Economic outlook
Editorial
Tomorrow never dies
It is always useful to take stock of what we managed to anticipate correctly in making previous decisions – and whatwe did not – in order to improve the decisions we now have to make. Let us thus go back a year, to June 2008, when we wrote: “We now expect the shockwaves to spread through the entirety of business and household financial markets: the spread of the crisis of the real economy via the restriction of credit in spring 2008 has been only the beginning. When a credit crunch commences in one given market – in this case, construction – economic history teaches us that it often blindly spreads to the others… The stage is set for Act II of the financial crisis of 2008.” Re-reading these lines now seems strange, remembering that,when they were written, very few in Europe were anticipating an economic crisis.
It is also strange to again take up our analysis –which has shown itself to be correct about the events that followed – with the descent into record recession across the entire OECD, the indeed unpredictable shocks that followed the collapse of Lehman Brothers, and the near-halving of world automobile production. But, as modesty demands, we should also point out that the blows that rained down over the past year have exceeded anything that we predicted.
Still, we can draw at least one lesson from looking back: that,when we opt for rationality and realism, we have good chances of getting close to the truth of events. So, from a rational and realistic perspective,what can we say about the future? Well, what is irrational is the current wave of unfounded optimism propagated during the months of May and June on world stock exchanges and reflected in confidence surveys: after the historic turning point of the 2009 crisis, how can one believe that everything could carry on as it was before? Rational thinking demands we admit that the profound structural problems at the root of this crisis – essentially, the issuing of credit on a scale unjustified by the productivity of economies – remain unresolved, and that redesigning the systems, balances and controls involved will clearly take a long time.
Realism also calls on us to consider that, after the absolutely unprecedented shocks undergone in the fabric of the global economy – in supply aswell as demand, in credit as well as savings – economic stability will take a long time to achieve , but that by necessity it will come. In concrete terms, it is likely both that the worst is behind us but also that we are entering into a period of convalescence, during which growth is likely to recover only weakly, and only in certain parts of the world – those which have opted formassive and immediate recovery measures, i.e., the US and China. The economy is not simply a matter of psychology: it is best to face the facts and avoid being lulled by a few harbingers of spring.
Businesses need to take decisions now: those that do so with realism and caution up to summer 2010 will do better than others in seizing all the opportunities that come and will emerge stronger from this long economic freeze. Tomorrow never dies, but we could be in for a long night.
Karine Berger
Source: Euler Hermes Economic Outlook, Summer 2009
On Atlas’s shoulders: a world of information
What would happen if Atlas, the legendary Titan of Greek mythology who bears the globe on his shoulders, were to shrug his shoulders and drop his burden? The question is a legitimate but also disturbing one, given the global economy’s continuing descent to the depths. In just a few short months at the end of 2008, turnovers fell by as much as 10%, 20%, or even 40% for some companies. This year will bring even worse. We continue to think that recovery in 2010 remains the most likely scenario, given US and Chinese budget and monetary plans. But there is no doubt that the recovery will be slow, fragile, and difficult. And this is because, this year, for the first time since the Second World War, world growth will be negative, and manifestly so. Moreover, the exceptional gravity of the shocks being felt means that we cannot rule out that other possibility: that of a triggering of deflation in the OECD countries next year. This is not the most likely outcome, but it is not beyond the realms of possibility.
At such an uncertain juncture, what is the right stance to take? As a credit insurer, we have a responsibility to stem the coming – and indeed already rising – tide of claims and insolvencies. We also have a responsibility to ensure that the security of commercial exchanges is guaranteed, and that forming accurate judgements on the situation of economic agents continues to remain possible. In this current shock of 2008-2009, more than in any past crisis, information plays a critical role. During an economic crisis, one of the key mechanisms of its amplification is a shortage of accurate information about the various economic agents. To use the technical terms, I refer to here to the risks associated with ‘adverse selection’ or with the ‘principal-agent problem’ (the ‘agency dilemma’). Broadly, because the risk of non-payment strongly increases, and because accurate information gets harder to obtain, bad allocation decisions are made, further worsening the recession…which, in turn, engenders further bad decisions. And so on. In the current situation, whether the crisis is accelerated or, alternatively, whether it is eased, will much depend on the extent of reciprocal information sharing by economic agents and the level of confidence they hold in one another, in particular concerning the scale of latent unpaid debts in their bank balances. The role of the credit insurer is to calculate commercial risks down the last decimal. In the past year, commercial risk has increased by a factor of two or three, irrespective of the initial situation of the businesses concerned. We need to be more selective in order to eliminate the risk of adverse selection, that is, the risk of overreacting to the crisis. This is a difficult, but necessary, balancing act.
