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A truly global slump. Do not look to the emerging economies for good news …

by Brad Setser
January 26, 2009

Only a few months ago it was common to argue that growth in the emerging world would prevent a global recession. That forecast looks increasingly wide of the mark. The slowdown in the emerging world now looks to be as severe – and potentially more severe – than the slowdown in the advanced economies.

Morgan Stanley’s currency team recently observed that “Brazil’s growth collapsed in 4Q08, with several activity indicators displaying the worst decline on record.” Earlier this year Brazil was growing strongly on the back of both strong domestic demand and strong global demand for its commodities. The domestic growth dynamic (and the improved state of the balance sheet of Brazil’s government) made me think it might be able to ride out this crisis relatively well. Guess not.

Russia is in even worse shape. Output is poised to fall sharply. Danske Bank expects a 3% fall. That might be optimistic. Moving from a budget that balances at $70 oil to a budget based on $41 a barrel isn’t fun even if Russia uses its fiscal reserve to adjust gradually. Eastern European economies that relied on large capital inflows rather than high commodity prices to support their growth aren’t doing any better.

The Gulf is in better shape than Russia, but that isn’t saying all that much. $40 a barrel oil requires the Gulf to dip into its foreign assets, but most countries still have plenty of spare cash (though not as much as before). Still, all of the Gulf is slowing. And the most exuberant bits of the Gulf – Dubai in particular – are in real trouble. Most of the Gulf’s sovereign funds under-estimated their countries need for emergency liquidity. They aren’t quite in the same position as Dubai’s Istithmar (looking to sell Barneys for cash as demand for luxury goods falls), but they presumably do wish that they had more liquid assets — and more assets that weren’t correlated with oil.

The commodity-importing BRICs aren’t doing much better. India is slowing. And China is really slowing. Stephen Green of Standard Chartered has constructed an indicator of Chinese economic activity that isn’t based on the government’s reported GDP data. It suggests a far bigger fall in Chinese output than in 1998.*

Chinese output shrank in the fourth quarter. The first quarter isn’t going to be any better.

China isn’t alone. The fall in Korea’s output in the fourth quarter was quite large. Even larger than the fall in output in UK, or Japan. Yuka Hayashi of the Wall Street Journal:

South Korea’s economy last quarter shrank 5.6% from the July-September period, or an annualized rate of 20.8%, according to J.P. Morgan, the sharpest contraction since the Asian financial crisis a decade ago.

Singapore and Taiwan are also contracting sharply. Singapore’s economy contracted an annualized rate of 12.5% in q4, and the huge fall in Taiwan’s exports cannot be good for its economic performance. Japan isn’t an emerging economy, but it too saw a sharp fall in output. It isn’t a stretch to think that Asian output could fall more in 2009 than in the 1997-98 Asian crisis.

Emerging economies who thought that they had protected themselves from sudden swings in capital flows by maintaining large reserves and running large external surpluses are discovering that their efforts to reduce their exposure to volatile global capital flows added to their exposure to a global slump in trade.

Emerging economies were growing faster than the mature economies prior to the crisis. But at this stage I wouldn’t rule out the possibility of an outright contraction in the output of the emerging world in 2009. And that could imply that a crisis in the US and Europe could end up producing a bigger absolute swing in activity in the emerging world than in the world’s mature economies …

* This graph was reproduced with permission from Stephen Green.

79 Comments

  • Posted by Indian Investor

    @ Cedric: By they I mean the Dept of Labor Secy, and so on. This has been done over time. Same thing with inflation statistics from the US govt. They measure inflation ex food and energy prices.
    All this misinformation is targeted at people who are generally unsophisticated and will believe everything the Government tells them to hide the level of trouble in the economy.

  • Posted by eb

    I’ve been an interested, but frustrated, reader of econ blogs for most of 2008 and I’m delighted to find an engaged community who, I hope, will share a little of their demonstrated patience with me.

