Global Economics: Now What? The W-Shaped scenario.
June 16, 2009
Is this really the end of the recession?
The new framework for modelling the world economy in a post transition-phase
state is still missing. The models we use still have major systemic errors in
them, we obviously still have the same valuation problems and mis-specification
of the policy mix. Despite some calling for the New Thinking, there is little
new that has been put forward in reality.
Much of the problem in valuations is still here. Others argue that while the
visible part of the sub-prime mess is mostly cleaned up, a lot of the less
visible, but rather sizeable side-effects of it are still on the books, without
‘proper’ valuation. I would add my own observation, that the way the markets
approached emerging markets has not really changed much, differentiation is
still not really the name of the game. If the capital markets asked for the a
realistic risk premium, some emerging market treasuries would have gone into
default, whatever the urgent ambulance package was. In any case, we would see a
much wider performance range from emerging markets than was the case the past
months.
Plus, the policy response has been mostly inadequate. The global economy has
gone through a transition phase the past ten years, making national level
policy responses unlikely to do the job. The problem is that to tackle the kind
of global crisis that is at hand, one would need to have enforceable monetary
and fiscal policy in place, on a global level, and that is clearly not there.
What has been there instead, after an initial bout of panic, is a set of
protectionist measures, and a happen-to-be-at-more-or-less-the-same-time fiscal
stimuli around the world that kind of works as harmonised global stimulus.
Yet, the current stimuli take most governments way-way beyond known
territories: deficits are up to levels unimaginable before, and debt as well as
debt projections are through the roof. For the majority of the governments the
current stimulus it is a one-off action. This one really needs to work.
Which takes us to the really bad news: most of the ‘green shoots’ seem to be
directly dependent on the fiscal stimuli. There is hardly anything else.
Scratch any bit of ‘end of recession’ data around, independent whether the US,
China, Germany, or Australia. Although there is some actual money in the
pockets, it is not that much. The biggest across the board factor is the change
of confidence. In other words, the governments are inducing a new bubble, and
we lay all our hopes on it.
This might work. Yet, there is a significant momentum towards further slowing
in the global economy. The multiplying effect of the initial hit is just taking
shape. The main survival strategy in sectors hit only indirectly by the crisis
has been to cut back spending as much as possible, and try to bridge over the
shortage of revenues from reserves and bank loans. Banks are still hesitant to
lend (even if they are ordered to by their respective governments, as we have
seen many examples around the world), which means that the bridging exercise is
mostly from own reserves. And there signs that reserves are running out.
If the global confidence boom will not be sustained, and there is plenty of
reason why it should not be, then the coming fall might turn out to be even
bigger than the one allegedly bottoming. The W-shape scenario might see a
deeper, and longer, second trough.
