Making Sen$e of 2010: The Next Crisis
Looking ahead to 2010, where do you foresee the likeliest crisis?
Chief economist, IHS Global Insight, an economic consulting firm
The U.S and world economies have emerged from recession and the recovery process has begun. Unfortunately, for most developed economies, this recovery will not feel like one in its early stages. Strong tailwinds (policy stimulus, improved financial conditions, and pent-up demand) are being partially neutralized by equally strong headwinds (rising unemployment rates, lingering hangovers from housing bubbles and the financial crisis, and the likely winding down of fiscal stimulus). Consequently, global GDP will grow only 2.8 percent in 2010, much better than the 2.0 percent drop in 2009, but well below the 3.5-4.0 percent trend rate of growth for the world economy.
While housing and capital spending on equipment are expected to show respectable gains, with consumer spending rising just 1.8 percent, stronger gross domestic product (GDP) growth will be impossible. One of the biggest drags on spending by households will be the unemployment rate, which should move up to around 10.5 percent during the first quarter.
Europe and Japan suffered through deeper recessions than the United States and are likely to see more modest recoveries. The Eurozone and the U.K. economies are expected to grow 0.9 percent and 0.8 percent, respectively, in 2010. Japan, on the other hand, will do better with GDP growth of 1.4 percent.
Growth in all the emerging regions will recover in 2010 and, with the possible exception of Emerging Europe, will outpace the United States, Europe and Japan. Non-Japan Asia will be at the forefront with GDP growth of 7.1 percent. Latin America, the Middle East and Africa will see gains in the 3–4 percent range. The laggard will be Emerging Europe, which will expand only 1.7 percent.
Professor at MIT’s Sloan School of Management and senior fellow at the Peterson Institute for International Economics
Back-to-back major financial crises are unusual. The most likely prospect for the global economy is a struggle to recover, with the central feature being financial systems staying weak as leading banks pay out large sums to their executives rather than rebuild their capital base. Growth will be disappointing and unemployment will stay discouragingly high in the United States — Jamie Dimon said as much last week, and given the economic and political clout now of his bank — JP Morgan Chase – we should pay close attention.
Still, in some parts of the world, the aftermath of the crisis of 2008-09 remains the pre-eminent concern and the credit category most under scrutiny remains “quasi-sovereigns,” i.e., entities like Dubai World that seemed to have the backing of a deep pocketed government during the boom, but under duress that support became less assured — although today’s announcement of cash being provided by Abu Dhabi suggests that the prospect for further panic in the Gulf region is quite limited.
Much more on edge these days is Greece. Greece has long had an issue with its fiscal deficits and debt levels. The general presumption was that membership in the eurozone would buffer the country against shocks and help keep interest rates on its government debt low. At the same time, membership in the European Union was supposed to provide a safety net – of unspecified support – should things get out of hand.
Increasingly, both assumptions are being questioned. The yield on Greek government debt has increased significantly and pressure from the bond market for fiscal austerity is increasing. Because Greece issues debt in a currency that it does not control (the euro), it is vulnerable in ways that bear some resemblance to the situation of Dubai World (or, if you prefer, Dubai itself – which has a lot of debt, not much cash flow or oil, and rich neighbors who are reluctant to reward what they increasingly see as profligacy).
The rhetoric of the G20, IMF, and European Union is that countries should not run contractionary policies – it’s too early for an “exit” from fiscal stimulus. But no one has stepped forward with a financial package that would help Greece manage its current dilemma; on the contrary, pressure at the European level is definitely pushing Greece towards more and earlier budget cuts.
How this plays out remains to be seen. The implications depend on how participants in global debt markets respond – do they see this year’s bonuses as arising from betting on a renewed boom or from speculative attacks on weak countries and quasi-sovereigns?
Former chief economist for the IMF and now professor of public policy and economics at Harvard University
With the “G3” (the United States, Europe and Japan) still implicitly backing all “systemically important” players in the world, it might be hard to see how a new financial crisis could unfold. But let’s not forget that the old one is not over yet. As the huge recent stress on Greek debt markets has revealed, it is still all a confidence game. Indeed, a number of smaller countries in Europe, including Hungary, the Baltics, Romania, Greece and Ireland, would all have great difficulty managing their debts if the security blanket of U.S., German and Japanese guarantees were pulled away. Confidence would evaporate, interest rates on their huge debts would soar, and all of these countries, and many more, would quickly face massive difficulties. Tightening their belts is painful with soaring unemployment, but borrowing from private markets could require paying almost impossible interest rates.
