Post by unlawflcombatnt on Jan 23, 2008 2:22:31 GMT -6
www.rgemonitor.com/blog/roubini/238858/
Nouriel Roubini wrote a great piece on his blog on Monday. The most interesting part was how the world will not de-couple from the U.S., and how depependent other countries are on the American consumer to purchase their imports to the U.S.
"First, note that the US accounts for about 25% of global GDP and a much larger fraction of international financial transactions. Thus, it is still the case that when the US sneezes the rest of the world gets the cold.
This hard landing is caused by the US housing recession getting worse, oil prices being high and rising, a severe liquidity and credit crunch being triggered by the housing and subprime bust that is now spreading to broader credit markets, a slack in labor markets as the unemployment rate is going up and, now, a shopped-out and saving-less consumer who is faltering as - now that home prices are falling – it cannot use anymore its home as its ATM machine and spend more than its income. Thus, following this serious US recession the rest of the world will not be able to immunize itself from a serious case of financial and real contagion that will rather cause a sharp and painful economic slowdown – short of a global recession - in the rest of the world.
There has been a debate for the last year on whether the rest of the world would decouple or recouple from the US economic slowdown. If the US were to experience a soft landing – i.e. a “soft patch” period of slow growth followed by a recovery – then the rest of the world has enough growth momentum and domestic demand to decouple from this US slowdown. But if the US experiences a hard landing – an outright recession as now unavoidable – then the rest of the world cannot decouple and it will experience a serious economic slowdown as well. The US consumer spends about $9 trillion; the Chinese one only $1 trillion; and the Indian only $600 billion. And consumers in Europe and Japan have been cranky as low real income growth and growth insecurities has led them to save more rather than spend more. So there is not enough dynamic and fast growing domestic demand in the rest of the world to take the slack of a now faltering US consumer. An unbalanced global economy where the US was for the last few years the consumer of first and last resort – spending more than its income and running a current account deficit – while China and many other countries were the producers of first and last resort – spending less than their income and running large current account surpluses – needed the sustained growth and spending of the US consumer to maintain its unbalanced growth momentum.
Specifically, the recoupling of the rest of the world to the US hard landing will be due to variety of channels of interdependence....
What are then the specific channels through which a US recession has contagious effects to other countries economies, financial markets and stock markets?
Financial Contagion. The fallout of the US subprime meltdown has now led to a broader and more severe liquidity and credit crunch in US financial markets that has now spilled over to Europe, Australia and other parts of the world. This financial contagion depends on a variety of factors: about half of the US securitized instruments – the now disgraced residential mortgage backed securities (RMBS) and the collateralized debt obligations (CDOs) that were repackaging of the same underlying RMBs – were sold to foreign investors around the world. That is why the financial losses of defaulting mortgages in places such as Las Vegas, Phoenix and Cleveland are now showing up in Europe, Australia and even in small villages in Norway as investors all over the globe bought this toxic junk of radioactive risky securities. So we are now observing a growing liquidity and credit crunch in Europe and other parts of the world, a serious case of financial contagion. Since European firms depend on bank lending more than US ones the emerging credit crunch in Europe will hit the European corporate sector and its ability to produce, hire and invest.
Also, losses in the banking and financial system and among investors around the world will increase as the European economies and other economies slow down in 2008, some economies experience an outright recession and a growing number of firms in the corporate sector face financial distress and defaults all over the world.
Financial contagion occurs through stock markets: days when the US stock market plunges are followed by similar sharp falls in Asian and European stock markets when such markets open next: part of this high contagious correlation of markets is due to the rise in global investors’ risk aversion when markets are in turmoil and volatile that leads them to dump risky assets – such as equities – from their portfolios. In recent years this correlation of global stock markets has significantly increased especially in periods of high volatility, risk aversion and financial markets turmoil.
But a more important part of the “contagion” is due to the fact that bad economic news in the US – such as signals of recession – that trigger a fall of the US stock market also lead to expectations of lower growth in other economies that triggers in turn a weakening of their stock markets. Thus, the recent sharp fall of global equity markets is a signal that investors are now realizing that the rest of the world cannot decouple from a US hard landing.
Direct trade links. Real economic contagion occurs importantly via direct trade links. If output and demand in the US falls – a recession - the resulting fall in private consumption, capital spending by firms and production leads to a reduction of US imports of consumer goods, capital goods, intermediate goods and raw materials. But US imports are other countries’ exports and important components of their overall demand. Thus a contraction of other countries exports reduces their economic growth rate.