    My first is a question that’s probably been long considered on this blog (if so, please link): how long can gross trade imbalances last? By my intuitive understanding of things, the US continues to borrow from the future with every budget deficit, thereby living artificially large today. Does this ultimately end when the US balance sheet reaches zero? And, are we over-estimating the size of the US economy by attributing to GDP the effect of this implicit stimulus?

    Next year’s deficit will set new records and I’m compelled by the argument made in another recent thread that the extraordinary supply/demand dynamics for treasuries next year will trump considerations of “on whom is the US dependent?”. The arguments that some of the oil economies will be net sellers along with Britain and other developed economies, all looking to simultaneously fund stimuli, similarly suggest that there will be much greater supply of debt than purchasers thereof. (Unless we can reliably convince ourselves that there is another $tr to come out of global risky investments? How would we estimate this?)

    A few questions follow:

    1) I’ve heard two alternatives discussed for how the US might position itself relative to its massive fiscal deficit next year: a) monetizing the debt and b) raising interest rates to some “market rate”. In the first case I’m curious how one would go about estimating the impact on inflation. E.g. suppose we were to estimate that demand for 0% treasuries fell $300bn short of requirements next year (like Germany’s failed bond offering last Fall, the US sells and no one buys). How do we estimate the impact on inflation and currencies if the Fed picks up the tab? How would China (and other dollar pegs) react to such a move, which devalues their dollar reserves?

    I have similar questions about the second option of moving to a market interest rate. There would be obvious objections from holders of existing treasuries, MBS, and other under-priced risks, who would be crushed if the risk free rate suddenly rose out of competitive necessity. But as-importantly: could the US sustain the debt payments of significantly higher interest rates?

    Finally linked to my last question on sustaining payments, I particularly liked Rien Huizer’s comment at 5:54: “…say world output falling to world levels of, say, 2002. The trick would be to make it stop there. World 2002 output (per capita) did not contain too much finance-dependent nonsense…”

    I’ve been trying for some time to wrap my head around how to estimate what “appropriate” US GDP is. That is, minus the effects of the spending orgy of the last six years. I like Rien’s model, but I think it’s optimistic: even in 2002 the US was benefiting hugely from cheap imports and consequently consumers had more money in their pockets to slosh around on other purposes in the US economy. Is such a starting point more appropriate for estimating the debt payments that the US can sustain?

    Finally a related question: we’ve talked extensively about what China or India “should do” as though they’re the only ones in serious trouble. I have a tremendously hard time seeing how the US (UK, Ireland, etc.) comes out of this without serious problems. What should the US do?

  • Posted by Ying

    Brad,

    I am just wondering if you can compare the credit ( or easy money) provided by foreign central bank to US government and the credit extended by US banking sector to its own consumers and businesses in US. I am just wondering which effect is bigger.

    In the past, US financial sector has been successfully monetized most illiquid assets such as loans, houses, equipments,factories to financial assets. Credits are extended on purchasing almost everything except groceries. Policies tilted towards pro-cyclical direction. This is probably what George Soros meant that sixty years credit expansion is probably going to end now.

    Credit and money are services provided by financial sector to its consumers and businesses. Shouldn’t the services of credit and money be subjected to public debate so people know the consequences of taking easy credit? I only see the failure of democracy.

    China didn’t do a very job in shifting economy away from export sector either. They have real estate bubble and financial asset bubble too. Not all slowdown can be attributed to the export sector.

  • Posted by Cedric Regula

    indian investor:

    I think data on unemployment is pretty straight forward to collect, they know how many they are paying, but employment data is extrapolated from surveys and is much more difficult.

    But I don’t think unemployment is anywhere near 25%. That would be noticeable when you walk down the street. Plus a lot of households are dual wage earners, with one spouse oftentimes not having a good paying carrier job. So if that’s the one lost, it means less household income but may still be survivable.

    But not having good employment data is disturbing because the Fed tells us that the two pieces of data they balance to arrive at interest rate policy are inflation and employment.

