The Perfect Storm: Heading Toward Global Recession

The financial ills that began in August 2007 metastasized sometime over the past few months into an economic contraction. The exact moment is unknown, but there's no mistaking the trend now. The only question is whether the global economy overall will suffer a recession. The risk is rising by the day, largely because the developed world is already in a slump. If the emerging markets succumb too, the next few years will be quite difficult, perhaps more than is generally expected.

The IMF forecasts that the advanced economies will contract by 0.25% next year (see chart below). If so, the downturn would mark the first fall in the developed world's real GDP pace on an annual basis since World War II. The good news, or so the IMF advises, is that a rebound will commence sometime in late-2009 and that emerging markets will still expand by respectable if no longer spectacular rates.

In the meantime, the U.S. has already reported a dip in GDP for Q3 and more of the same looks likely. The sharp drop in October's retail sales, as reported on Friday, is the statistical poster child for expecting a string of negative numbers in the coming quarterly GDP updates here.

"Consumer confidence is beleaguered," Bill Martin, CEO of ShopperTrak, a Chicago-based retail analysis firm, tells The Christian Science Monitor. "There is no good news to look for anywhere. People are just squirreling away money."

That's an especially pernicious problem for U.S. economic activity, which is heavily reliant on consumer spending. The challenge is only compounded by the ongoing real estate correction, rising unemployment and similar ills now swirling throughout the globe. Can you say perfect storm?

Japan has now joined Germany among the developed world's recession club. It's only a matter of time before we have confirmation of the eurozone's slump.

If there's any hope for moderating the cycle's worst effects, it comes from so-called emerging markets, and that means that domestic demand in these nations will prove resilient in the face of global headwinds otherwise. It's not clear that this outcome will survive reality, but that's the best-case scenario and for the moment many analysts subscribe to this view.

As we write, there's still statistical support for expecting China (to cite the obvious example) to beat the odds. And the good news is that it's still growing. Optimists say that the Middle Kingdom's GDP will continue rising even in the face of recession in the developed world. The current IMF forecast for China calls for growth just under 10% this year, falling to 8.5% in 2009. That's well below the sizzling 11.9% logged last year, although for China the moderating outlook has already triggered plans for a massive fiscal stimulus in an effort to keep the party going.

Overall, IMF expects emerging economies to grow 6.6% this year and by 5.1% in 2009. That's slightly lower than forecasts from only a month ago, and the current projections may be downgraded yet again. If so, that's a distressing prospect for the advanced economies. As emerging markets' fortunes fade, the pain will be that much greater for the developed world because of its weakened conditions elsewhere. The world economy has relied in no small measure on emerging nations in recent years. If and when that source of demand gives way, the already sober outlook for economic activity will take a further hit. The potential for a self-reinforcing negative feedback loop isn't easily dismissed. As such, watching events in China, India, Brazil and other developing nations has greater import than ever these days.

To be sure, governments around the world are hardly standing idle. Monetary and fiscal levers are being redirected in a new war on minimizing the cyclical pain that is now everywhere. Results are still unclear, although the effort promises to be massive in a collective sense. If the stimulus fails, it won't be for lack of trying.

Yet even if the coordinated plans of governments work as expected, there's no avoiding the economic pain that awaits. The correction is here, it's taking a toll and the best to hope for is that monetary and fiscal policies will lessen the bite. But for the foreseeable future, the world must live with diminished expectations. The macro context is everything at the moment, and it promises to dictate much of what happens for some time. Escaping the wrath of betas, if you will, will prove difficult for investors and everyone else.

Comments

[johnnywalker:]

Small and probably irrelevant point: what you describe is a positive feedback loop, not a negative feedback loop. "Positive" and "negative" refer to the response of the system to a stimulus. If the system responds in the same direction as the stimulus, it is "positive". If the system responds in the opposite direction, it is "negative."

2008 Nov 17 12:12 PM

[Pipo:]

Despite all the doom and gloom Jim Rogers said yesterday in London that he was buying into this. He is usually right.

www.jimrogers-investme...

2008 Nov 17 01:39 PM

[jepittman:]

My initial reaction to this is 'if this is news to anyone, where have they been for the last six weeks?'. How easy was it to write this? In my experience the easy trade is usually wrong and the best trades make you want to throw up.

