Hoping Beijing 'gets it'
Already the big economic themes of 2010 are clear. It will be a year of recovery, of banker bashing, of debt reduction and of growing protectionist pressure. And it will be a year of two distinct halves, with fears growing about the durability of the pick-up as the months roll by. Make the most of the good times.
The short-term picture is certainly better than 12 months ago. China is booming on the back of exports growing at an annual rate of 40%. The leading indicators for the United States, which in 2006 and 2007 anticipated the downturn, are now pointing to growth of about 3% this year. Analysts in the City—London’s financial district—believe the United Kingdom’s economy expanded by about 0,5% in the final three months of 2009.
With policy likely to remain loose for some time, these trends will continue. But unless this recovery breaks with historical precedent, some words of caution are in order.
In the past, severe crises in the global economy have persisted for several years and gone through distinct phases. The US during the Great Depression, for example, saw a deep plunge in output after the Wall Street Crash, followed by a fairly brisk recovery in the mid-1930s and then a further serious setback in 1937. The economy only really returned to permanent health when the US went to war in 1941.
It was a similar story in the 1970s and 1980s. The post-war boom was brought to a halt by the oil shock of 1973, with the recession of 1974/5 followed by a period of uneasy stability in the late 1970s before a second oil shock led to an even bigger slump in the early 1980s.
In both cases, the economic crisis took more than a decade to play itself out, which was hardly surprising given the structural weaknesses that needed to be addressed.
So what’s different about this crisis that should make us believe that the global economy can return to rude good health in three years? Not a lot. The fundamental imbalances have yet to be addressed, while the necessary reform of the financial sector has not yet gone nearly far enough.
That’s not to belittle what Barack Obama did last week when he announced a levy on 50 large financial firms. “We want our money back,” he said at the White House. “And we’re going to get it.”
After spending most of his first year in office adopting a softly-softly approach to Wall Street, Obama has at last responded to the anger on Main Street at what the president called “the massive profits and obscene bonuses” made possible by taxpayer bailouts.
Public finances in the US—as in the UK—have deteriorated significantly as a result of the crisis, so the $90-billion (about R674-billion) raised from the levy is not to be sniffed at. It will put some (albeit insufficient) limits on the growth of banks and hence, indirectly, tackle the “too big to fail” problem.
But it will also limit private-sector credit growth, intensifying and prolonging the debt deleveraging already in prospect for the next half-decade.
A report by the McKinsey Global Institute (MGI) last week outlined the position. It noted that a long period of deleveraging nearly always follows a major financial crisis, with this tending to last for six to seven years and leading to a reduction in the ratio of debt to GDP of 25%.
The study identified households and the commercial property sectors in three mature economies—the US, Britain and Spain—as being most vulnerable to severe debt deleveraging. No real surprise there, as they were the three countries to have the biggest property bubbles.
By 2007, bank lending for residential mortgages was equivalent to 81% of GDP in the UK and 73% in the US. In comparison, bank lending to businesses was equivalent to just 46% of GDP in the UK and 36% in the US. “If history is a guide,” the MGI report said, “we would expect many years of debt reduction in specific sectors of some of the world’s largest economies, and this process will exert a significant drag on GDP growth.”
MGI says that little deleveraging has so far taken place, because any decrease in private-sector debt has been matched by increases in public debt: “We therefore see a risk that the mature economies may remain highly leveraged for a prolonged period, which would create a potentially unstable economic outlook over the next five to 10 years.
“The bursting of the great global credit bubble is not over yet.”
It is that backdrop that raises doubts about the durability of China’s recovery. In theory, the Chinese need to boost domestic consumption rather than relying on exports. Otherwise, with the US unable to act as the world’s consumer of last resort, the world will be flooded with goods that nobody wants.
The lack of global demand will force down prices, making the threat of deflation extremely real and adding to pressure for trade barriers.
Some analysts, such as Stephen Roach at Morgan Stanley, think Beijing “gets it” and China will take dramatic action to rebalance its domestic economy. Let’s hope Roach is right, because the alternative is that the whole world economy becomes like Japan after its bubble burst.
“The elements of a ‘globalised Japan’ are being put into place,” Charles Dumas of Lombard Street Research said. “Government debt is increasing, seemingly without limit, in response to the bursting of a private debt-fuelled asset-price bubble. The onset of persistent deflation is in sight. And slower growth seems probable, that third element of Japan’s ‘long night of the 1990s’.”
Dumas believed that far from re-engineering its economy towards domestic consumption, China has returned to its comfort zone of export-led growth.
In the short term it can do so because the renminbi is undervalued, particularly against the euro. News last week that German growth stalled in the fourth quarter of 2009 was significant. It was an early sign that the inventory-driven pick-up in Europe is running out of steam.
Against this backdrop, it is difficult to see why the recovery should be smooth. MGI sagely anticipated a prolonged period of cold turkey as debt addiction is sweated out of the system, and that’s even without fresh shocks.
The banks are still weak, markets are febrile, the public mood is sour. Dumas is concerned that by late 2010 or early 2011 there will be a second leg to the global downturn, this time with political as well as economic ramifications.
If he’s right, things will then get very nasty indeed. As I said, enjoy it while it lasts.—