For one perspective, the Carnegie Endowment for International Peace had a session at the end of April featuring a few IMF economists. Marco Terrones (link to PowerPoint at the bottom of the page) looked at the typical duration of a recession and the ensuing recovery. The duration of recovery is measured to the point at which the economy reaches its previous peak output (the output level when the recession began – December 2007 in our case). He looked at 122 recessions since 1960. 

Terrones’s key point was that recessions last longer, and take longer to recover from, if they are linked to financial crises or if they are globally synchronized, for reasons that are probably evident to our readers: popping credit bubbles lead to an increase in the savings rate, dampening consumption; and globally synchronized recessions mean that no country can export its way back to growth. On average (slide 5), a recession that is both linked to a financial crisis and globally synchronized will last three quarters longer than normal (seven rather than four), and recovery, measured from the beginning of the recession, will take seven quarters longer than normal (fourteen rather than seven). (There is obviously some correlation there, since the longer the recession, the more ground needs to be made up.)  Those are just averages, but projecting onto our experience that means recovery would start in Q4 2009, but we would not reach our peak (December 2007) output level until late 2011. Since the workforce will have grown by a few percent in the interim, unemployment would not reach December 2007 levels – if ever – for another year or two. 

Seven quarters of contraction and seven of recovery to previous peak don’t seem that bad. Of course, this is still just an estimate based on data going back to 1960, and there is nothing in that time period like what the world is going through today.

This analysis is covered in greater detail in Chapter 3 of the IMF’s April World Economic Outlook.

By James Kwak

• Japan: -4.0%
• Germany: -3.8%
• Eurozone: -2.5%
• Italy: -2.4%
• U.K.: -1.9%
• U.S.: -1.6%
• France: -1.2%

Figures are from Bloomberg. Canada seems to be doing better, but Bloomberg doesn’t have quarter-over-quarter rates.

And here are the year-over-year figures:

• Japan: -9.7%
• Germany: -6.9%
• Italy: -5.9%
• Eurozone: -4.6%
• U.K.: -4.1%
• France: -3.2%
• U.S.: -2.6%
• Canada: -2.3%

Not pretty.

By James Kwak

First concrete action should be remove cash from Banrural and bankrupt the bank of the corrupt.

I guess he also said the bank was corrupt. Well, people have said that around here, too.

More broadly, the government is in crisis, with frequent popular protests, over allegations that Rodrigo Rosenberg was assassinated on the orders of the president because he uncovered evidence of murder and corruption by the government. 

Here’s a request from a friend:

One of the things keeping our friends out in the streets safe is that the international community is paying attention to what´s going on. If you could take a few minutes and send an email to your country´s ambassador in Guatemala – if from the US it’s Mr. Stephen G. McFarland at AmCitsGuatemala@state.gov - letting him or her know that you are concerned about what´s going on in Guatemala and hope your country is doing its best in assuring people´s right to peacefully protest against the violence in Guatemala, and to help investigate the murders, it would really go a long way. If you have another nationality then writing to your Ambassador in Guatemala would also be of great importance.

Gracias de todo corazón!

By James Kwak

The committee was mostly in favor of the US continuing to play a leading role in supporting the IMF, but pressed the witnesses to explain whether the IMF could lose this money (highly unlikely), how this would protect American jobs (definitely, but hard to quantify precisely), and if the broader package of IMF reform should also be supported (e.g., the proposed gold sales are being reassessed, to see they could generate more resources for aid to developing countries).

Politico is reporting that US funding for the IMF is likely to be attached to the war supplemental spending bill.  The subcommittee’s chairman, Gregory Meeks, seemed positive – as did all the Democrats who spoke, along with Gary Miller, the Ranking Member/Senior Republican.  But, based on remarks made by at least two Republican members of the subcommittee, there is likely to be a big public fight at some point.  My guess is that the Democratic side will press hard for President Obama to more publicly explain why supporting the IMF (and the G20) is very much in the US interest.

The main points from my written testimony are below.  While Treasury represents the US vis-a-vis the IMF and traditionally has considerable scope for action, the views of Congress on IMF details are very important as both guidance and constraints.  In our advice on the wide range of IMF-related issues below, both I and the other witnesses laid out broadly similar views with varying emphasis – there was actually much more disagreement among committee members than at the witness table.

Main points

Low income countries have been severely affected by the global economic downturn.  Many of the worst consequences, including on the poorest people, have yet to be felt.

In that context, by contributing to the stabilization of the world’s financial system, the G-20 summit had a positive effect.  However, it left open a large number of important issues, some of which call for immediate congressional attention.

