EconoMonitor

Nouriel Roubini's Global EconoMonitor

Global Economy: Short on options

What is the outlook for the global economy? First, the recovery will be multi-speed: anaemic, sub-par, below-trend and U-shaped in the US and most other advanced economies, given a multi-year slog of private and public sector deleveraging that has barely begun; more robust and V-shaped in most emerging economies where potential growth is higher, debt and leverage in private and public sectors lower, and financial markets more robust. 

Second, 2010 is a year of two halves. Output in the second half will be weaker than in the first, as growth’s tailwinds turn into headwinds: the inventory adjustment – that accounted for a significant part of growth in H1 – is mostly done; the fiscal stimulus ends up a drag on economic growth as economies move towards fiscal austerity; the base effect – comparing H1 2010 with a free falling H1 last year – is gone; and a number of tax policies that stole demand and growth from the future – cash for clunkers, investment tax credits, first time homebuyers tax credits – have expired.

Third, one cannot rule out a W or L-shaped double-dip recession in some advanced economies: US, eurozone PIIGS (Portugal, Italy, Ireland, Greece, Spain) and Japan.

In the US, growth will reach a stall speed of 1% or lower in H2, while housing double dips and home prices fall, unemployment rises towards 10% and credit remains tight. This slowdown is not priced-in by the market, but when it comes, stock prices could correct, credit spreads widen, volatility increase and risk aversion spike – thereby tipping the real economy into a double-dip recession.

In the eurozone, GDP is contracting in Spain, Ireland and Greece, while barely growing in Italy and Portugal. The risk is of an L-shaped near-depression. Spring’s trillion dollar eurozone bailout only kicked the can down the road: sovereign spreads in the PIIGS are now back to May levels. The bank stress tests turned out to be a fudge: rather than a E3.5 billion capital hole, Anglo Irish alone could face one of E40 billion, let alone other Irish, Spanish, Belgian and Greek banks and German Landesbanks.

The fundamental problems of the PIIGS remain unresolved: large public debt and deficits, sizeable current account deficits which imply high foreign liabilities in the private sector; a loss of competitiveness; near-depression; and the risk of deflation.

Japan, meanwhile, is in long-term economic coma, consisting of: low potential and actual growth; public debt close to 200% of GDP; poor demographic trends which impair growth and long-term fiscal liabilities; weak and unstable governments incapable of structural reforms; inefficient non-traded and service sectors; almost entrenched deflation; and, an overvalued currency that weakens competitiveness.

Fourth, advanced economies are running out of policy bullets. In 2009 when the global economy was in free fall, all policy options were available: pushing policy rates to 0% and sharply increasing base money through quantitative easing (QE); running fiscal deficits of 10% of GDP in most advanced economies; backstopping, ring-fencing and bailing out financial institutions. But today, if growth sharply disappoints – let alone double-dips – fiscal deficits cannot be sharply increased, as bond vigilantes are waking up and most advanced economies are in fiscal austerity mode, including the US where a fiscal drag is incipient.

Central banks will do more QE, but this “QE2” will be ineffective: US banks are sitting on $1 trillion of excess reserves earning near 0% and not lending: why, then, would they lend the second trillion, after QE2? Monetary policy is becoming impotent and so cannot deal with private debt and solvency problems that constrain credit creation. States’ ability to bail out the financial system – if another downturn occurs – is limited. Banks too big to fail are also too big to be saved or bailed out because fiscally stressed sovereigns – especially in the eurozone – do not have the resources.

In short, we are running out of policy bullets to prevent another downturn, should it materialize.

Fifth, no economy is an island. Full decoupling cannot occur in emerging market economies. Protracted economic weakness in G3 economies will be transmitted to emerging markets via trade, capital flows, commodities and currencies channels as well as through heightened risk aversion which will lead to falls in risky assets globally. China and other Asian nations that rely on export-led growth and have low (high) consumption (savings) rates will, give G3 weakness, face higher downside risks to growth compared to those that depend more on domestic demand (India, Indonesia, Brazil, Turkey).

In light of these risks, financial market volatility will remain high. Investors should remain risk averse as downside risks to equities and risk assets are greater than upside risks: better to preserve capital given the rising risks of tail events in the real economies and financial markets. 

Nouriel Roubini is chairman of Roubini Global Economics (www.roubini.com), professor at New York University and co-author of Crisis Economics

Originally published at Emerging Markets and reproduced with permission.


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8 Responses to “Global Economy: Short on options”

sOctober 12th, 2010 at 2:43 am

Sixth, those who caused the losses are not held responsible for their actions. Rather, through fudging the data and buying the policy makers, they remain in power and divert the costs of the repair on the unconnected masses. Result: massive poverty, disgusting wealth and an economy on an unsustainable path.

GuestOctober 12th, 2010 at 3:19 am

The current foreclosure documentation crisis presents a direct challenge to the rule of law in the United States. Those calling for a federal solution will soon find that none exists. Property rights, land title and mortgage law are fundamentally state law issues, administered at the county level. So too are the rules of evidence, notarisation and title transfer. A Congress or administration that attempts to usurp state law to impose a pro-bank foreclosure process will find itself on the losing side, even with a pro-bank federal court and Supreme Court.Securities law can be federal because securities trade across state borders. Property law will remain state law because property is fixed and definite within the borders of a state.Worse, the documentation crisis doesn’t just impact foreclosure properties, but brings into question the legal status of all mortgaged properties where the mortgage was contracted under the MERS processes. As a result, virtually all Americans – families and businesses – could find that their single greatest wealth asset class is now shackled with legal uncertainty and illiquidity because title cannot be adequately proven to buyers or title insurers.Obviously asset classes that are derivative of property ownership – MBS, CMBS and CDOs – will become even more problematic, unpriceable and illiquid.If the banks really did lose control of the title and mortgage note control process during the boom, it will take decades to sort in a deflationary bust. And Washington will lose even more of the scant legitimacy it still possesses with an angry citizenry if it seeks to shift the costs on taxpayers rather than bankers.Many citizens are already wondering why they pay underwater mortgages to banks that themselves ignore the rule of law and evade accountability for their losses. Many more wonder why they pay taxes that Congress gives to bankers and other bail-out beneficiaries. If the very homes they live in are given clouded title as a result of the foreclosure documentation crisis, expect class warfare to follow.

Octavio RichettaOctober 12th, 2010 at 5:31 am

It feels like 2007 all over again, when few listened to da Profesor’s warnings. Many foolishly believe that because there are more bears now the thing to do is to become a contrarian bull. There is a lot more to being a succesful contrarian. The fact that, in past downturns, big bears have looked like fools sticking to their views when things turn around does not mean a turnaround is inminent. This breed of frivolous bulls will, once again geu slauthered.0..,

sOctober 12th, 2010 at 6:49 am

Investors should buy stocks and sell cash and bonds because governments are continuing to print too much money and may create a new “credit bubble,” Marc Faber, publisher of the Gloom, Boom & Doom report, told reporters during a forum in Seoul today.Frivolous bulls already seem to be celebrating “Quantitative Easing” II (Bernanke language for sucking up the debts).

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