Monday, 14 December 2009

Assessing the damage...

Cees Bruggemans, chief economist of FNB, gave his assessment of the costs of the financial crisis in one of his weekly commentaries published on the 24th November 2009. Here follows excerpts from the article:
The original focus was very much on financial asset losses, with estimates in the trillions of dollars, and equity markets tanking with losses in the tens of trillions.

But though the financial asset losses were painful and real (ultimately some $2.5 trillion worth, of which three-quarters by now written off, yet questions remaining whether global toxic assets really have been fully dealt with), the equity paper losses have already been mostly erased as markets bounced sharply in 2009.

The global output forever lost in 2008-2009 probably amounted to $3 trillion, with at least twice that opportunity loss still to be counted through 2015-2020.

The agonising pain deluged on bank shareholders and managements, hedge funds and insurers, especially in large parts of the West, has been on vivid display throughout. But this was ultimately only a small sliver of humanity facing the piper.

Much larger numbers of people ultimately paid a major price because of the financial failure of preceding years and the manner in which the financial crisis hit the global economy broadside.

The number of US housing foreclosures runs in the many millions. A much larger multiple lost their work and livelihood. So far, some 8 million private sector jobs have been lost in the US alone, a number that will still climb by another 1 million through Easter 2010. To this must be added another 1 to 2 million discouraged workers ceasing to look for work and falling from view. And we must then still incorporate the substantial shortening in US working time, going by temporary workers and reduced working hours. And then we must still allow for the 1-2 million youngsters newly added to the labour pool during 2008-2009 for whom there was little scope overall.

This amounts to a lot of pain in a 150 million workforce, where nominal wage increases are currently minimal and bonuses mostly reduced, heavily constraining household income. Together with tightened bank credit and terms, and consumer unwillingness to take up new debt, it paints a picture of a weakened colossus.

In the years ahead, policy action in the US and elsewhere is geared to get financial markets functioning normally again, extending credit to creditworthy customers, but also to support effective demand, thereby gradually restoring business confidence in the future and a willingness to take risk and resume investing (and hiring) more boldly again.

Yet it will be slow going. Not only are employers fiercely intend on improving productivity (and repairing their bottom lines), thereby allowing GDP and national income to expand, but they prefer doing so without rehiring of new labour, at least in the short term.

Then, in the case of the US, once employers finally start hiring again, the first 100 000 of new jobs created monthly will merely absorb newcomers to the labour force (population growth and migratory changes). Only thereafter will the economy start to rehire from the unemployment pool and possibly create new opportunities for currently discouraged individuals.

Absorbing the new additions to the labour pool, and reducing unemployment to acceptable levels could well take up to a decade, considering the relative slow cyclical take-off currently underway, the high emphasis on improving productivity, the lingering uncertainty in so many walks of life, and the consequent inhibition to start hiring normally again quite soon.

Instead, the hardship for many will be spread out over many years.

The senior leadership in the various major central banks (Fed, ECB, BOE) and in national governments (US, UK, Germany, France and others) seem highly aware of these realities and their possible political implications. Under these circumstances we don't encounter any early eagerness to withdraw support for their respective economies, rather the contrary as evidence multiplies of staying the course for longer, though trying to placate bond market vigilantes every step of the way.

Yet state finances are deteriorating, calling for early remedial action. Even so, governments seem intend on discovering how far they can go with their support actions to ensure that economic recovery truly vests. And though central banks are now actively signaling a gradual reduction in quantitative easing (bond buying) next year, they will do so warily, throughout cautiously examining whether the perceived normalization of financial markets proves genuine and can continue.

Meanwhile, with resource slack as large as it is, core inflation at 1% and likely still moving closer to zero next year, and inflation expectations subdued, the major central banks have every reason to keep their interest rates near zero for longer, probably throughout 2010, as ever so gently signaled by Fed, ECB and BOE.

Tuesday, 1 December 2009

The next crisis looming: Asset bubbles?

Robert Zoellick, president of the World Bank, recently aired his views on certain dangers arising from the massive monetary and fiscal stimuli governments have embarked upon to avoid the dire consequences of the financial crisis of 2008. Here are some excerpts from the article that was published on
As the world begins to recover from the worst downturn since the Great Depression, the conventional wisdom is that we have employed lessons of the past effectively: a flood of money; a dose of fiscal stimulus; and an avoidance of the worst trade protectionism.
Of course, governments knew these dramatic actions would have consequences. Central banks have been watching carefully for early signs of the traditional danger – inflation. Yet in a new era of global competition, companies are unlikely to have the pricing power that led to “demand pull” inflation in decades past; nor are unions likely to be able to make wage demands that contributed to “cost-push” stagflation. Walmart and the developing world’s labour force have changed the paradigm.
Yet the revival of John Maynard Keynes should not lead us to ignore Milton Friedman: where will all that money go? For a hint of the future, look to Asia, where a new risk is emerging: asset bubbles.
Asia is now leading the world economy with increases in industrial production and trade, partly reflecting the growth in China and India. This welcome economic upswing is accompanied by rising equity and property prices.
The combination of loose money, volatile commodity markets and poor harvests – such as occurred recently in India – could make 2010 another dangerous year for food prices in poor countries. Asset bubbles could be the next fragility as the world recovers, threatening again to destroy livelihoods and trap millions more in poverty.
Unfortunately, the chapters in the history books about how to deal with asset bubbles usually precede tales of woe. Asset bubbles can be more insidious than traditional product inflation, because they seem to be a sign of health: higher values lift the real economy, which in turn can send the bubbles higher.
Waiting for bubbles to burst and then cleaning up the aftermath is now a new lesson of what not to do. But tightening interest rates too abruptly – especially where recoveries are weak, such as in the US and Europe – could trigger another downturn.
Australia, with its ties to the Asian economies, has already raised interest rates. Asian countries, which traditionally follow the US Fed’s monetary policy, will be under pressure to follow. But raising rates while the Fed keeps its rates close to zero would cause Asian currencies to appreciate. This would make their exports more expensive and decrease overseas sales, hurting recoveries based on exports. More­over, there is competition from China. The renminbi is tied to a declining US dollar that makes Chinese goods cheaper to buy than those of Asian rivals.
It would also help if North America and Europe took a closer look at the agenda that Australia and many Asian countries are starting to pursue. To build confidence and opportunity for the private sector, the Asia-Pacific countries are advancing structural reforms – including in service sectors – to boost productivity and potential growth. These reforms will help them to compete even if their currencies appreciate.
Perhaps the primary lesson from history is for countries to co-operate in making assessments that distinguish their situations, avoiding one-size-fits-all “exit strategies”, and cautioning against currency or trade protectionism.
These will be the challenges for the Group of 20 nations in 2010. The G20 had better put asset price bubbles and new growth strategies on its agenda. Otherwise, the solutions of 2008-09 could plant the seeds of trouble in 2010 and beyond.