First and foremost, low income countries need to receive considerable additional resources in order to weather the crisis.  This crisis is not of their making and, prior to this shock, poorer countries were making considerable progress along the lines of implementing exactly the policies advised by richer countries and the International Monetary Fund (IMF).

The IMF has adapted its standard forms of conditionality to current circumstances.  The goal of protecting core social spending is commendable and long overdue, and the implementation in recent East European and Pakistan programs is encouraging.  However, the retreat from structural conditionality has probably gone too far and needs to be reappraised; the weaknesses of low income countries arise from and are manifest in disproportionate power of key individuals or sectors, and this needs to be addressed in a transparent manner wherever the IMF is engaged.  In situations where such issues have been taken on board – as with transparency for extractive industries – the reception among civil society has been very positive.

The potential US legislative package (including IMF gold sales, its new income model, and $100 billion for the New Arrangements to Borrow) is worth serious consideration but also needs careful congressional review.  The $250bn issue of Special Drawing Rights is a bold move which, while it involves some risks, is well worth taking – hopefully, this will be regarded as a pilot project for potentially larger increases in resources for troubled countries, on an “as needed” basis.

The G20 called for $6 billion of additional concessional resources from the Fund over the next 2-3 years for Low Income Countries, including some vague phrasing on money from gold sales. So far, the gold piece of this puzzle remains stalled at the level of the IMF’s executive board.  More transparency around board discussions on this and other items would reveal who is holding up change and for what reason.

Providing additional resources to low income is a very good idea, and increasing the resource flow from and through the IMF is timely and appropriate.  If these resources can come from “extra” proceeds from gold sales, that would be an attractive solution – particularly as the income model needs some adjustment in the light of (a) the increase in Fund lending over the past 12 months, and (b) the introduction of the Flexible Credit Line, which offers the promise of Fund revenue even during quiet times for the global economy.  However, it is too early to determine how profoundly the Fund’s income model will be affected by this crisis and how the world responds.

As long as the Fund lends at concessional rates to low income countries (and the relevant, Poverty Reduction and Growth Facility interest rate is only 0.5% per year currently), loans may be attractive relative to grants – the key issue is the resource flow that is available, i.e., does lending allow more transfers in a meaningful and sustainable manner.  Avoiding unsustainable debt burdens is of course of paramount importance.

Most important, we should take all available actions to shore up low income country defenses against this crisis.  We should also guard against any form of complacency.

For that reason, it is most important that the IMF be authorized to restore its budget to its early 2008 level (i.e., before the 15-20% across the board cuts were implemented).  Cutting the budget and letting go some of the most experienced IMF staff was the unfortunate result of gross macroeconomic negligence at the level of leading industrialized countries, including the US and its G7 partners.  At the same time as the IMF was warning, clearly and firmly, that a global crisis was developing, major shareholders pushed through budget cuts that resulted in some of the IMF’s best people leaving the organization.

Undoing the budget cuts would be embarrassing to leading European countries, but it should fine support from the Obama Administration – after all, it was their idea to make increasing IMF resources a central issue at the recent G20 summit.  The IMF simply does not currently have sufficient skilled staff to undertake all the important tasks it has been asked to handle.

The G20 summit effectively agreed to end the European monopoly on the position of Managing Director at the IMF.  Since the summit, there has been some indication of backsliding on this issue, but assuming that European countries can be kept to their commitments, this would be a major step in the right direction.  Given that the next leadership change is likely to take place in a little over a year, identifying and supporting sensible candidates from emerging markets would be most constructive.  If an Indian or a Brazilian, for example, could be brought in as Managing Director, that has the potential to greatly expedite the rebuilding of the IMF’s legitimacy and its engagement throughout the developing world.

Unfortunately, IMF credibility has been somewhat damaged by its inability to follow through on exchange rate surveillance, particularly with regard to China.  While there seems to be a movement towards implicit agreement among leading countries, in and around the G20, to take this issue of the table, that would be a serious mistake.  Countries must not think that competitive devaluation (or even sustaining accidental undervaluation) is a sensible or attractive policy.  This will lead to greater global imbalances and potential instability, as some countries compete to get current account surpluses and other countries – willingly or not – run deficits.

Unless and until countries are assured that there is an effective international lender of last resort, they will be tempted to try to accumulate large amounts of reserves.  This creates problems for reserve currency countries (e.g., the United States) as well as for the global system as a whole.  We need an international system that can handle these issues and prevent them from becoming destabilizing.  The IMF should be given another chance to show that it can help run the global system in a constructive fashion.  This is of paramount importance for the United States and for everyone who wants to participate in an open international trading system – particularly low income countries, which have few other opportunities to grow and which remain highly vulnerable to shocks of all kinds.

By Simon Johnson

Not so much.