Since the U.S. is running a current account deficit that is still close to $700 billion this year, the effect of a U.S. slowdown on its imports is likely to be larger than its share of the global economy. Also, note that a number of countries are heavily dependent on exports to the U.S. (both as a share of their total exports and as a share of GDP). These economies include obviously Canada and Mexico but also China, Japan, Korea and a significant part of the rest of Asia (Singapore, Hong Kong, Malaysia, Philippines, and Thailand). China is particularly at risk in the case of a US slowdown as so much of its recent growth has relied on the growth of exports, and of exports to the US of consumer goods that are now at threat as the US recession will be driven by a fall in private consumption.
Indirect Trade Links. If US imports fall and thus Chinese exports to the US fall, the Chinese demand for intermediate inputs from the rest of Asia falls and thus – indirectly - the growth of demand and exports of these Asian economies falls. Some have incorrectly argued that the large growth of inter-Asian trade in the last decade makes this region’s growth less dependent on US growth. But studies have suggested that this argument is faulty as the cyclical and structural dependence of Asia on US growth is now larger than a decade ago. The reasons is as follow: its used to be the case that Asian countries such as Korea, Taiwan and others produced final goods that were exported directly to the US. But with the rise of Chinese competitiveness in such goods the pattern of trade in Asia has now changed: increasingly these Asian countries produce intermediate inputs – such as computer chips - that they export to China and then China assembles them - into final goods (say consumer electronic goods) - and then exports them to US. So greater inter-Asian trade does not mean less dependence – rather greater dependence – on US growth.
Effects on commodity prices. Since the US and China have been the two major drivers of global growth in the last few years – the former as the consumer of first and last resort and the latter as the producer of first and last resort – the slowdown of these two locomotives of global growth – following a US hard landing - will seriously affect the rest of the world; in particular, there will be a sharp drop in the demand for commodities – oil, energy, food, minerals – and in the price of such commodities that had surged in the last few years following the high growth of China and, in part, India and other economies.. The ensuing fall in commodity prices will hurt the exports and growth rate of commodity exporters in Asia, Latin America and Africa. For example Chile’s exports of copper and its price will fall as both the direct demand from the US and the indirect demand from China will fall in the context of a US recession and of a global economic slowdown.
Global Deflationary Effects of a Weaker US Dollar. The US economic slowdown and the ensuing reduction in US policy interest rates has led to a sharp weakening of the value of the US dollar relative to many floating currencies. While this weaker dollar may stimulate US export competitiveness it is bad news for other countries that export to the US as the strengthening of their currencies relative to the US dollar increase the price of their goods in US markets and makes their export competitiveness lower. So a weak dollar is bad news for the exports and economic growth of many countries that depends on the fast growth of exports to the US as an important engine of their growth....
Bursting of Global Housing Bubbles. A cycle of housing boom and bubble followed by a bust has occurred in the US. But similar booms and bubbles did occur in many other parts of the world as easy money, low long-term interest rates and financial innovation occurred in many countries. We have seen such housing booms in Spain, UK, Ireland and, in smaller measure in Italy, Portugal, Greece, France; in Central and South Europe (the Baltic nations, Hungary, Turkey); in Australia, New Zealand and parts of Asia (China, Singapore and parts of India). With a lag we are now observing the beginning of the bursting of such bubbles outside of the US, especially in the UK, Spain and Ireland. Such bust will lead to a domestic economic slowdown in these countries and outright recession in some....
Bad news from the US and falling confidence of US consumers, firms and investors can be transmitted to a fall of confidence of similar economic actors in other countries: confidence is contagious. Global investors become more risk averse and dump risky assets (equities, credit instruments, etc.) not just in the US but across the globe; large international multinationals may decide to cut back new capital spending on factories and machines not just in the US but also in other countries as losses on their US operations lead to more caution and less internal funds available for global capital expansion (a “corporate boardroom investment strike”). Consumer confidence outside the US – especially in Europe and Japan – was weak to begin with; it can only become weaker as an onslaught of lousy economic and financial news in the US affects the “animal spirits” of consumers worldwide.
