The world seems quiet. Sure, we have record job losses in the US, a likely decline in global trade for 2009, and what seems like to be a Great Leap Downwards for Chinese growth. But no one is quite as worried as they were a month ago, let alone two months ago. It feels, perhaps, like a “regular” global recession (albeit not something we have seen in 20+ years), in which growth decelerates markedly, but then we start to rebound in a timely manner.
Now, I’m happy to accept that as part of my current baseline view (and we will revise our forecast accordingly). But there are serious downside risks to this forecast, i.e., we could move again into crisis mode. The three places I look at on a daily basis for crisis-promoting potential are:
1. The US financial sector. There is still pressure around the insurance industry and some parts of the banking system will surely need more capital before too long. But the rather generous terms of the Citigroup bailout have reassured shareholders and the Fed is providing massive lifelines, we think, to the needy of any kind. And while the auto industry could still have an accident, most likely there is enough cash just around the corner to get them into February. Plans for a big fiscal stimulus have also probably reassured people to some (vague) extent, at least for the time being.
2. Emerging markets. Here the news is pretty bad and not as widely known as all that is wrong with US financials. In particular, I’m struck that many of the most perceptive analysts of China have clearly realized that growth has hit a serious wall, yet they feel unable to mark down their forecasts dramatically. I don’t know if this is more about not wanting to upset clients or the Chinese authorities (or the Chinese authorities who are your clients), but there is definitely cognitive dissonance afoot. Still, with the oil market taking a long hard look at $40 oil and thinking about the lack of likely technical resistance at that level, I rather suspect that the broader commodity sector has seen through the Chinese Veil. Still, crisis is about discontinuity and default, and there is real potential for some oil producing and commodity exporting countries to run into serious payments problems. No one has yet thought enough about some of these far-flung places (no names please) and their interconnections with the rest of the global system.
3. The eurozone. This is where the crisis potential really lies (no change from last week). The credit default swap spreads say there is danger ahead for Greece, Ireland, Italy, and – if that is true – for others also. This is a classic fiscal problem pure and simple, although it is the macro hedge funds who are sounding the horn – saying it is time to go hunting (remember: as liquidity returns to the core financial markets, it becomes easier to take big negative bets). These eurozone sovereigns have a great deal of debt and this debt is not in a currency they control – ironically, through joining a currency union they created a potential emerging market situation, in which a national strategy of moderate inflation and depreciation is no longer an option and debt burdens must be dealt with through painful fiscal adjustment. The real crisis, however, arises from the fact that almost no one in Europe – and definitely no officials – either see this coming or are willing to take any action to head it off. Note that while the ECB has begun to cut interest rates, as we recommended in October, no one in Europe feels it is their job to take on the broader systemic issues that we emphasized need to be dealt with at the same time – in complete contrast to the situation in the United States (at least as the Obama team becomes seriously involved).
As we have seen time and again since mid-September, what really leads to serious crisis is denial. There is not much denial left in the US (although watch this space for any update to that) and there is no much I could tell you about, for example, Russia that would really shock at this point. But suggesting the idea that a serious sovereign credit problem looms in Europe is enough to make me quite unpopular with some of my current and former colleagues.