On this side of the Atlantic, the Obama administration and the Fed have been working night and day in an attempt to turn around the economy: Fed funds rate reduced to zero, $800 billion stimulus package, new plan to aid struggling homeowners, new plan for buying toxic assets, new budget, decision by the Fed to buy long-term Treasury bonds, new domestic regulatory framework outlined this week, etc. We’ve been plenty critical of various aspects of the U.S. response, but at least they’re trying.

(Continental) Europe, by contrast, has decided they’ve done enough and it’s time to sit back and watch.

First, in an interview for Monday’s Wall Street Journal (no-subscription-required summary here), Jean-Claude Trichet, head of the European Central Bank, said that no new measures are needed to combat the global economic crisis. Then Mirek Topolanek, the prime minister of the Czech Republic and the president (in this rotation) of the European Union called the U.S. emphasis on fiscal stimulus “the way to hell.” And all of this is coming in the week leading up to the next G20 summit. What happened to diplomacy?

While it is relatively easy to write off a prime minister whose government collapsed on Tuesday night, there is a very real divide between the United States and, in particular, Germany, the heavyweight in the European economy. And it’s very clear that the Germans (and the French) do not want to spend more money, increase their budget deficits, or do anything except talk about international financial regulation.

I think there are three possible reasons for this attitude.

1. The Germans believe that the economy will recover on its own from this point. Given that not even the optimists in the Treasury Department believe this, I don’t see how this could be the case.
2. They are so afraid of any risk of inflation that they would rather suffer through an extended recession and high unemployment. This could be possible, although misguided, especially since Germany is already in worse shape than the U.S., with its economy expected to shrink by 3.8% this year (vs. 2.5% for the U.S.).
3. They realize that their economy is driven by exports, and therefore they are planning to free ride off of the U.S. stimulus package. In this scenario, Germany gets to contain its national debt and minimize the risk of inflation, while letting other countries turn the global economy around.

Now, we’re not blameless here, what with our “Buy American” provision in the fiscal stimulus. But at least our government isn’t closing its eyes and assuming the problem will go away.

• Disproportionately large banking sectors (the Iceland problem) in some countries, such as the U.K.
• High exposure to U.S.-originated toxic assets (up to 50% of those assets, I have heard estimated).
• Major exposure to emerging markets, primarily Eastern Europe and secondarily Latin America, which have been harder hit by this crisis than anyone else.
• Higher pre-crisis national debt levels (for many but not all countries).
• For countries that use the euro, no control over monetary policy.

On top of these structural problems, there is denial:

The IMF says European and British banks have 75pc as much exposure to US toxic debt as American banks themselves, yet they have been much slower to take their punishment. Write-downs have been $738bn in the US: just $294bn in Europe.

Finally, whatever you want to say about the inevitability of the decline of American hegemony, the U.S. dollar and U.S. Treasury bonds still play a unique role in the global economy, which probably allows us to take on more debt than other countries without crippling our economy through currency depreciation and high interest rates. Or, as Yves Smith puts it, “The nice thing about having the reserve currency is the US isn’t worried about that sort of thing…..yet.”

Update: Arnold Kling linked here, and added this great comment:

It’s been years since I read Steve Roach describe the United States as the “tallest pygmy” in world currency markets, and it’s a metaphor that just seems to always apply.

• Japan, in what looks like sign of desperation, announced a plan to buy shares directly in companies (not just banks) that are having trouble raising capital. The idea seems to be that, since companies are having trouble borrowing money from banks, they should get it from the government instead. This looks like a much broader and more direct intervention – deciding who gets capital and who doesn’t – than anything that has been contemplated in the U.S.
• Germany, the largest economy in the EU and one once thought to be relatively safe in the current crisis (as compared to the U.S. or the U.K., with our overgrown financial sectors), is now projected to see a contraction in GDP of over 3% (composite Bloomberg forecast) – but still struggled to pass a stimulus package of $65 billion – or 2.5% of GDP – over 2 years.  And despite an annual government deficit under 3% of GDP (ours is over 8% by comparison), the political pressure is to reduce the deficit and return to a balanced budget out of fear of inflation. This only highlights the tensions within the Eurozone between countries with different economic situations and priorities.
• The Institute for International Finance projects that net private sector capital flows (investments, whether direct investment, equity, or debt) to emerging markets will be $165 billion in 2009, a staggering 65% drop from 2008. Commercial banks are expected on balance to withdraw $61 billion from the region. As a result, regions such as Eastern Europe whose recent growth was dependent on foreign lending are likely to contract for some time to come, as companies are unable to refinance their debt.
• Robert Zoellick, head of the World Bank, estimates that the economic crisis has pushed 100 million people around the world into poverty.