Constraints on Monetary and Fiscal Policy in Counteracting a Global Economic Slowdown. Finally, today the ability of policy authorities around the world to use monetary and fiscal policy to stimulate their economies and dampen the effect of a US and global demand slowdown are more limited than in 2001 recession. Then, the Fed slashed rates from 6.5% to 1%, the ECB from 4% to 2% and the Bank of Japan cut its policy rate down to 0%. Today the Fed is easing again but it cannot ease as aggressively as in 2001 as it has to worry about inflation and about the risk of a disorderly fall of the dollar that may lead foreign investors to reduce their financing of a still huge US current account deficit. While in Europe and Japan monetary policy had been recently tightened or, at best, kept on hold and the ECB is in denial of the serious downside growth risks in the Eurozone. Similarly, in 2001 there was a massive fiscal stimulus in the US (as we went from large budget surpluses to large budget deficits), in Europe where the 3% deficit limits were breached in the major eurozone economies and in Japan where the deficit went as high as 10%. Today instead, the existence of large structural budget deficits – and high public debt - in the US, Europe and Japan limits the fiscal stimulus that policy authorities can afford. Finally a weaker dollar is a zero-sum game: it may benefit the US but it hurts the competitiveness and growth of the US trading partners.
In conclusion, all these channels implies that a US recession will have painful effects on economic growth and financial markets across the globe: in a “flat world” of globalization trade and financial links boost growth across countries in good times; but they also lead to negative transmission of shocks from large countries like the US in bad times.
Thus, while the rest of the world will not experience an outright recession (while at the same times some specific countries may actually follow the US into a recession path) the global economic slowdown and financial losses – in equity markets and in other risk assets’ markets - that will follow the US recession will be much larger than what it is usually expected....
2008 will be the year of re-coupling rather than de-coupling both in financial markets and the real economies; and the effects will be painful for the US and global economy. So, as Bette Davis warned in All About Eve: “Fasten your seatbelts as it’s gonna be a bumpy ride!” Not just bumpy; rather very ugly and scary as the risks of a systemic financial meltdown – that would seriously worsen the economic downturn and around the world - are seriously rising. As argued in detail in the past in this column this is the first crisis of financial globalization and securitization, an episode of a severe and worsening liquidity and credit crunch, a most severe case of systemic risk that will have dire consequences for the growth rate of the US and the global economy."
Nouriel Roubini wrote a great piece on his blog on Monday. The most interesting part was how the world will not de-couple from the U.S., and how depependent other countries are on the American consumer to purchase their imports to the U.S.
"First, note that the US accounts for about 25% of global GDP and a much larger fraction of international financial transactions. Thus, it is still the case that when the US sneezes the rest of the world gets the cold.
This hard landing is caused by the US housing recession getting worse, oil prices being high and rising, a severe liquidity and credit crunch being triggered by the housing and subprime bust that is now spreading to broader credit markets, a slack in labor markets as the unemployment rate is going up and, now, a shopped-out and saving-less consumer who is faltering as - now that home prices are falling – it cannot use anymore its home as its ATM machine and spend more than its income. Thus, following this serious US recession the rest of the world will not be able to immunize itself from a serious case of financial and real contagion that will rather cause a sharp and painful economic slowdown – short of a global recession - in the rest of the world.
There has been a debate for the last year on whether the rest of the world would decouple or recouple from the US economic slowdown. If the US were to experience a soft landing – i.e. a “soft patch” period of slow growth followed by a recovery – then the rest of the world has enough growth momentum and domestic demand to decouple from this US slowdown. But if the US experiences a hard landing – an outright recession as now unavoidable – then the rest of the world cannot decouple and it will experience a serious economic slowdown as well. The US consumer spends about $9 trillion; the Chinese one only $1 trillion; and the Indian only $600 billion. And consumers in Europe and Japan have been cranky as low real income growth and growth insecurities has led them to save more rather than spend more. So there is not enough dynamic and fast growing domestic demand in the rest of the world to take the slack of a now faltering US consumer. An unbalanced global economy where the US was for the last few years the consumer of first and last resort – spending more than its income and running a current account deficit – while China and many other countries were the producers of first and last resort – spending less than their income and running large current account surpluses – needed the sustained growth and spending of the US consumer to maintain its unbalanced growth momentum.
Specifically, the recoupling of the rest of the world to the US hard landing will be due to variety of channels of interdependence....
What are then the specific channels through which a US recession has contagious effects to other countries economies, financial markets and stock markets?