    We know inflation data is bogus. Plus we put lots of Chinese stuff in it and call it “our” inflation index. Then the Fed tells us if asset prices go up, that is NOT inflation. Then employment statistics are bogus and we don’t even know how many workers are in the country.

    So that is how the Captain at the Fed steers the ship.

  • Posted by seatru

    I doubt if a single index can predict any country’s economic trend in the next quarter, especially if the country is accused of manipulating its statistics deliberately.

  • Posted by FG

    Gillies: a global contraction of industrial civilisation interspersed with occasional growth rallies. a coming period comparable with the european middle ages

    I take it you are investing in machine guns makers and whiskey brewers?

    There is no real equivalent in the past. We have saturated the planet. At the current growth rate of 1.3%/y, humanity would reach 23 billions in 100 years. Of course it won’t happen. The ways in which it won’t happen is the question.

    The greatest limitation of mankind is its inability of understanding exponentials.

  • Posted by rkelly

    Brad,

    I think all we can say for certain right now is that 2008Q4 was abysmal for global growth – the combination of collapses in trade financing, commodity prices, and US consumers – that sets a lot of countries up for a very low starting point for growth in 2009. On the downside, we still have to deal with the risk of further banking surprises and hits to financing and credit. We also have to deal with the normal recession dynamics of bankruptcies, not just in advanced economies but all those commodity-dependent EMs that saw the price their goods fetch collapse and all those manufacturing centers like Asia that saw Japanese and American demand suddenly disappear. Maybe outside of Eastern Europe we don’t have to worry as much about fx mismatches or maturity mismatches (that we know of…but ain’t that always the kicker?), but such sharp moves in prices most certainly are going to reveal problems in local firms that overstretched themselves. And that process may play itself globally out over the next 12-18 months so that will take time.

    But, on the upside, there should be a wave of increased purchasing power showing up for imported energy dependent consumers (think US, Japan, and India). US incomes are falling, but guess what’s falling much, much faster? Inflation. And that means real incomes are rising. Most of what I’ve seen suggests there’s a good 2-3 quarter lag between spikes in oil prices and the biggest impact of the economy. That means the upward spike in 2008H1 fed through in 2008H2, and the downward spike in the second half of the year should try to work its way through in 2009H1. And until American consumers start spending again, Asian economies won’t be growing again.

    The pessimistic forecasts for advanced economies generally see them contracting a bit over 2% in 2009. Since they make up half of global GDP (PPP), that means EMs would have to grow by less than 2% to get global growth below 0% for 2009. That still seems like it might be difficult.

    The NICs were hit bad because of how leveraged they are to trade and will almost definitely contract in 2009. Russia is probably next most likely to contract in 2009, but if you look at their reported q/q GDP over the last several years, it looks more like a Madoff quarterly statement – way too stable – than growth of a commodity-dependent economy. Brazil is probably next in line with the same commodity dependencies as Russia but without much of the baggage and poor macro management. But Brazil may have contracted by something like 3.5% unannualized in 08Q4. That’s going to be a tough hole to dig out of in 2009, and you still have to worry about how the collapse of commodity export business’ profits feed through into the domestic economy, and is at least likely to come in under that 2% threshold in GDP growth needed to counterbalance the advanced contraction.

    But those regions get you less than 10% of global GDP (toss in Eastern Europe that will probably also contract and you still just get to 13.5ish%), while China and India make up almost 16% of the global economy and neither is likely to post 0% or sub-2% growth in 2009. India doesn’t look like it was hit as bad in Q4 and generally doesn’t have the same exposure to global trade as others. For China, you have to separate arguments of what China’s GDP REALLY is versus what is (and will be) reported. An issue with SCB’s index above is that it doesn’t look like it matches up well with official data (whether y/y or cumulative), especially over the last 5 years. The SCB’s index may say growth is running below 0%, but official data say Q4 y/y was 6.8% and with lending/credit data showing some sort of stabilization in December, you could probably pencil in something like 6% y/y GDP growth in Q1. It will be hard to get Chinese reported GDP below 0% or even close to 2%.

