The global economic recovery since the severe recession of 2008-2009 was artificially boosted by various countries massive monetary stimuli and hoping to bailout their country's economy out of the financial turmoil. But the fundamental excesses that led to the crisis - too much debt in the private sector - have not been addressed, for private sector deleveraging has barely started. Now there is massive re-leveraging of the public sector in advanced economies, as a result of massive budget deficits driven by automatic stabilisers, counter-cyclical Keynesian fiscal stimulus and the socialisation of private losses.
Thus, a protracted period of anaemic sub-par growth in advanced economies as the deleveraging of households, financial institutions and soon governments, starts to kick in.
Moreover, countries that spent too much - the United States, Britain, Spain, Greece and others - now need to deleverage, and are thus spending, consuming and importing less, some may seem to be going into the "protectionism" effect although free-market does not endorse such practice. Countries that saved too much - those in emerging Asia, China, Germany and Japan - are not spending more to compensate for the fall in spending of the first group and in a world of excess supply, global aggregate demand will be weak, pushing global growth much lower.
The global economic slowdown for the second quarter of this year, will accelerate in the second half of the year. The fiscal stimulus will become a drag on growth as austerity programmes in most countries kick in. Inventory adjustment, which boosted growth for a few quarters, will run its course. The effects of tax policies that stole demand from the future - such as the 'cash for clunkers' scheme in the US, investment tax credits, tax credits for home buyers, or cash for green appliances - will fizzle. Labour market conditions will remain weak; a sense of malaise will spread among consumers.
The likely scenario for advanced economies is a mediocre U-shaped recovery, even if a W-shaped double dip is avoided. In the US, growth was already below trend in the first half - 2.7 per cent in the first quarter and a mediocre 2.2 per cent in the second quarter. It will slow down further to 1.5 per cent growth in the second half of this year and into next year. Thus, even if the US technically avoids a double dip, it will feel like a recession, given mediocre job creation, larger budget deficits, a further fall in home prices, larger losses by banks on mortgages, consumer credit and other loans, and the risk that the US Congress will take protectionist action against a China that has allowed only a token appreciation of its currency.
In the euro zone, the outlook is even worse. Growth is likely to be close to zero by the end of this year, as fiscal austerity takes hold, along with an increase in the cost of capital. Increases in risk aversion as well as sovereign risk will further undermine business, investor and consumer confidence in Europe. And the weakening of the euro will hurt the growth prospects of the US, China and emerging Asia.
Even China is showing signs of a slowdown as the tightening to deal with asset inflation takes effect. The slowdown in advanced economies and the weakening of the euro will further dent Chinese growth in the second half of this year. The world's leading growth locomotive is thus slowing, from over 11 per cent towards a 7 per cent rate by year's end. This is bad news for exporters in the rest of Asia, especially commodity exporters, who rely on Chinese imports.
Japan where domestic demand is anaemic will be hit hard. It suffers from low potential growth, given the lack of structural reforms and ineffective governments, a large stock of public debt, an ageing demographic and a strong yen that tends to get stronger during bouts of global risk aversion.
A scenario where US growth slumps to a mediocre 1.5 per cent, where euro zone and Japan growth slows to zero per cent, and where China slows below 8 per cent is not a global double dip but it will feel awfully close to one. Also, any additional shock could tip this fragile global economy, growing at close to stalling speed, into a full fledged double dip. The sovereign problems of the euro zone could get worse, leading to another round of asset price correction, global risk aversion, and financial contagion. Also, one cannot exclude the possibility that Israel might strike Iran within the next 12 months. Then oil prices could rapidly spike and tip the global economy into a recession.
Major policymakers are running out of policy ideas. If the risk of a double dip rises, some additional quantitative easing will not make much of a difference. Also, there is little room for further fiscal stimulus in most advanced economies; consequently, the ability to bail out financial systems that are too big to fail, but also too big to be saved, will be sharply constrained, given the fiscal deficits.