Financial Contagion. The fallout of the US subprime meltdown has now led to a broader and more severe liquidity and credit crunch in US financial markets that has now spilled over to Europe, Australia and other parts of the world. This financial contagion depends on a variety of factors: about half of the US securitized instruments – the now disgraced residential mortgage backed securities (RMBS) and the collateralized debt obligations (CDOs) that were repackaging of the same underlying RMBs – were sold to foreign investors around the world. That is why the financial losses of defaulting mortgages in places such as Las Vegas, Phoenix and Cleveland are now showing up in Europe, Australia and even in small villages in Norway as investors all over the globe bought this toxic junk of radioactive risky securities. So we are now observing a growing liquidity and credit crunch in Europe and other parts of the world, a serious case of financial contagion. Since European firms depend on bank lending more than US ones the emerging credit crunch in Europe will hit the European corporate sector and its ability to produce, hire and invest.
Also, losses in the banking and financial system and among investors around the world will increase as the European economies and other economies slow down in 2008, some economies experience an outright recession and a growing number of firms in the corporate sector face financial distress and defaults all over the world.
Financial contagion occurs through stock markets: days when the US stock market plunges are followed by similar sharp falls in Asian and European stock markets when such markets open next: part of this high contagious correlation of markets is due to the rise in global investors’ risk aversion when markets are in turmoil and volatile that leads them to dump risky assets – such as equities – from their portfolios. In recent years this correlation of global stock markets has significantly increased especially in periods of high volatility, risk aversion and financial markets turmoil.
But a more important part of the “contagion” is due to the fact that bad economic news in the US – such as signals of recession – that trigger a fall of the US stock market also lead to expectations of lower growth in other economies that triggers in turn a weakening of their stock markets. Thus, the recent sharp fall of global equity markets is a signal that investors are now realizing that the rest of the world cannot decouple from a US hard landing.
Direct trade links. Real economic contagion occurs importantly via direct trade links. If output and demand in the US falls – a recession - the resulting fall in private consumption, capital spending by firms and production leads to a reduction of US imports of consumer goods, capital goods, intermediate goods and raw materials. But US imports are other countries’ exports and important components of their overall demand. Thus a contraction of other countries exports reduces their economic growth rate.
Since the U.S. is running a current account deficit that is still close to $700 billion this year, the effect of a U.S. slowdown on its imports is likely to be larger than its share of the global economy. Also, note that a number of countries are heavily dependent on exports to the U.S. (both as a share of their total exports and as a share of GDP). These economies include obviously Canada and Mexico but also China, Japan, Korea and a significant part of the rest of Asia (Singapore, Hong Kong, Malaysia, Philippines, and Thailand). China is particularly at risk in the case of a US slowdown as so much of its recent growth has relied on the growth of exports, and of exports to the US of consumer goods that are now at threat as the US recession will be driven by a fall in private consumption.
Indirect Trade Links. If US imports fall and thus Chinese exports to the US fall, the Chinese demand for intermediate inputs from the rest of Asia falls and thus – indirectly - the growth of demand and exports of these Asian economies falls. Some have incorrectly argued that the large growth of inter-Asian trade in the last decade makes this region’s growth less dependent on US growth. But studies have suggested that this argument is faulty as the cyclical and structural dependence of Asia on US growth is now larger than a decade ago. The reasons is as follow: its used to be the case that Asian countries such as Korea, Taiwan and others produced final goods that were exported directly to the US. But with the rise of Chinese competitiveness in such goods the pattern of trade in Asia has now changed: increasingly these Asian countries produce intermediate inputs – such as computer chips - that they export to China and then China assembles them - into final goods (say consumer electronic goods) - and then exports them to US. So greater inter-Asian trade does not mean less dependence – rather greater dependence – on US growth.
Effects on commodity prices. Since the US and China have been the two major drivers of global growth in the last few years – the former as the consumer of first and last resort and the latter as the producer of first and last resort – the slowdown of these two locomotives of global growth – following a US hard landing - will seriously affect the rest of the world; in particular, there will be a sharp drop in the demand for commodities – oil, energy, food, minerals – and in the price of such commodities that had surged in the last few years following the high growth of China and, in part, India and other economies.. The ensuing fall in commodity prices will hurt the exports and growth rate of commodity exporters in Asia, Latin America and Africa. For example Chile’s exports of copper and its price will fall as both the direct demand from the US and the indirect demand from China will fall in the context of a US recession and of a global economic slowdown.