One of the themes of this crisis has been that whatever problems we have here in the U.S., countries with weaker borrowing power, currencies, social safety nets, and financial sectors face much bigger problems. That isn’t changing.

In the meantime, The New York Times has some overview articles on a few topics we’ve raised recently:

• The role of Chinese savings in the bubble
• The collapse in Japan’s export sector
• Germany’s reluctance to launch a large stimulus package

In Argentina, we’ve already seen the government nationalize the private pension system in what many believe to be a naked grab for cash with only a distant relationship to the rule of law.

In Russia, a central government with a war chest of over $500 billion in foreign currency reserves (at least when the crisis started) now has the power to determine which of the billionaire oligarchs will survive and which will be bankrupted. Yesterday the government provided $2 billion (WSJ, subscription required) to the Alfa Group, Mikhail Fridman’s conglomerate, to avoid save him from giving up his 44% stake in a cellular carrier to Deutsche Bank. On Friday, another billionaire will have to come up with $4.5 billion to avoid giving up 25% of the metals company OAO Norilsk Nickel to Western banks including Merrill Lynch and Royal Bank of Scotland, and will likely turn to the government.

Arguably the government’s power in this situation is analogous to the powers the US has granted to the Treasury Department to choose winners in the financial sector. Still, given the other things we know about Russian politics, it is not too far-fetched to see government money used to protect Vladimir Putin’s political allies, impoverish his opponents or nationalize their assets, and keep Russian assets out of Western hands. (Whether the government will have enough money for the job is another question.)

Another likely reaction of governments faced by financial and economic crisis is a return to (or, in many cases, an increase in) protectionism. Richard Baldwin describes how the current state of global trade agreements makes this not only possible but likely, further hurting the global economy.

Finally, there’s (still) Zimbabwe, forgotten by the world, where power-sharing talks are still going nowhere.

1. The UK announced specific plans to recapitalize three of its largest banks – RBS, HBOC, and Lloyds TSB – with up to 37 billion pounds of government money. Separately, Barclays announced plans to raise money independent of the government. This seems to be the implementation of a plan that was announced last week.
2. Mitsubishi finally closed its deal to invest $9 billion in Morgan Stanley, gaining a 10% dividend on its shares (similar to Buffett’s investment in Goldman). This deal, which had been pending for weeks and some had given up for dead, will help boost confidence in Morgan Stanley. Note that unidentified sources have claimed that the US government promised to protect Mitsubishi’s investment; it’s not clear if that’s part of the final deal.
3. The Federal Reserve and several of its counterparts announced an expansion in the supply of credit to banks around the world in US dollars. The Fed said it will make available as many dollars as the other participating central banks need. They will then lend the money out to their banks against whatever collateral is appropriate under their rules. This is another move to increase liquidity in the financial system; however, for several weeks now it’s been apparent that liquidity alone is not enough to solve the problem.
4. Following yesterday’s agreement in principle, major Eurozone countries are announcing their rescue plans today, including both bank guarantees and recapitalization. Germany announced 400 billion euros to guarantee bank loans and 80 billion euros for recapitalization; France announced 320 billion for loan guarantees and 40 billion for recapitalization; Spain passed legislation providing 100 billion for loan guarantees and allowing the government to recapitalize banks by buying shares. I believe Italy is expected to make an announcement soon.

In summary, governments are taking the kind of steps that are necessary to halt the crisis. Loan guarantees and bank recapitalization are two of the steps we have been advocating. However, the jury is still out on whether they are coordinated and decisive enough. The much-followed TED spread (a measure of banks’ willingness to lend to each other) is only down by 7 basis points, although that may in part be due to the fact that the bond market is closed in the US today due to a holiday. All eyes are now on Washington, where a more definitive bank recapitalization plan is widely expected. Neel Kashkari, Paulson’s point man on the crisis, said today only that “We are designing a standardized program to purchase equity in a broad array of financial institutions.” (He said a lot of other things on a broad range of other topics.) Finally, this burst of support for wealthy countries’ banks could have unintended effects on emerging markets, as we discussed previously.

Update: Austria, the Netherlands, and Italy are also on board.

In Zimbabwe, site of some of the deepest suffering in the world today, Robert Mugabe reneged on a power-sharing deal with Morgan Tsvangirai and the opposition party. Sure, he might have done it anyway, but it’s a lot easier when the world’s attention is elsewhere and every major power has other things to worry about. We rarely comment on non-economic issues, but in hard times, you can watch for more and more behavior like this.

Please comment if you’ve seen other cases of politicians using the crisis as cover for things they might not try otherwise.

Feel free to comment with criticisms or suggestions.