Is This A Crisis Or Just A Recession?

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.

11 responses to “Is This A Crisis Or Just A Recession?

  1. Ashish Srivastava

    I am yet to see any major article from you about the falling commodity prices, esp oil prices. I agree sharp drop in oil price has ease the pockets of many, but no one can deny that this trend could lead to a major fuel supply shortage in the future. What do you think the overall affect would be and what would you suggest to curb this problem? Do u think production cut by OPEC is a solution?

  2. I am surprised to hear that some are not as worried as they were a month ago. I am just beginnining to see the real manifestation of the crisis. I now know people who have lost their jobs and some who are facing bankruptcy in the next few months. They cannot find other jobs and they cannot sell any assets to raise money. Local retail businesses are staffing checkout lines with managers rather than hourly employees. All of these people are spending much less which will feed more job loss.
    I am not much of a macroeconomic thinker, but on a microeconomic level many people are scared to death.
    Thank you for this website and your webcasts. They are great and very helpful.

  3. In my 58 years of life, I have never witnessed a response to an economic crisis like the one we are seeing today.

    Central banks are seriously cutting interest rates. Just this past week, Bank of England cut their rate to 2% from 3%; the European Central Bank cut their rate from 3.25% to 2.5%; and the Swedish Riksbank cut their 3.75% rate to 2.0%. This month the Fed will likely cut their rate to 0.5%. Perhaps more dramatic is the fact that the Fed is now expanding the money supply through the use of “quantitative easing” measures.

    The effects of such measures will clearly lag by a few months. But eventually the actions of the central banks will have a dramatic effect.

    On top of this there are very large stimulus programs being proposed and implemented in a number of countries. China has said it will pour over half a trillion dollars into its economy as a stimulus. It is possible the Obama stimulus will be over $700 billion.

    The response of governments around the world to this crisis is unprecedented. The strong fiscal and monetary responses will absolutely have a dramatic effect in the next 6 to 12 months. It would not surprise me if the recession ends in this country by the middle of next summer.

    If this financial and economic crisis has demonstrated anything, it is that governments around the world are capable of working together and taking strong measures to support the global economy.

  4. Yes, joint response (from global central banks and governments) to this crisis will definitely show some improvements over next few months.

    Question: Is it going to be V shaped recovery (since we have so much easy monetary policy around the globe) or is it going to be sluggish recovery?

    Some points I was thinking about differences between last downturn and this one: During last recession (2001), banks were not in bad position, money was available cheaply, real estate looked cheap etc. But this time, it seems banks will be much more careful in lending (and there will be more regulations as Obama promised today)…

  5. “There is not much denial left in the US ..”

    Aren’t we still in denial about the counter-party risks associated with the CDS market? Why doesn’t anyone talk about GM in terms of the outstanding swap risk if they default (with the exception of econblogs)? Seems to me people must be thinking about it, but are refusing to talk about it. Don’t we have lots of zombie-shell-companies (and countries) who won’t be able to survive the down cycle, and whose losses in default could be insanely magnified by the derivatives black hole?

  6. It would not surprise me if the recession ends in this country by the middle of next summer.

    Whew. I’ve had the same thought (I was thinking later than summer 09 though) but worried I was crazy to be so optimistic.

  7. fearAndTrembling

    Let me just say upfront, I am woefully ignorant with regards to macroeconomics, so anyone who wants to argue that I have no business putting a dog in this fight has got a pretty good case. But I do have an interest in language, and I can’t resist commenting here because what I see happening in this post captures my own frustration with the discourse that surrounds the current financial “crisis.” (I confess that as an amateur, I can’t fathom it as anything other than that.) It is as if there are only two ways in which the current economic situation can be thought about. It is either a crisis of immense magnitude–and the shorthand for that in the mainstream media is of course the Great Depression, which, blissfully, is not explicitly mentioned here–or it’s not. If it’s the former, be afraid, be very afraid. If it is the latter, it’s move along folks, back to Christmas shopping, nothing to see here.

    It may be that this kind of “binary” analysis, as it were, is called for, because it simply accurately reflects what is happening. It is in fact either the Great Depression or something else, significantly less worse, and there is no other way to talk about it.

    And yet, from the perspective of economic innocents like myself, this mode of analysis just seems under nuanced, both from a personal and public perspective. From the personal perspective, at the age of 56, I have seen more than a third of my retirement savings disappear. I feel fortunate to be employed as a programmer in a job that is almost certainly counter cyclical, but I am terrified of losing it. From a public perspective, all three American auto companies are in a state of collapse, the state of California, the world’s eight largest economy, is in very real danger of defaulting and making plans to pay vendors with IOU’s, virtually every state government in the U.S. is running a deficit, and the Fed is doing things that none of us have seen done in our lifetimes. Whether it is the Great Depression redux or not, it is, to my way of thinking, a crisis, and even then, assuming for a moment it is a “crisis” and not a mere “recession,” viewing it through the lens the 1930’s just does not help very much, because the effects might be just as serious and yet manifest themselves in quite different ways, at least in terms of their impact on the details of ordinary life.

    It seems as if we are all suffering from a sort of economic “Katrina” effect. If it is not a category 5 hurricane that slams into the continental United States and destroys a major city, not to worry, unless of course it is a mere cat 3 and flattens your house in Galveston. But of course from the point of view of a person who lost a house in Galveston and that of one who lost a house in New Orleans, whether it was was a category 5 storm or a strong category 2 storm, whether it was a “crisis” or a “just a recession,” really does not make all that much difference.

    But all carping aside, I second the notion from a commentator above that the website and webcasts are fabulous. Thanks much, Simon, for all you are doing.

  8. Pingback: Sunday links: dump last year’s folly « Abnormal Returns

  9. Nice to know that I’m not the only optimist in the world. Maybe too early, but noticed a lot of footage from the Great Depression on television.
    Deflation was the “dot com” of 1930-1933. Cash in the mattress generated 10% annualized returns for 3 years. Think of it as the 30’s version of pets.com.
    Some of the supposed virtues of that decade were simply nostalgia for a winning speculative strategy. National Bank of Sealey
    We have a Fed chairman who wrote papers on how that wasn’t going to happen again. He is backed up by hedge fund managers running the Treasury. How can anyone believe that hoarding cash is going to be a winning strategy?
    I am starting to believe that what we may be facing may be as monumental as the GD years, but it won’t be simply a rerun. One ugly little secret of the GD was that there were more then a few winners that managed to keep a low profile as their incomes bought 1/3 more and their relative status improved.

    Factoid: The latest COLA is 5.8 percent for Social Security benefits and SSI payments. Social Security benefits will increase by 5.8 percent beginning with the December 2008 benefits. So, if we had a 10% decrease in the CPI, would retirees have 15.8% more real income?

    Nothing is impossible, I suppose. But I would find a resurgence of pets.com less surprising.

  10. I’m pleased you are optimistic and I do hope it is contagious. Here is a cumulous from london….

    http://missmarketcrash.blogspot.com/2008/12/whither-thou-goest.html

    kind regards,

    MissMarketcrash

  11. What about the potential for a trade war between the US and Japan or Europe over automobiles? If Congress bails out GM and it starts producing hybrids for 15 to 20 thousand dollars what will be the response?
    Or is it possible that Congress can be involved in the production of a cool car?