    So if China/India and their satellites can pull off a 4-5% growth rate in 2009, than the Russia/Brazil/NIC/EE/satellites can see -1% contractions in 2009 and you still pull off global growth of 0%. So global growth right around 0% seems a good bet, but it will take another big shock to get it much below that imho. Still, from 1960 to now, global growth has never been 0% so that’s not anything to be happy about.

  • Posted by locococo

    On a shorter term – before we all die_

    While weighting the »IMFs future projections«production industry s products please bear in mind they just finished having a crisis and are currently busy with engineering the new SDRs (backed by dollars) blast while searching for deficit countries to bail out all at the same time.

    Some of those migh even issue their reserve and the goodwill.

    On goodwill s goodwill:
    – nice comments to go with the fastest appearance of tonnes of new Treasuries, given the Treasury – with its new representative- has to beat the market to it. No doubts yet, it will.
    – as for derivatives, are we to understand that they – coupled with controlled schedule of credit events – are ensuring the dollar stays in the reserve? If true, then “the deficits truly won t matter” awaits down the road, as a….. surprise. Or an endless and limitless swap. In such end, this might turn out as an O – instead of an L – shaped recession.

    And then, there s also the gold – right at that spot for all the wrong reasons and all of the blunders. It want s to decouple and plots itself spot.

    It is not the whole world that turned Keynesian, just the people who think that they run it

  • Posted by locococo

    About the cycles – even the farmers have access to future markets to rotate and derive their presents. That tho don t mean that they know how to use them in a “proper”, “financial” kind of way.

    Of plotting the spot.

  • Posted by Waiting Out

    Brad,

    This is a question to you and perhaps someone you know in the inside of the new administration. What is the view of this “Currency Manipulation” charge of China by Tim G? What is your view of the counter-argument that if China is manipulating its currency it is in fact keeping the Yuan high because in the last a few months all the major currencies (par Yen and Yuan) have devalued by a large amount to the US dollar?

  • Posted by Cedric Regula

    EB:

    I’ll give some of the questions a try, at least how I see it. These take a while to type, so I’ll post as I go.

    1)”My first is a question that’s probably been long considered on this blog (if so, please link): how long can gross trade imbalances last? By my intuitive understanding of things, the US continues to borrow from the future with every budget deficit, thereby living artificially large today. Does this ultimately end when the US balance sheet reaches zero? And, are we over-estimating the size of the US economy by attributing to GDP the effect of this implicit stimulus?”

    The total current financing need of the US is the total of the fiscal deficit plus trade deficit. Then we also need to re-fi existing debt. What we have been doing is growing credit bubbles. We can break these down into segments. Consumer, corporate, muni, and federal. Outside of banking and probably auto, airline and casino industries, corporate debt was improving. Consumer debt got much worse. The federal debt ceiling is 11.4T. Last I saw US GDP was close to 14T so that ratio works out to 81% and we used to chastise European countries for being at that level. Plus going much higher than that can get a downgrade from Moody’s.

    US personal net worth is $50T which sounds like a reasonably cushy number for a USG debt of $11.4. But on the other hand, there was that recent movie out, IOUUSA or something like that, and there someone calculated if you throw in future liabilities (entitlements like SS, Medicare, pensions), total USG liabilities come to $55T. So that means we are broke already if we expect to ever see these entitlements.

    As far as the trade imbalances go, most of it outside of oil is stuff we can do without, or we already bought enough to last us a while. Oil is back to a more reasonable level. Then a lot of what we export is in less price sensitive products and much of it is tied to foreign government spending on equipment, infrastructure, transport, healthcare, defense, etc…. So we can just buy less imports if we want. But for job growth we need to export more. But thinking that will ever happen with price sensitive consumer products or mundane industrial products with direct Asian competition is not realistic.

    But we seem addicted to fiscal deficits and they mushrooming out of control. There will be much more global demand for financing this year. That should put upward pressure on interest rates. There will be much temptation among debtor nations to monetize the debt in the name of economic stimulus.