In February, The Economist published delayed and disturbing statistics, showing the correlation between sales of novelist Ayn Rand’s US best-seller Atlas Shrugged and announcements of recovery programmes. There is a good correlation between them, for at least two reasons. First, Rand was a long-standing friend of former Federal Reserve chairman Alan Greenspan, and there were rumours that his decisions were highly influenced by her book. Economic actors hoped to find the solution to the crisis in its pages, and, more pragmatically, which sector would be the next to collapse. The second reason is that the book tells the story of the collapse of the US economy, sector by sector, and state by state. It tells us how, one day, Atlas decides to shrug his shoulders. But what is the identify of this Atlas, whose action spells the undoing of the world economy? For the answer, I leave it to you to read the story of Dagny Taggart, the main character in Rand’s novel.
Karine Berger
Source: Euler Hermes Economic Outlook, Spring 2009
Which pumps to prime?
It only lasted a few hours, and, in all honesty, it was a matter of just a few basis points.
But all the same, in the week of December 10, at a time when the Federal Reserve had yet to make its spectacular decision to opt for a zero interest rate policy, US three-month treasury bills for the first time in history posted a negative yield! US monetary policy was at the brink of the unthinkable in this exceptional financial crisis. The governors of the Federal Reserve, after having fixed their lead interest rates in a range between 0% and 0,25% on December 17, have no more room for manoeuvre on the interest rate front. And, by undertaking an unprecedented increase in Fed holdings via the acquisition of illiquid or even risky new assets (e.g.,mortgage obligations, for example), it has also significantly reduced its scope for future action.
Admittedly, quantitative interventions remain possible theoretically. But using interest rates for balancing financial markets and especially for shaping expectations is no longer possible. Do we need to be reminded that this kind of monetary policy turned out to be a one-way ticket for the Japanese economy in the 1990s? Of course, this new American experiment has been weighed and calculated in light of, and informed by, the Japanese experience. Even so, many observers see this as a leap into the dark. This is all the more the case given that there remains really not alternative means of priming the pump for the world economy. US monetary policy now finds its hands tied, while American budget policy is chained to some very heavy balls. Public debt in the OECD countries is mushrooming, raising serious concern over the actual efficacy of the many recovery plans announced in December. These are the equivalent of 5% of GDP in the US (against debt of 60% of GDP), 1.5% of GDP in Germany (with debt of 65% of GDP), and 5% of GDP in Italy (with debt of 104% of GDP).
This winter it has become fashionable to re-read the great John Maynard Keynes. Also worth reading is Barro (‘Are Government Bonds Net Wealth?’, Journal of Political Economy, 1974): the Ricardo-Barro equation says simply that debt cannot mount in unlimited fashion, and that all public debt is at the expense of private debt, i.e., that beyond a certain level of debt, recovery is no longer possible. This means that, no matter how we eventually manage to restart the pump, the profound imbalances of the OECD economies will not be reabsorbed. Private and public agent indebtedness is scaling historic peaks, and it is extremely probable that a slightly hasty exit from the global crisis will conceal a shift of bubbles from certain markets to others. What the present crisis is questioning is the very economic growth thatwe have enjoyed for the past ten years.
Undoubtedly, despite painting ourselves into monetary and budgetary corners, We will manage to restart the economic pump, but without having answered the
initial question posed by the crisis of 2008-2009: exactly which pump should we prime?
Karine Berger
Source: Euler Hermes Economic Outlook, Winter 2008-2009
2008 – the year of living dangerously
With the end of summer 2008, storms are battering world stockmarkets like the hurricanes lashing the coasts of America. After the US Treasury rescue of FannyMae and FreddieMac, and especially after the grant of Chapter 11 protection to investment bank Lehman Brothers – founded 160 years ago – all the facts that seemed to slightly ease concerns over the summer are nowforgotten, and 2008 is nowwell and truly the year of living dangerously on the financial and economic front. Admittedly, commodity prices, and in particular oil prices, have started to ease, but, for themoment, they continue to fluctuate around levels never seen prior to 2008. Also admittedly, the US situation has seemedmore
favourable,with growth of 1% in the second quarter of the year, but this upturn is explained in very large part by export price competitiveness gains related to the fall in the dollar against all other currencies. Over the whole of 2008, more than three quarters of US growth will come from the contribution of foreign trade, and it will be impossible for theworld’s leading economy to repeat this performance next year.