Thus, as the delusions of a rapid V-shaped recovery go out of the window, the advanced world will, at best, be in a long U-shaped recovery. In some cases - the euro zone and Japan, in particular - the U may stretch into an L-shaped near-depression, struggling to avoid a W-shaped double dip recession. Even the V-shaped recovery in stronger emerging markets will be dented, for no country is an island and many emerging economies - including China - are dependent on now-anaemic advanced economies.
With all said, both Europe and America seem to be suffering from delusions—of strength and weakness respectively. In Europe it is far too early to say of sign of recovery on at least two counts. First, Germany apart, the euro area remains weak. Spain, whose economy is barely growing and where the jobless rate is 20%, would love to have America’s problems. Second, Germany relies on exports, not spending at home: the home market is one of the few places where sales of Mercedes cars have fallen this year and obviously in bad times, such luxury items would be least wanted as they are not "needs".
How real are the risks of a double dip in the United States? The recovery has lost momentum in part because shops and warehouses are fuller, so that the initial boost to demand from restocking is fading. The housing bust still casts a shadow. Households must save to work off excess debts. Firms fearful of weak consumer spending are cautious about investing. Bank credit is scarce. All this stands in the way of a full-blooded recovery. But a slide into a second recession would require firms to cut back again on stocks, capital spending and jobs. The cash buffer corporate America has built up in case of harder times makes a fresh shock of that kind unlikely.
Yet even without a double dip, America could plainly be doing better. Its firms might be more willing to spend their cash if they had a clearer sign from Mr Obama how he intends eventually to close their country’s fiscal deficit (and the extra taxes that might entail). But in the short term eyes are fixed on the Federal Reserve. On August 10th the central bank acknowledged that the recovery had slackened and said it would reinvest the proceeds from the maturing mortgage securities it owns in government bonds. This was a small shift back towards “quantitative easing”—but less than the bears wanted.
Anxiety about deflation remains justified: any sign of it would require much bolder measures from the central bank. However, for the moment the Fed has sent the right signal: concern but not panic. Apart from anything else, it is not clear that yet more monetary stimulus would have created many new jobs. The relatively high level of job vacancies in America seems consistent with far lower unemployment. Some firms have complained that the available workers do not have the skills that they want. Unemployment, sadly, may thus have deep roots, with more people this time remaining out of work for longer. It will be a hard slog. But on the current evidence don’t expect America’s recovery to grind to a halt.
Next year 2011 may seem to be another critical performing year for the global economy and top policy makers better wake up from their comfort zone and start to think what else to do about the current "sick" economy condition.
By following Textbook strategy, we could try some luck below :
One strategy is to buy long-term Treasury bonds, which many people already appear to be doing as a hedge against general economic troubles. Yields on 10-year Treasury securities have plunged to 2.8 per cent from about 3.8 per cent in late April.
Strategists who've expressed concerns about deflation aren't necessarily predicting a return to protracted, Depression-era downward price spirals. Robert Arnott, chairman of the asset management firm Research Affiliates in Newport Beach, California, said that while a brief bout of modest deflation was a threat in the short run, inflation - or rising prices that eat away at consumers' purchasing power - remained the bigger long-term menace. As a result, Mr Arnott isn't focusing entirely on near-term deflation. Rather than buying long-term Treasuries, he suggests an investment in Treasury inflation-protected securities.
Need to be choosy
Among corporate securities, investors should pay attention to companies' balance sheets. 'You want to avoid highly leveraged companies,' said Carl Kaufman, manager of the Osterweis Strategic Income fund. In a deflationary environment, a debt-ridden company would have to pay back obligations with increasingly valuable dollars.
In inflation, you're cheapening the value of dollars over time. In deflation, it's the opposite: dollars become dearer over time. Fixed-income investors may want to focus on high-quality companies that routinely generate tons of cash. The same argument goes for equity investors as well.
Standard & Poor's, says that in deflationary times, some stocks could actually post gains. Throughout the 1990s, when the Japanese stock market began to crater under the weight of deflationary forces, technology, telecommunications and healthcare shares rose on local markets.
