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Massive debts bode ill for full financial recovery
By Nouriel Roubini |
July 20, 2010, Tuesday
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Print Edition
Print Edition
THE global economy, artificially boosted since the recession of 2008-2009 by massive monetary and fiscal stimulus and financial bailouts, is headed towards a sharp slowdown this year as the effect of these measures wanes.
Worse yet, the fundamental excesses that fueled the crisis - too much debt and leverage in the private sector (households, banks and other financial institutions, and even much of the corporate sector) - have not been addressed.
Private-sector deleveraging has barely begun. Moreover, there is now massive re-leveraging of the public sector in advanced economies, with huge budget deficits and public-debt accumulation driven by automatic stabilizers, counter-cyclical Keynesian fiscal stimulus, and the immense costs of socializing the financial system's losses.
At best, we face a protracted period of anemic, below-trend growth in advanced economies as deleveraging by households, financial institutions, and governments starts to feed through to consumption and investment.
The global slowdown - already evident in second-quarter data for 2010 - will accelerate in the second half of the year. Fiscal stimulus will disappear as austerity programs take hold in most countries.
Inventory adjustments, which boosted growth for a few quarters, will run their course. The effects of tax policies that stole demand from the future - such as incentives for buyers of cars and homes - will diminish as programs expire.
Labor-market conditions remain weak, with little job creation and a spreading sense of malaise among consumers.
The likely scenario for advanced economies is a mediocre U-shaped recovery, even if we avoid a W-shaped double dip.
In the US, annual growth was already below trend in the first half of 2010 (2.7 percent in the first quarter and estimated at a mediocre 2.2 percent in April-June). Growth is set to slow further, to 1.5 percent in the second half of this year and into 2011.
Whatever letter of the alphabet US economic performance ultimately resembles, what is coming will feel like a recession.
Mediocre job creation and a further rise in unemployment, larger cyclical budget deficits, a fresh fall in home prices, larger losses by banks on mortgages, consumer credit, and other loans, and the risk that Congress will adopt protectionist measures against China will see to that.
In the eurozone, the outlook is worse. Growth may be close to zero by the end of this year, as fiscal austerity kicks in and stock markets fall. Sharp rises in sovereign, corporate, and interbank liquidity spreads will increase the cost of capital, and increases in risk aversion, volatility, and sovereign risk will undermine business, investor, and consumer confidence further.
The weakening of the euro will help Europe's external balance, but the benefits will be more than offset by the damage to export and growth prospects in the US, China, and emerging Asia. Even China is showing signs of a slowdown, owing to the government's attempts to control economic overheating.
The slowdown in advanced economies, together with a weaker euro, will further dent Chinese growth.
This is bad news for export growth in the rest of Asia and among commodity-rich countries, which increasingly rely on Chinese imports.
An important victim will be Japan, where anemic real income growth is depressing domestic demand and exports to China sustain what little growth there is.
Japan also suffers from low potential growth, owing to a lack of structural reforms and weak and ineffective governments (four prime ministers in four years), a large stock of public debt, unfavorable demographic trends, and a strong yen that gets stronger during bouts of global risk aversion.
Sources of shock
A scenario in which US growth slumps to 1.5 percent, the eurozone and Japan stagnate, and China's growth slows below 8 percent may not imply a global contraction, but, as in the US, it will feel like one.
And any additional shock could tip this unstable global economy back into full-fledged recession.
The potential sources of such a shock are legion. The eurozone's sovereign-risk problems could worsen, leading to another round of asset-price corrections, global risk aversion, volatility, and financial contagion.
A vicious cycle of asset-price correction and weaker growth, together with downside surprises that are not currently priced by markets, could lead to further asset-price declines and even weaker growth - a dynamic that drove the global economy into recession in the first place.
Policy makers are running out of tools. Additional monetary quantitative easing will make little difference, there is little room for further fiscal stimulus in most advanced economies, and the ability to bail out financial institutions that are too big to fail - but also too big to be saved - will be sharply constrained.
So, as the optimists' delusional hopes for a rapid V-shaped recovery evaporate, the advanced world will be at best in a long U-shaped recovery, which in some cases - the eurozone and Japan - may be long enough to stretch into an L-shaped near-depression. Avoiding double dip recession will be difficult.
In such a world, recovery in the stronger emerging markets - the great hope for the global economy - will suffer, because no country is an island economically.
Indeed, growth in many emerging-market economies - starting with China - is highly dependent on retrenching advanced economies. Fasten your seat belts for a very bumpy ride.