    How long that can go is anyone’s guess, but I’m just watching my chance of ever getting a SS check diminish with every Federal budget.

  • Posted by Observer

    Cedric,

    Regarding the unfunded liabilities of the US, Pete Peterson has been talking about it for years. I think the number that he worked up was $44 trillion in Medicare and SS over the next 75 years. There’s a youtube video of his interview with Charlie Rose back in ’04, where he mentioned Volcker as saying that there would be a hard landing of the dollar within the next five years.

    Mr. Peterson of course, was the Chair of the Council on Foreign Relations.

  • Posted by Twofish

    Indian Investor: All this misinformation is targeted at people who are generally unsophisticated and will believe everything the Government tells them to hide the level of trouble in the economy.

    Getting useful numbers out of statistics is a very difficult job, but I think it’s far overboard to say that there are meaningless. I’ve seen research papers that have gotten some useful findings from Soviet statistics from the 1930’s knowing full well that they were cooked. Even cooked statistics are very useful.

    Also I don’t see any particular reason why the US government would want to understate the seriousness of unemployment. If anything, the new administration would like to overstate those numbers since it provide more political justification to do what they want to do.

  • Posted by Cedric Regula

    EB questions: I’ve heard two alternatives discussed for how the US might position itself relative to its massive fiscal deficit next year: a) monetizing the debt and b) raising interest rates to some “market rate”. In the first case I’m curious how one would go about estimating the impact on inflation. E.g. suppose we were to estimate that demand for 0% treasuries fell $300bn short of requirements next year (like Germany’s failed bond offering last Fall, the US sells and no one buys). How do we estimate the impact on inflation and currencies if the Fed picks up the tab? How would China (and other dollar pegs) react to such a move, which devalues their dollar reserves?

    The impact of monetizing the debt is unpredictable, the market reaction is going to happen far sooner than we ever see what it does to inflation. Holders of treasuries shouldn’t like it and the dollar should weaken. A weaker dollar means pegers have to buy more treasuries to peg. Gold will probably be seen as an alternative. Maybe oil too, but you still need somewhere to ship the contract. But gauging the scope of the market reaction is pure guesswork. It may get the middle east to turn into gold bugs again. It may get the Chinese to decide its time to chew their arm off and escape the golden handcuffs holding them to the US. It may make interest rates go up if the Fed finds themselves as the only buyer for 11.4T of debt. It will certainly make people wonder if BW2 is still a good idea. If we weaken the dollar significantly we will add import inflation again to domestic inflation. Or maybe something more benign happens.

  • Posted by Twofish

    eb: I’ve been trying for some time to wrap my head around how to estimate what “appropriate” US GDP is.

    If you have massive layoffs, no inflation, and increasing unemployment, then GDP is too low since it would be higher if people were doing useful things.

    eb: Is such a starting point more appropriate for estimating the debt payments that the US can sustain?

    If you look at debt/GDP ratios then the US doesn’t have a particularly high debt amount. Let’s be clear that this financial crisis did not happen because people were unwilling to lend to the United States. If anything, this crisis has made people *more* willing to lend to the US. The financial crisis happened because the internal economy of the United States was badly structured, and the very real productivity gains of the last few years were not shared distributed well, and that the money that the US had been able to borrow was wasted.

    In this situation trying to get out of the problem by cutting debt will make the situation worse. If you cut debt, then GDP will fall faster than your debt, and you’ll end up in even worse shape.

    The time to cut debt is when times are good. Times are not good.

    The notion that the way out of a depression is to spend lots of money and get yourself in debt is very counterinituitive and because it is so counterinitutive, it’s why it took a decade to get out of the last depression.

  • Posted by Observer

    There’s a difference in pumping money into the financial system to prop up asset prices and preserve stability and pumping money into the goods and services market, where the money goes directly into the hands of consumers and corporations. To take an extreme example, the US gov’t could hire ten thousand people to dig holes in the middle of nowhere in California, and those who get hired to dig the useless holes would get paid handsomely, but no real good or service is produced, yet those workers will have greater purchasing power. In the short term, this will create an upsurge in demand, and a corresponding uptick in supply, but over the long run it would just lead to higher prices.

