necessarily. First, note that China has already reduced interest rates three times in the last few months and eas[ed] some credit controls. But monetary and credit policy easing may be ineffective: if capex spending by the corporate sector starts to fall sharply as the fall in next exports leads to a sharp fall in the expected return on new capital spending on exportables, a reduction of interest rates and/or an easing of credit controls will make little difference to such capex spending: easing money and credit will be like pushing on a string as the overinvestment of the last few years has led to a glut of capital goods. There is indeed already evidence [for] that, but corporate loan demands have diminished sharply while commercial banks have hesitated to lend while choosing to firewall risks. The government can ease money and credit, but it cannot force corporat[ions] to spend and banks to lend if loan demand is falling because of low expected returns on investment.

Could fiscal policy rescue the day and prevent a Chinese hard landing? The optimists argue yes by pointing out that fiscal deficits and public debt are low in China and that China has the resources to engineer a rapid fiscal stimulus in a short period of time. But the ability of China to implement a rapid and massive fiscal stimulus is limited, for a variety of reasons. First, the combined effects of natural disasters, social strife in the West, and the Olympics have created a large hole in the central government budget this fiscal year. The Ministry of Finance may have dipped into various stabilization funds to avoid the appearance of running a large deficit. For regional and municipal governments, the decline in turnover in local property markets has reduced the flow of fees and taxes, causing them to delay ambitious industrial development plans, in some cases. Second, a hard landing in the economy and in investment would lead to a sharp increase in non-performing loans of the -- still mostly public -- state banks; the implicit liabilities from a serious banking problem would then add to the implicit and explicit budget deficits and public debt. Note that the poor quality of the underwriting by Chinese banks -- which financed a huge overinvestment in the economy -- has been hidden for the last few years by the high growth of the economy. Once net exports go bust and real investment sharply falls, we will see a massive surge in non-performing loans that financed low return and marginal investment projects. The ensuing fiscal costs of cleaning up the banking system could be really high. Third, as pointed out by Michael Pettis -- a leading expert of the Chinese economy -- a surge in tax revenues in last four years has been more than matched by the surge in spending, so that if revenue growth diminishes/reverses, it might not be easy to slow spending growth proportionately. Contingent liabilities from non-performing loans could also reduce resources available for a fiscal stimulus.

In summary, with traditional monetary policy becoming less effective, non-traditional policy tools aimed at generating greater liquidity and credit (via quantitative easing and direct central bank purchases of private illiquid assets) will become necessary in many advanced economies. And while traditional fiscal policy (government spending and tax cuts) will be pursued aggressively, non-traditional fiscal policy (expenditures to bail out financial institutions, lenders, and borrowers) will also become increasingly important in these advanced economies.

In the process, the role of states and governments in economic activity will be vastly expanded. Traditionally, central banks have been the lenders of last resort, but now they are becoming the lenders of first and only resort. As banks curtail lending to each other, to other financial institutions and to the corporate sector, central banks are becoming the only lenders around.

Likewise, with household consumption and business investment collapsing, governments will soon become the spenders of first and only resort, stimulating demand and rescuing banks, firms, and households.

The long-term consequences of the resulting surge in fiscal deficits are serious. If the deficits are monetized by central banks, inflation will follow the short-term deflationary pressures; if they are financed by debt, the long-term solvency of some governments may be at stake unless medium-term fiscal discipline is restored.

Nevertheless, in the short run, very aggressive monetary and fiscal policy actions -- both traditional and non-traditional -- must be undertaken to ensure that the inevitable stag-deflation of next year does not persist into 2010 and beyond.

Will Aggressive Monetary and Fiscal Measures Prevent Stag-deflation in 2009?

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RGE Lead Analysts | Dec 12, 2008

Central banks around the world have undertaken a number of measures to forestall deflation and lift the global economy out of economic slump and credit crisis. Aside from traditional monetary policy tools such as official interest rate cuts and relaxations in reserve requirements, central banks have resorted to alternative unconventional tools. Quantitative easing has begun in the epicenters of the credit crisis, U.S. and Europe, who may be joined by other central banks as they too head towards zero interest rates in leaps and bounds (Sweden moved the most in the developed world by 175bp in one shot). With monetary policy transmission broken by the unwillingness of the private sector to lend or borrow, central banks have had to scurry for alternatives to rate cutting in order to restore markets. They set up an alphabet soup of liquidity facilities that lend funds or purchase assets, offered guarantees on deposits and loans, and established currency swap lines, in addition to a host of fiscal stimulus packages announced by governments. Check out “Policy Responses to the Global Credit Crisis”