Global Deflationary Effects of a Weaker US Dollar. The US economic slowdown and the ensuing reduction in US policy interest rates has led to a sharp weakening of the value of the US dollar relative to many floating currencies. While this weaker dollar may stimulate US export competitiveness it is bad news for other countries that export to the US as the strengthening of their currencies relative to the US dollar increase the price of their goods in US markets and makes their export competitiveness lower. So a weak dollar is bad news for the exports and economic growth of many countries that depends on the fast growth of exports to the US as an important engine of their growth....
Bursting of Global Housing Bubbles. A cycle of housing boom and bubble followed by a bust has occurred in the US. But similar booms and bubbles did occur in many other parts of the world as easy money, low long-term interest rates and financial innovation occurred in many countries. We have seen such housing booms in Spain, UK, Ireland and, in smaller measure in Italy, Portugal, Greece, France; in Central and South Europe (the Baltic nations, Hungary, Turkey); in Australia, New Zealand and parts of Asia (China, Singapore and parts of India). With a lag we are now observing the beginning of the bursting of such bubbles outside of the US, especially in the UK, Spain and Ireland. Such bust will lead to a domestic economic slowdown in these countries and outright recession in some....
Bad news from the US and falling confidence of US consumers, firms and investors can be transmitted to a fall of confidence of similar economic actors in other countries: confidence is contagious. Global investors become more risk averse and dump risky assets (equities, credit instruments, etc.) not just in the US but across the globe; large international multinationals may decide to cut back new capital spending on factories and machines not just in the US but also in other countries as losses on their US operations lead to more caution and less internal funds available for global capital expansion (a “corporate boardroom investment strike”). Consumer confidence outside the US – especially in Europe and Japan – was weak to begin with; it can only become weaker as an onslaught of lousy economic and financial news in the US affects the “animal spirits” of consumers worldwide.
Constraints on Monetary and Fiscal Policy in Counteracting a Global Economic Slowdown. Finally, today the ability of policy authorities around the world to use monetary and fiscal policy to stimulate their economies and dampen the effect of a US and global demand slowdown are more limited than in 2001 recession. Then, the Fed slashed rates from 6.5% to 1%, the ECB from 4% to 2% and the Bank of Japan cut its policy rate down to 0%. Today the Fed is easing again but it cannot ease as aggressively as in 2001 as it has to worry about inflation and about the risk of a disorderly fall of the dollar that may lead foreign investors to reduce their financing of a still huge US current account deficit. While in Europe and Japan monetary policy had been recently tightened or, at best, kept on hold and the ECB is in denial of the serious downside growth risks in the Eurozone. Similarly, in 2001 there was a massive fiscal stimulus in the US (as we went from large budget surpluses to large budget deficits), in Europe where the 3% deficit limits were breached in the major eurozone economies and in Japan where the deficit went as high as 10%. Today instead, the existence of large structural budget deficits – and high public debt - in the US, Europe and Japan limits the fiscal stimulus that policy authorities can afford. Finally a weaker dollar is a zero-sum game: it may benefit the US but it hurts the competitiveness and growth of the US trading partners.
In conclusion, all these channels implies that a US recession will have painful effects on economic growth and financial markets across the globe: in a “flat world” of globalization trade and financial links boost growth across countries in good times; but they also lead to negative transmission of shocks from large countries like the US in bad times.
Thus, while the rest of the world will not experience an outright recession (while at the same times some specific countries may actually follow the US into a recession path) the global economic slowdown and financial losses – in equity markets and in other risk assets’ markets - that will follow the US recession will be much larger than what it is usually expected....
2008 will be the year of re-coupling rather than de-coupling both in financial markets and the real economies; and the effects will be painful for the US and global economy. So, as Bette Davis warned in All About Eve: “Fasten your seatbelts as it’s gonna be a bumpy ride!” Not just bumpy; rather very ugly and scary as the risks of a systemic financial meltdown – that would seriously worsen the economic downturn and around the world - are seriously rising. As argued in detail in the past in this column this is the first crisis of financial globalization and securitization, an episode of a severe and worsening liquidity and credit crunch, a most severe case of systemic risk that will have dire consequences for the growth rate of the US and the global economy."