Facing Reality

The financial ills that began in August 2007 metastasized sometime over the past few months into an economic contraction. The exact moment is unknown, but there’s no mistaking the trend now. The only question is whether the global economy overall will suffer a recession. The risk is rising by the day, largely because the developed world is already in a slump. If the emerging markets succumb too, the next few years will be quite difficult, perhaps more than is generally expected.

The IMF forecasts that the advanced economies will contract by 0.25% next year (see chart below). If so, the downturn would mark the first fall in the developed world’s real GDP pace on an annual basis since World War II. The good news, or so the IMF advises, is that a rebound will commence sometime in late-2009 and that emerging markets will still expand by respectable if no longer spectacular rates.


In the meantime, the U.S. has already reported a dip in GDP for Q3 and more of the same looks likely. The sharp drop in October’s retail sales, as reported on Friday, is the statistical poster child for expecting a string of negative numbers in the coming quarterly GDP updates here.

“Consumer confidence is beleaguered,” Bill Martin, CEO of ShopperTrak, a Chicago-based retail analysis firm, tells The Christian Science Monitor. “There is no good news to look for anywhere. People are just squirreling away money.”

That’s an especially pernicious problem for U.S. economic activity, which is heavily reliant on consumer spending. The challenge is only compounded by the ongoing real estate correction, rising unemployment and similar ills now swirling throughout the globe. Can you say perfect storm? Japan has now joined Germany among the developed world’s recession club. It’s only a matter of time before we have confirmation of the eurozone’s slump.

If there’s any hope for moderating the cycle’s worst effects, it comes from so-called emerging markets. China, to cite the obvious example, is still growing. Optimists say that the Middle Kingdom’s GDP will continue rising even in the face of recession in the developed world. The current IMF forecast for China calls for growth just under 10% this year, falling to 8.5% in 2009. That’s well below the sizzling 11.9% logged last year, although for China the moderating outlook has already triggered plans for a massive fiscal stimulus in an effort to keep the party going.

Overall, IMF expects emerging economies to grow 6.6% this year and by 5.1% in 2009. That’s slightly lower than forecasts from only a month ago, and the current projections may be downgraded yet again. If so, that’s a distressing prospect for the advanced economies. As emerging markets’ fortunes fade, the pain will be that much greater for the developed world because of its weakened condition. The world economy has relied in no small measure on emerging nations in recent years. If and when that source of demand gives way, the already sober outlook for economic activity will take a further hit. As such, watching events in China, India, Brazil and other developing nations has greater import than ever these days.

To be sure, governments around the world are hardly standing idle. Monetary and fiscal levers are being redirected in a new war on minimizing the cyclical pain that is now everywhere. Results are still unclear, although the effort promises to be massive in a collective sense. If the stimulus fails, it won’t be for lack of trying.

Yet even if the coordinated plans of governments work as expected, there’s no avoiding the economic pain that awaits. The correction is here, it’s taking a toll and the best to hope for is that monetary and fiscal policies will lessen the bite. But for the foreseeable future, the world must live with diminished expectations. The macro context is everything at the moment, and it promises to dictate much of what happens for some time. Escaping the wrath of betas, if you will, will prove difficult for investors and everyone else.

Originally published on November 17, 2008 at The Capital Spectator and reproduced here with the author’s permission.