Tuesday, February 3, 2009

Predictions from Nouriel Roubini and Ian Bremmer

Great Depression, World War II and Global Financial Crisis

Geopolitical risks would also become more severe if a U-shaped global recession were to mutate — because of mistaken policy responses — into an L-shaped stag-deflation (a deadly combination of economic stagnation, recession and deflation). After all, the stock market crash of 1929 turned into a Great Depression because of poor monetary, banking and fiscal responses. When the Depression became global, trade wars — starting with the Smoot-Hawley tariff — further contracted global exports and imports, capital controls became pervasive and defaults in emerging markets became the norm. Some similar risks are emerging today as countries become more protectionist and impose capital controls. Ecuador already defaulted on its foreign debt and others are teetering on the verge of a sovereign debt crisis. In the 1930s, the botched policy response and severe depression led to the rise of nationalistic, militaristic and aggressive regimes in Italy, Germany, Spain, Japan to name a few. The final result was World War II.

Today, the lessons of the Great Depression have hopefully been learned and a destabilizing L-shaped global stag-deflationary slump should be avoided. But monetary easing is weak in some regions and is less effective in the presence of insolvency/credit problems. Fiscal stimulus is constrained in many countries by previous high deficits and debts and cleaning up and bailing out the financial system is constrained by the “too-big-to-save” banks (i.e. losses in large, internationally active banks are much larger than the resources of small open economies to rescue them). And widespread and disorderly defaults by households, firms and financial institutions may follow a severe debt deflation.

Capitalism is not Dead

This is not a final crisis of capitalism and market economies. To paraphrase Churchill, market oriented capitalism is the worst economic system apart from the alternative. But the specific brand of Anglo-Saxon, laissez faire, wild-west, free market fundamentalism without prudential supervision and regulation of financial systems has been debunked. Central banks that are usually the lenders of last resort have become the lenders of first and only resort. And the new Keynesian Finance ministries have become the spenders of first and only resort, as private demand – consumption, residential investment, capex spending – is plunging

MNCs - No Longer Powerful

Globally, today’s leading multinational institutions — the UN Security Council, the IMF, the World Bank, etc — no longer reflect the true balance of political and economic power in the world

Global Financial Crisis - white Swan

The global financial crisis — missed by most analysts — shows that most forecasters are poor at pricing in economic/financial risks, let alone geopolitical ones. In normal times, markets are poor at pricing low probability, fat tail risks (black swan events), but the recent global financial crisis was a white swan event, as it followed a gradual build-up of predictable financial vulnerabilities that were ignored by most. But when the proverbial financial or geopolitical shocks hit,
the market over-reaction can become severe, as fear follows greed and markets tend to react in extremely risk-averse ways, replacing the denial and indulgence of good times with the extreme risk-aversion of bad times.

Protectionism - Reverse Globalization

Protectionist pressure will become more severe if the global economic slump is more protracted and deep. Certainly Doha is dead as multi-lateral trade liberalisation is impossible. Protectionist tariff actions have already started to emerge in places such as Russia and India and they may spread further. Trade-distorting subsidies are more likely than tariffs (see the rescue of Big Auto in the US). Currency tensions — for example between the U.S. and China — could escalate into trade wars. One also needs to worry about financial protectionism as a backlash against sovereign wealth funds and even FDI that may take place

What happens to BRIC countries?

This is the first globally synchronized recession and there are very few places to hide as the forces of recoupling shatter the myth of decoupling: first markets and then real economies have become almost perfectly correlated. Among the BRICs, Brazil and India are less affected than Russia and China, but even Brazil will suffer from falling commodity prices, shrinking export markets and an increase in investors’ risk aversion; thus growth may be barely positive.

India depends less than China on global trade flows, but it depends more on capital flows to finance a large current account deficit, and its’ banking system financed a credit boom with foreign liquidity that is now drying up.

A hard landing in Russia is unavoidable with growth being sharply negative (-3 percent or worse) if oil prices average $40 a barrel this year. For a country like China that needs a growth rate close to 10 percent to move 10 million poor rural farmers every year to the modern urban industrial sector, a drop to 5 percent growth or below (a most likely outcome) is effectively a hard landing. Since the legitimacy of the Communist Party depends on achieving high growth, I believe the hard landing that China will experience this year will have political consequences. Even when growth was 10 percent plus China had over 70,000 mass protests every year according to official records; with growth in the hard landing territory (actually likely negative in Q4 of 2008 and through the middle of 2009) protests will increase, especially as millions of migrant workers return to cities after the Chinese New Year to find that there are no jobs, and as millions of university graduate discover a challenging job market. So while the risk of a political revolution is limited, the more severe the hard landing, the more likely is the chance that the anger of the masses is converted towards the domestic authorities, rather than being channeled in a nationalistic and anti-foreign direction.

Urbanization of India and China - Next Drivers for Global Growth

The return to potential growth will imply rapidly rising demand from urbanizing and industrializing China, India and other emerging markets.

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