    When the Fed pumps money into the banking system, it was merely meeting the demand of people making a run on the bank, and those making a run aren’t likely to go out and spend their money but rather park them in gold or in the Treasuries. So in a way it’s a recycling process, but inflation does not immediate ensue because people are not demanding goods and services with their money.

  • Posted by Cedric Regula

    EB question:”I have similar questions about the second option of moving to a market interest rate. There would be obvious objections from holders of existing treasuries, MBS, and other under-priced risks, who would be crushed if the risk free rate suddenly rose out of competitive necessity. But as-importantly: could the US sustain the debt payments of significantly higher interest rates?”

    All debt securities would drop in response to a higher 10y rate, but you can still hold to maturity and you are OK then. That was the original idea behind issuing longer term debt. And if we get higher inflation instead then you are killed with having real loss, that is also taxable. So if we hear screams from the PIMCO trading desk, just ignore them.

    It would be a problem for banks that are holders of the stuff and have to mark-to-market. So that problem needs to be addressed somehow with a “bad bank” or one of those ideas.

    I think we would be headed for higher interest rates in a roundabout way anyway if they monetized the debt. The question of whether we can sustain the debt at higher interest rates needs to be addressed someday anyway. Having a downgrade from Moody’s won’t help. They might have to tax people more, cut spending, etc..

    Of course they always say can’t do those things in a bad economy. Then when the economy gets good they say they can’t do those things because that would make the economy get bad. Go figure.

  • Posted by Rien Huizer

    eb, twofish et al:

    Nice term, “appropriate GDP”. But, really, no idea. Sustainable GDP? Bubble-free GDP? Anayway, apart from the fact that a one-dimensional and flawed concept as GDP is not my favorite benchmark of economic performance (did not the new US president say something similar recently?) I was just trying to locate a past level of output that would be smaller than 2007/8 and less boosted by many of the things that have disappeared since then or were much less important then. Things like building and financing useless residences, fragile wealth (resulting from unsound financial engineering for instance), in general the real economy effects of a period of unusually irresponsible and epidemic finance in most of the developed world (and pretty much the same in the developed pockets of the NIC, BRICs etc.).

    We could go back further of course. Some asset markets have given up mote than 10 years of value growth (an interesting story by itself. Look at the direct effect of widespread technical insolvency of financials (easy to measure) plus the impact of far less private equity activity (removing a weird sort of put option from most stocks) and the disappearance of the easy money that fed the retailers and the automotive and construction industries).

    If we take the stock market as a leading indicator (perhaps with some adjustments for the rise and fall of the financial sector, historically speaking probably a cluster of outliers -a very interesting research topic, incidentally) and the stock market bottoms out at 1996 levels about now, and then languishes (i.e. not rallies in 2009/10) for a couple of decades, that would probably be associated with a a target output bottom (to be reached in a couple of years from now or later with keynesian painkillers) of , I would guess, at best 85% of current GDP, assuming not too much globalization. I am simply using the stock market as a kind of emotional leading indicator. (Yes I know that the stockmarket in the interwar period did not languish after the collapse). But in Japan, the only modern large -scale precedent in a very highly developed economy (the Asian and Scandinavian crises were more different) there was quite a bit of languishing, for reasons that people still argue about. No doubt Japan’s largely unchanged process of non-market allocation played a role in that, and the US does not have an equivalent (although it is pretty good at wasting taxpayers money too) but it is not impossible that we may see very little optimistic animal spirits and schumpeterian creators for a long time.

    So, I do not know what realistic target level would be, but I do not believe that artificially maintaining output will work in a downturn of this type, despite the collapse oil oil and industrial commodity prices and easy monetary policy. Re the effect of energy price fluctuations, recommend Killian’s article in the Journal of Economic Litterature, december 2008 issue.

