The crisis and how to deal with it...
Nouriel Roubini is forecasting the end of contration in Q4 2009. This seems reasonable to me. But that doesn't mean that the US or the world economy will normalise anytime soon. Speaking at a seminar somewhere in Asia, Nouriel Roubini said:
"A more sober analysis suggests we're closer to the bottom; there is light at the end of the tunnel, but it's going to take a while longer, and the recovery is going to be weaker than otherwise expected."
Once the recession ends, "U.S. economic growth is going to be below potential for at least two years," he said, amid multiple imbalances in the housing sector and the financial system, and the rise of public debt.
Roubini predicted China would post a 6 percent growth rate this year, a "hard landing" considering it grew by 10 percent for a decade.
The problem with most forecasts today is the shape of what will come after the economy stabilises. Most governments, like the Belgian, count on normalisation. The US government counts on 3% growth, the Belgian reckons GDP will start to grow by 2-2,5% once things settle down. I don't buy into that scenario. Growth in the US was doped with credit. Taking away the dope, will bring growth to 1,75%-2,25% when it normalises. And that could well be after 2010. In Belgium growth was also doped, by the government. This implies that the sustainable growth rate without further deficit spending would be in the zone of 1-1,5%. Belgium is on the road for a decade of 1,25% growth. The public budgets all counting on >2% growth for the coming years. This means that some recalculations and very harsh measures will have to be taken. Pension promisses and social spending will become a growing drag on the productive sector, the GM scenario could become the blueprint for the Belgian economy. A slow descent, loss of market share, a slow suffocation because of increasing social charges on an ever smaller productive basis.
An interesting interview with some leading economic thinkers was published by NYBooks. Thisarticlesummarises the debate. The participants were former senator Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros, and Robin Wells, with Jeff Madrick as moderator. I have highlighted some quotes.
: There are two features that I think deserve to be pointed out. One is that the financial system as we know it actually collapsed. After the bankruptcy of Lehman Brothers on September 15, the financial system really ceased to function. It had to be put on artificial life support. At the same time, the financial shock had a tremendous effect on the real economy, and the real economy went into a free fall, and that was global.
The other feature is that the financial system collapsed of its own weight. That contradicted the prevailing view about financial markets, namely that they tend toward equilibrium, and that equilibrium is disturbed by extraneous forces, outside shocks. Those disturbances were supposed to occur in a random fashion. Markets were seen basically as self-correcting. That paradigm has proven to be false. So we are dealing not only with the collapse of a financial system, but also with the collapse of a worldview.
Niall Fergusson, author of the ascent of money, is very punchy in his comments:
: Well, if you listened carefully to what Paul Krugman said, he actually agreed with me. Because what he said was that everything is just fine as long as the financial credibility of the United States isn't called into question, but my point is that it will be called into question. Of course it will. According to the administration's crazily optimistic forecast for a recovery, it's going to be a 3 percent growth rate next year, 4 percent the year after that, 4.6 percent the year after that. If you believe those numbers, you'll believe absolutely anything, but they are there in the administration's budget document. Even if those numbers turn out to be true, the federal debt will rise over the next five to ten years to around 100 percent of gross domestic product.
But since those numbers are clearly wrong, and the trend growth rate of the US will be much closer to 1 percent than to 4, it seems reasonable to anticipate a much more rapid explosion of federal debt to somewhere in the region of 140 or 150 percent of gross domestic product. Even if the private savings rate rebounded to its highest point in the postwar period, it would still account for no more than 5 percent of gross domestic product. But this year's deficit, as I said earlier, is likely to be north of 12 percent of gross domestic product. So it doesn't quite add up.
The Fed has committed itself to buying $300 billion worth of treasuries this year, but clearly it will have to buy a great many more than that. Remember, $1.7 trillion or so are coming onto the market. And you assume that the credibility of the United States in the eyes of Americans, as well as foreign investors, is going to withstand this? At some point the United States does start to look like a Latin American economy, not only to people abroad but maybe to people at home. If the Fed's balance sheet explodes to up to $3 or $4 trillion, who knows how big it could get. At what point do people stop believing in the US dollar as a reserve currency, or even as a store of value for their own savings?
Finally, the comments byBill Bradleystruck me. Bradley is a former professional basketball player, McKinsey guy, democratic senator, and running for presidential nomination (Democrats) in 2000. He also presents a program on the radio.
: As we look at the future, we also have to look at the mistakes policymakers made in the last ten years. It's not news that people are greedy. But we made conscious decisions not to put limits on that natural human impulse. What were the mistakes? In 1999, we allowed investment banks, banks, insurance companies to combine: we eliminated the Glass-Steagall Act, which prohibited commercial banks from operating as investment banks. Why was Glass-Steagall put into law? Because the last time we didn't limit greed we got into trouble, the Great Depression.
The second mistake was in 1999, the explicit decision by the Clinton administration and Congress not to regulate derivatives, in particular credit default swaps. In 2002 they were worth $1 trillion and today they're worth $33 trillion, and that decision not to regulate derivatives created the following sequence: you have mortgages; then a thousand mortgages are packaged and sold as a mortgage-backed security; a thousand mortgage-backed securities are packaged and sold as a collateral debt obligation [CDOs]; then a thousand collateral debt obligations are packaged and sold as a CDO squared; and insuring each one of those bundles are credit default swaps, which are a part of that $33 trillion. And our government deliberately decided not to regulate this chain of investments.
One result was that the 374 people in the London office of AIG who were responsible for AIG derivatives destroyed a company that had 116,000 employees in 120 countries. Why? Because there was no regulation at all.
The third decision was in 2004. The SEC allowed banks to go from 10 to 1 leverage to 30 to 1 leverage. And guess what? Once they were allowed to do it, they did it. So if we're going to look at the future, we might think of undoing those three mistakes.
Finally, we might want to remember that the chairman of the Federal Reserve is supposed to remove the punch bowl from the party when the party gets out of control. And that did not happen in the Greenspan years. The opposite happened.
We are living in historic times. These years will be known as a turning point with multiple shocks that coincided. The more you see, the more you can be sure that things will never be the same. The balance of power is shifting, big companies are disappearing, countries are on he brink of bankruptcy, wealth has been destroyed, and new technology is quickly developing.
Countries that are trying to restore the economy to the old system will fail.