2008 Nov 17 02:52 PM

[aarc:]

Stock markets are leading the economies of the world into recession with the uncontrolled meltdown we have had over the last 2 months. Even China was not spared by the Shanghai index meltdown despite a 9% economic GDP. This in turn forced the hand of China leaders to initiate a $600B stimulus and are starting to consider govt stock market intervention to halt the Shanghai and Senzhen indexes meltdown. The US will need $2T to match China's stimulus package with the difference that China still has a vibrant local economy while the US economy is already in the sewer.

Stock markets are not going to reverse the trend while the economy remains weak. Likewise, the economy is not going to recover while the stock market keeps on plunging.

What is needed is for a govt such as China, Japan, or France to act as stock market guarantor of last resort in order to prevent a potential global stock market meltdown. Govts have the initiative to offer such guarantee since tax income will keep on diminishing as the their economkes plunge into an unknown abyss.

US govt is still dysfunctional and not in a position to initiate such program unless Paulson use the remaining $450B TARP (with tacit Congress approval) as cash reserve for such program. $1.5T of cash reserve or more may be needed to guarantee at least $30T of stock market capital. $2.5T if the stock market is to be restored to prestine condition of $50T.

Once a country's government started guaranteeing investor capital investments; other countries are going to follow in a hurry. China may not even need $300B cash reserve to guarantee their tiny stock markets. A vast majority of Chinese are not investors but rather bank savers.

After all, capital investment is the lifeblood of a country's economy. Without fresh capital, no economy will be able to grow, much less reverse the downward trend. With a guarantee program; both the stock market and the economy will reverse direction toward growth with no delay. Company bankcrupcies will be reduced to the bare minimum. Employee retrenchments will stop immediately and investors' and consumers' confidence will be restored.

Two possible solutions preferable done in tandem or one after the other:

1. Gov't to guarantee investor stock market purchases (both common and preferred shares) against company bankcrupcies for 5 years but would require investors to hold the stocks for at least 2 years.

This will not be limited to institutional investors but to all investors including company employees 401k and moms and pops. Remember, more than 50% of US population (and most other developed countries) have direct investments into the stock markets. In effect, the stock markets have become the depository of American savings instead of the banks.

2. Govt to guarantee institutional as well as big private investors' capital investments into troubled but solvent companies for 10 years with minimum 5 years holding period at face value. This will prevent solvent companies with liquidity problems to be able to survive and prosper. Insolvent companies will be allowed to fail unless their failure will cause the failure of the entire guarantee program.

Govt must install a mechanism not only to prevent but to arrest stock market volatility from rising with a maximum allowable percentage of stock price guarantee per day during the first few months of buy-back program which could be from 3 months to 5 months. Allowing only maximum guaranteed price increases of 3% per day during the first few months and 1% per day for the remaining months. Stock market prices will be allowed to fluctuate freely, only that the guaranteed amount will be restrained.

Lets face it; govt is already guaranteeing almost everything under the sun with trillions of dollars to no effect. Direct intervention into the stock market by govt buying stocks is not the business of the government - it is the business of the investors.

It is the business of the govt to restore investor confidence by giving them at least a minimum guarantee for their capital - making capital investments at par value with savings.

Direct capital infusion to existing businesses by investors is going to provide immediate economic results.

Banks using population savings to invest into potential business enterprises will take considerable time with the banks already in trouble as it is. Banks are not in the right position in order to revive the economy - investors do.

What the government can do is prevent bank failures and at the same time utilize investor capital to prevent systemic failure and to start reviving the economy.

2008 Nov 17 03:05 PM

[Jason Rines...:]

Your idea AARC is similar to my own except the idea I have is more specific and involved the Small Business Administration that guarantees half the loan from a regional bank willing to provide a loan to a small business. The advantage of the SBA is that it has offices in almost every town across America and a tremendous amount of intellectual capital directly and with retired, successful volunteers to boot. Here is the problem:

Those with these kinds of common sense ideas are not 'known' in our chronie capitalist society we are living in. Hence, such idea will only be listened to when the system has already collapsed. Sometimes, you just can't avoid our frail human nature without pain being a wake-up catalyst. Nor was this idea new here on SA, it was sent to President Bush in 2007 and confirmed as read. I fear the Obama Admin will also be prone to corporate chroniesm with Clinton appointees, whom inherited the Internet boom, a Real Estate boom and avoided the face of terrorism which requires expenditure of blood and treasure. The best this crop of government can do at this point is likely to not louse it up further. I do hope I am dead wrong.

2008 Nov 17 04:02 PM