  • Posted by Rien Huizer

    Observer:

    Actually people dig holes in the middle of the desert (or nowhere) all the time. They are called greenkeepers and golfers consider them useful.. One of the traps we tend to fall into when looking at keynesian policies is that no one knows what is useful, and what deserves to be stimulated in order that the economy is reverting back to growth. Just randomly removing budget constraints will get you a bubble. Directing money to the right kind (in whose opinion?) of productive assets may get you white elephants as an unintended consequence. Doing what is going on now will improve the employment and profit prospects in China and Mexico, but hardly in the US and EU, and employment and profit generate the taxes that must ultimately service the resulting debts..Relevant and reliable macroeconomic decisionmaking models that can be used to target government spending do not exist.

  • Posted by bsetser

    waiting out — see my next post. my strong sense is:

    a) speculative outflows out of china have increased
    b) China generated negative reserve growth in december by flirting with an rmb devaluation, which then led it to have to use its reserves to support its currency in the face of large outflows for the first time.

    get rid of the mini deval (which didn’t last in dec) and i am not sure china would have had to sell its reserves. but the pace of reserve growth has slowed.

    the yuan incidentally has deprecited v the yen, so that isn’t the issue. it has appreciated v the won. but the big problem china faces is the rmb’s appreciation v europe … and of course, the global contractoin in trade/ the fact that the more you gear your economy to exports the more exposed you are too a fall in global trade.

    over time tho i have trouble seeing how china could sustain a deval for long without renewed intervention, as the CA is in substantial surplus and the fall in commodity prices/ domestic invetment slump will keep the surplus up – -and barring a huge collapse in confidence, i don’t see sustained outflows equal to the ongoing surplus. for now flows are drive by an unwinding of the reval bet. but that will peter out …

    that at least is how i see it.

  • Posted by Twofish

    Observer: To take an extreme example, the US gov’t could hire ten thousand people to dig holes in the middle of nowhere in California, and those who get hired to dig the useless holes would get paid handsomely, but no real good or service is produced, yet those workers will have greater purchasing power.

    And right now it doesn’t matter. The economy is contracting so, it would be a good thing if people get paid to do anything. The problems start once the economy starts expanding. It’s a political economy problem. Once lots of people get paid lots of money to do something, they will have political power to continue to be paid to do it, even if it doesn’t make any sense. So while you have the option, you need to think a bit about what you want people to do.

    But don’t think too long.

    Rien Huizer: Some asset markets have given up mote than 10 years of value growth (an interesting story by itself.

    Which tells you that you shouldn’t always listen to markets since sometimes they are just crazy. Even with subprime stupidity, there have been lots of wealth generating advances that have existed in the last ten years.

    Rien Huizer: No doubt Japan’s largely unchanged process of non-market allocation played a role in that, and the US does not have an equivalent (although it is pretty good at wasting taxpayers money too) but it is not impossible that we may see very little optimistic animal spirits and schumpeterian creators for a long time.

    I think this is unlikely. Someone pointed out to me that Japan got into a protracted situation of economic stagnation partly out of political choice. People saw what needed to be done to have a dynamic economy, and they just didn’t like the trade-offs.

    But both the US and China are different, and the people in charge know it. It is unconceivable to me that the public in the US or China would tolerate extended diminished economic growth or cuts in standards of living. People just will not stand for it.

    If the current set of leaders don’t show any progress in a year or two, there will be a massive uprising to replace them with new leaders.

  • Posted by Twofish

    bsetser: b) China generated negative reserve growth in december by flirting with an rmb devaluation, which then led it to have to use its reserves to support its currency in the face of large outflows for the first time.

    I suspect that Geithner’s remarks on currency manipulation were mostly a shot across the bow, removing sustained devaluation from the list of Chinese policy alternatives. If China continues to peg at current rates and if trade deficits keep falling then I don’t think that there will be issues with currency.

    On the other hand if there is a sustained drop in the RMB, then at that point we are in a new situation. Personally, I seriously doubt that China is going to drop the RMB, because I can’t see any way that China benefits from that. If you do see a major devaluation in the RMB, then you will see the US react by increasing tariffs.