Go for blue chips
Investors who want to maintain their stock weightings should consider high-quality, large, blue-chip companies that have balance-sheet strength. Companies like Google and Microsoft often have an added advantage: dominance over their industries, enabling them to maintain their prices even if others in the industry start to lower theirs.
Stocks that pay dividends would also make sense, because the cash thrown off by these shares would be quite valuable in a deflationary environment.
If investors really fear deflation, they might consider increasing the cash in their portfolios. There's a strong case for building up dry powder. If something bad happens economically - whether it's deflation or inflation - that generally provides a good buying opportunity for investors who have some cash
How real are the risks of a double dip in the United States? The recovery has lost momentum in part because shops and warehouses are fuller, so that the initial boost to demand from restocking is fading. The housing bust still casts a shadow. Households must save to work off excess debts. Firms fearful of weak consumer spending are cautious about investing. Bank credit is scarce. All this stands in the way of a full-blooded recovery. But a slide into a second recession would require firms to cut back again on stocks, capital spending and jobs. The cash buffer corporate America has built up in case of harder times makes a fresh shock of that kind unlikely.
Yet even without a double dip, America could plainly be doing better. Its firms might be more willing to spend their cash if they had a clearer sign from Mr Obama how he intends eventually to close their country’s fiscal deficit (and the extra taxes that might entail). But in the short term eyes are fixed on the Federal Reserve. On August 10th the central bank acknowledged that the recovery had slackened and said it would reinvest the proceeds from the maturing mortgage securities it owns in government bonds. This was a small shift back towards “quantitative easing”—but less than the bears wanted.
Anxiety about deflation remains justified: any sign of it would require much bolder measures from the central bank. However, for the moment the Fed has sent the right signal: concern but not panic. Apart from anything else, it is not clear that yet more monetary stimulus would have created many new jobs. The relatively high level of job vacancies in America seems consistent with far lower unemployment. Some firms have complained that the available workers do not have the skills that they want. Unemployment, sadly, may thus have deep roots, with more people this time remaining out of work for longer. It will be a hard slog. But on the current evidence don’t expect America’s recovery to grind to a halt.
Next year 2011 may seem to be another critical performing year for the global economy and top policy makers better wake up from their comfort zone and start to think what else to do about the current "sick" economy condition.
By following Textbook strategy, we could try some luck below :
One strategy is to buy long-term Treasury bonds, which many people already appear to be doing as a hedge against general economic troubles. Yields on 10-year Treasury securities have plunged to 2.8 per cent from about 3.8 per cent in late April.
Need to be choosy
Among corporate securities, investors should pay attention to companies' balance sheets. 'You want to avoid highly leveraged companies,' said Carl Kaufman, manager of the Osterweis Strategic Income fund. In a deflationary environment, a debt-ridden company would have to pay back obligations with increasingly valuable dollars.
In inflation, you're cheapening the value of dollars over time. In deflation, it's the opposite: dollars become dearer over time. Fixed-income investors may want to focus on high-quality companies that routinely generate tons of cash. The same argument goes for equity investors as well.
Standard & Poor's, says that in deflationary times, some stocks could actually post gains. Throughout the 1990s, when the Japanese stock market began to crater under the weight of deflationary forces, technology, telecommunications and healthcare shares rose on local markets.
Investors who want to maintain their stock weightings should consider high-quality, large, blue-chip companies that have balance-sheet strength. Companies like Google and Microsoft often have an added advantage: dominance over their industries, enabling them to maintain their prices even if others in the industry start to lower theirs.
Stocks that pay dividends would also make sense, because the cash thrown off by these shares would be quite valuable in a deflationary environment.
If investors really fear deflation, they might consider increasing the cash in their portfolios. There's a strong case for building up dry powder. If something bad happens economically - whether it's deflation or inflation - that generally provides a good buying opportunity for investors who have some cash
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