(The author is chairman of Roubini Global Economics (www.roubini.com), Professor at the Stern School of Business, New York University, and co-author of the book "Crisis Economics." Copyright: Project Syndicate, 2010.www.project-syndicate.org. Shanghai Daily condensed the article.)
Worse yet, the fundamental excesses that fueled the crisis - too much debt and leverage in the private sector (households, banks and other financial institutions, and even much of the corporate sector) - have not been addressed.
Private-sector deleveraging has barely begun. Moreover, there is now massive re-leveraging of the public sector in advanced economies, with huge budget deficits and public-debt accumulation driven by automatic stabilizers, counter-cyclical Keynesian fiscal stimulus, and the immense costs of socializing the financial system's losses.
At best, we face a protracted period of anemic, below-trend growth in advanced economies as deleveraging by households, financial institutions, and governments starts to feed through to consumption and investment.
The global slowdown - already evident in second-quarter data for 2010 - will accelerate in the second half of the year. Fiscal stimulus will disappear as austerity programs take hold in most countries.
Inventory adjustments, which boosted growth for a few quarters, will run their course. The effects of tax policies that stole demand from the future - such as incentives for buyers of cars and homes - will diminish as programs expire.
Labor-market conditions remain weak, with little job creation and a spreading sense of malaise among consumers.
The likely scenario for advanced economies is a mediocre U-shaped recovery, even if we avoid a W-shaped double dip.
In the US, annual growth was already below trend in the first half of 2010 (2.7 percent in the first quarter and estimated at a mediocre 2.2 percent in April-June). Growth is set to slow further, to 1.5 percent in the second half of this year and into 2011.
Whatever letter of the alphabet US economic performance ultimately resembles, what is coming will feel like a recession.
Mediocre job creation and a further rise in unemployment, larger cyclical budget deficits, a fresh fall in home prices, larger losses by banks on mortgages, consumer credit, and other loans, and the risk that Congress will adopt protectionist measures against China will see to that.
In the eurozone, the outlook is worse. Growth may be close to zero by the end of this year, as fiscal austerity kicks in and stock markets fall. Sharp rises in sovereign, corporate, and interbank liquidity spreads will increase the cost of capital, and increases in risk aversion, volatility, and sovereign risk will undermine business, investor, and consumer confidence further.
The weakening of the euro will help Europe's external balance, but the benefits will be more than offset by the damage to export and growth prospects in the US, China, and emerging Asia. Even China is showing signs of a slowdown, owing to the government's attempts to control economic overheating.
The slowdown in advanced economies, together with a weaker euro, will further dent Chinese growth.
This is bad news for export growth in the rest of Asia and among commodity-rich countries, which increasingly rely on Chinese imports.
An important victim will be Japan, where anemic real income growth is depressing domestic demand and exports to China sustain what little growth there is.
Japan also suffers from low potential growth, owing to a lack of structural reforms and weak and ineffective governments (four prime ministers in four years), a large stock of public debt, unfavorable demographic trends, and a strong yen that gets stronger during bouts of global risk aversion.
Sources of shock
A scenario in which US growth slumps to 1.5 percent, the eurozone and Japan stagnate, and China's growth slows below 8 percent may not imply a global contraction, but, as in the US, it will feel like one.
And any additional shock could tip this unstable global economy back into full-fledged recession.
The potential sources of such a shock are legion. The eurozone's sovereign-risk problems could worsen, leading to another round of asset-price corrections, global risk aversion, volatility, and financial contagion.
A vicious cycle of asset-price correction and weaker growth, together with downside surprises that are not currently priced by markets, could lead to further asset-price declines and even weaker growth - a dynamic that drove the global economy into recession in the first place.
Policy makers are running out of tools. Additional monetary quantitative easing will make little difference, there is little room for further fiscal stimulus in most advanced economies, and the ability to bail out financial institutions that are too big to fail - but also too big to be saved - will be sharply constrained.
So, as the optimists' delusional hopes for a rapid V-shaped recovery evaporate, the advanced world will be at best in a long U-shaped recovery, which in some cases - the eurozone and Japan - may be long enough to stretch into an L-shaped near-depression. Avoiding double dip recession will be difficult.
In such a world, recovery in the stronger emerging markets - the great hope for the global economy - will suffer, because no country is an island economically.
Indeed, growth in many emerging-market economies - starting with China - is highly dependent on retrenching advanced economies. Fasten your seat belts for a very bumpy ride.
(The author is chairman of Roubini Global Economics (www.roubini.com), Professor at the Stern School of Business, New York University, and co-author of the book "Crisis Economics." Copyright: Project Syndicate, 2010.www.project-syndicate.org. Shanghai Daily condensed the article.)
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