Fortunately for Greece, the International Monetary Fund, with wads of loose cash, will surely come riding to the rescue if the European Central Bank does not act first. But it is all very tricky, since neither the IMF nor the ECB wants to be accused of fostering “moral hazard” by freely funding spend-thrift governments. So they will wait until the last minute to come in, by which time the crisis will have deepened, and political dynamics will have created an air of great uncertainty.
Unfortunately, under the umbrella of the euro, a number of countries have piled up massive debts. But now, with confidence fading, countries such as Greece cannot avail themselves of inflation to reduce the real burden of their debts. My Greek economist friends insist their country will not default and they are probably right. The challenge they face, however, is what to do as markets continue to doubt them, forcing them to pay very high interest rates.
In our new book This Time is Different: Eight Centuries of Financial Folly, Carmen Reinhart and I find that waves of international banking crises are often followed within a few years by a wave of sovereign (government) debt crises. It is unlikely this time will be all that different, though normally, 2010 might be a little early in the cycle for the aftershocks of government debt crises to unfold.
Global economic policy strategist based in Washington, D.C., and author of The World Is Curved
Let me offer two scenarios — a potential conventional crisis as well as a counterintuitive view about global supply capacity concerns.
Significant jumps in an economy’s public debt to GDP ratio have a history of leading to high, and economically damaging, real interest rates. Today America’s debt is on course to hit an incredible 140 percent of GDP. If that happens, we could be forced to pay 6 or 7 percent of our GDP annually just to service this debt. To put this in perspective, the entire U.S. federal budget is only 20 percent of GDP.
As bad as this sounds, the international situation is worse. The euro zone already matches America’s debt trajectory. In Japan, the debt to GDP ratio even now is approaching a whopping 217 percent. Translation: The world at some point could experience unprecedented inflationary headwinds.
Yet there is a counterintuitive theory that goes something like this: As big a problem as today’s ballooning debt represents, the world may be facing an even greater economic problem: huge oversupply capacity. In other words, there are too many producers and not enough consumers, particularly with the U.S. consumer, once the world’s consumer of last resort, now pulling back. Global demand can’t catch up with this continual oversupply of goods and services. In this disinflationary world, bond prices — instead of collapsing (with interest rates shooting through the roof) — rally and interest rates actually decline. This disinflationary phenomenon sounds attractive were it not for the fact that it would likely make a second global banking crisis all but a certainty.
China is at the center of such a scenario. It is experiencing an economy with huge and growing oversupply capacity. To fuel that capacity, the Chinese government has been dramatically increasing government investment as a form of demand. The fear, however, is that this new capacity will someday explode, with prices quickly dropping.
Consider the example of steel. Today the Chinese have enough steel capacity to meet the needs of the United States, Japan, Russia, and all 27 nations of the European community combined. China may also be experiencing a kind of overcapacity in the granting of subsidized bank loans. Today, the joke goes, a cocker spaniel might receive a non-collateralized loan from a state-run Chinese bank were the dog living in a politically sensitive region.
Using these loans, the Chinese government-initiated investments in the last year alone have amounted to 50 percent of GDP. At some point, the large Chinese state-run banks could experience a huge crisis in nonperforming loans.
None of this is to deny China’s impressive performance to date, at least as presented to the outside world. Yet Premier Wen Jaibao himself admitted recently that “China’s current economic recovery is not based on a strong foundation … domestic drivers for economic recovery are insufficient.”
That is why Washington needs to be more nimble in its economic thinking. Yes, America has an enormous debt problem, as do large parts of the world. But we cannot be like the proverbial “generals fighting the last war.” Global overcapacity is a situation that bears close observation. After all, last June, in the midst of the deepest recession since the 1930s, the 10-year Treasury interest rate was almost 4 percent. Today, with the economy recovering, the situation has changed. But instead of interest rates rising, they have dropped. The 10-year Treasury is below 3.4 percent. In a healthy world economy and credit market, that’s not supposed to happen.