At the same time, the spreads applied on lending to businesses (i.e., the premium over government bond rates that large companiesmust pay in order to raise finance on the markets) have not stopped increasing, demonstrating the genuine blockage in investment finance, affecting even very large global businesses. And at the beginning of September, the bankruptcies on the part of financial institutions in the US and of major world industrial or services companies have shown, rather, that the worst is yet to come. The euro zone outlook is now a cause of increased concern following its results for the second quarter, during which overall domestic demand in the zone contracted. The European economies have thus moved into tune with the US crisis since spring, and the preliminary figures for the summer period suggest that this situation is not improving. The economic crisis will continue to spread on both sides of the Atlantic over the course of the autumn, first in the construction sector, also via the financial crisis in credit markets,which undoubtedly has yet to claim all its victims, and lastly with the crisis in consumption, durably traumatised by the explosion in prices of some weeks back.
In this context, the economic policy responses planned by various OECD countries offer food for thought: it is during the autumn that most governments complete their budgets for the following year, and wherever they can – that is wherever budgetary lee way resulting from good management in previous years permits – governments have opted for recovery policies. It is noted that the United States, Spain, the United Kingdom, and undoubtedly Germany, are all ready to inject not inconsiderable sums into their economies in order to avoid recession. What do these four countries have in common? They all returned to a balanced budget in the course of the last four years. By contrast, France and Italy find themselves blocked: with their public finances mired in debt that kept rising even during the years of economic growth since 2003, both countries are bound hand and foot in the face of the economic downturn and the upheaval in the financial markets.
Karine Berger
Source: Euler Hermes Economic Outlook, Autumn 2008
A little reminder of the 1970's
‘Oil shock’ – the very phrase seems a little old-fashioned, or at least ‘retro’, so long has it been since we last experienced one. But hearing it again now, thirty years on, the old memories come flooding back – the global redistribution of wealth, the ineffectual monetary policies, the drive to save energy – all brought back to mind by those two words, themselves a sort of Proustian reminder, redolent of oil and the 1970s.
We had forgotten, first of all, that an oil shock is above all a violent redistribution of the world’s wealth, from those who use oil to those who produce it. To give an idea of the scale of this, the rise from $73 a barrel last year to an average of a little over $120 a barrel this year corresponds to the sudden transfer of $620 billion from the major net importing countries to the major oil exporting countries. This calculation, based on 2008 alone, needs to be doubled if we are to gauge the latent shock that has been developing from2003 onwards. Overall, it works out to around 2.4% of world GDP, which, since 2003, has changed hands simply because of the rise in the price of oil. For the record, the oil shocks of 1973 to 1980 represented a transfer of 1.9% of world GDP. Another thing we had forgotten is that the initial shock always gives rise to multiple international macroeconomic shocks.
First, the general equilibrium in current account balances obviously gets called into question. However, the OECD countries are not necessarily the ones that suffer the most damaging effects: wealth transfers also occur between developing countries, and to an even greater extent today than thirty years ago. Among the ten biggest net oil importers, we find China, India and Taiwan. China, the third biggest net importer, is seeing its much-heralded external surplus trimmed by $60 bn, or 1.4% of its GDP. Naturally, the question of the dollar pegging of currencies of some producer countries, for example Abu Dhabi, is equally called into question.
Second, inflation is revived. Even if the shock is not quite on the same scale on opposite sides of the Atlantic, the euro zone being partially shielded by the high level of the euro, the effects are still very similar on consumer prices, up by 4% in the euro zone in June, and by 5% in the US in the same month. Undergoing, thus, a fairly similar shock, the consequences are identical: in the US and the euro zone alike, household consumption is floundering at its lowest rate of growth seen for a decade. This sudden shortfall in domestic demand is what is sending growth to around zero – in the US, in France or in Italy alike – in this second half of 2008.
Third, serious uncertainty surrounds the state of business profitability: the supply shocks of the 1970s gave way to several years during which production was restructured across the world, notably in industry. Still, this second chapter of the 2008 shock has not yet been written. And, in the face of all these more or less confirmed outcomes, there again arises the issue of energy independence: thirty years after the first campaigns to save energy, the landscape of oil dependency is extremely diverse, notably in terms of the choices made to either pursue or forego nuclear energy.
France, which has taken the former route, has assured itself 50% self-sufficiency in energy. Among its neighbours, the figure is only 18% in the case of Italy and less than 40% for Germany. These great differences could well determine a large part of the economic future of each of these economies.
Karine Berger
Source: Euler Hermes Economic Outlook, Summer 2008
Euler Hermes Group