    I think that we may be back to 1998, when everyone *wanted* the PRC to peg to the dollar.

  • Posted by Rien Huizer

    Twofish,

    1. stockmarkets are a common leading indicator. All kinds of things may be wrong with financial markets but for the purposes of my argument (of where to look for a bottom), it may be a good idea to see when some asset markets (as proxy for wealth in a recession that seems to display severe wealth effect problems). It is far from scientific, but, OK that is not the purpose of bloging.
    2. Re Japan: what I meant includes political elements of course. And I hope you’re right about the intolerance for not-hardship-defeating leaders in the US and China. But kep in mind the public response to that type of leaders in Germany and Japan in the 1930s…
    3. Re US recession fighting measures: I guess that there is ood chance that by helping US consumers, the US gvt will get the unintended consequence of helping Chinese producers…If China helped Chinese consumers, would that help US producers??

  • Posted by locococo

    It s getting harder to balance the yield curve (refinancing at ridiculous rates) vs. the price of gold as assets classes risk reassessment and the resulting (asset class) re-shuffle is going on.

    It` s a race to beat the markets to issue before the above procedure blows some of the fog away.

  • Posted by Mari

    Bsteser: “Emerging economies who thought that they had protected themselves from sudden swings in capital flows by maintaining large reserves and running large external surpluses are discovering that their efforts to reduce their exposure to volatile global capital flows added to their exposure to a global slump in trade”.

    Great Synopsis of current EM problems…

    97-98 currency crisis = reserve accumulation result
    08-09 economic slowdown =????

    What’s next? – As a reader of this blog, I know you wish for them not subsidize the rich countries by “managing” exchange rates…but did you think the reserve accumulation answer when they went into 97-98 crisis? if so, whats their next move? if not – what else?

  • Posted by locococo

    Hey! Don t look there! There s trouble, see. See this chart. And this one. Trouble I say. As in r o u b l e with a t infront.

    It s here sir. Here we are. No problems here, see. Hell we invented this. Ok now Here you go sir, your truckload of our nice sounding words. It s all safely registerred, don t you worry a bit. It s Electronic. Just as seen in the commercial / presented by our new set of carefully handpicked – all Keynesian – trustlooking models. Now, hand over the money. All there, good. Do you want more sir? No? Sure? Ok, then, but …

    …you ll be back.
    Trust me 

    (American International Group Inc., the insurer saved from collapse by government money after losses on credit-default swaps, offered about $450 million in retention pay to employees of the unit that sold the derivatives)

  • Posted by phaedrus

    Well the new IMF projections are out and emerging economies still expected to grow vis a vis a contraction in the developed economies

    http://www.imf.org/external/pubs/ft/weo/2009/update/01/index.htm

    “• Advanced economies will experience their sharpest contraction in the post-war period, the Update said. The IMF expects real activity to contract by around 1½ percent in the United States, 2 percent in the euro area, and 2½ percent in Japan.

    • Though more resilient than in previous global downturns, emerging and developing economies will also suffer serious setbacks. For example, growth is expected to slow to 6¾ percent in China and 5 percent in India.

    • Global growth is projected to rebound in 2010 to 3.0 percent after falling sharply to just 0.5 percent in 2009, when measured in terms of purchasing power parity. The 2009 world growth forecast has been revised downward by 1.7 percent compared with the last IMF projection last November.”

  • Posted by Simon

    The similarities between what is happening now in the West and what has happened to some emerging economies in the past are striking.

    Similar crises brought about by the same protagonists within the same framework. Similar except that this time it’s global.

    Greed, incompetence, a passive or ignorant electorate or no real electorate, have allowed the princes of capitalism and their cohorts to bring death, starvation and misery, to the world this time.

  • Posted by Gears Manufacturers

    Thanks…well informed!!

  • Posted by London Mortgage Advisors

    The world still thrives on economic growth, and until this changes, conflict over such matters will continue.

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