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Emmanuel Kayode
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My Name is Emmanuel Kayode. I am currently working at one of the large investment banks. I have a great passion for finance and world economy. I graduated from Towson University where I majored in Finance and with a minored in Economics. Besides from individual stocks, I'm very truly enjoy... More
  • Finding reason to the "new normal" 0 comments
    Oct 6, 2010 9:44 PM
    As part of PIMCO’s new philosophy about the “new normal”, one most ask themselves if the points they make are really worth noticing. Being that they are one of the largest firms in the bond market and having a steady and prestigious rap sheet, one must not take their points with a grain of salt. In a investment outlook on their website by founder and managing director of PIMCO, Bill Gross called “Alphabet Soup” he makes a great point into what is causing this slowdown in economic recovery and what needs to be done, in order to escape this “new normal”. He states that developed countries are over burden with debt to consider expanding their GDP and developing countries are too continuously exporting but afraid to borrow and consume, which is slowing down global economic growth. And he states that this is a problem because of a lack in aggregate demand, which I find quite fascinating and true.
    To first understand why aggregate demand is an issue in this instance, one must first understand the meaning of aggregate demand and relative change in aggregate demand. Aggregate demand can be described as a total demand in an economy for goods and service at a given price and a given time. It can be described as the sum of Gross Domestic Product (Consumption, government spending, investments spending, net exports). For this aggregate demand schedule to shift, a country must experience an increase in one or more variables in GDP. But in times of the “new normal” as PIMCO’s Bill Gross calls it, developed countries are experiencing low growth and developing countries are having insufficiently levels of consumption and are not growing fast enough, which is resulting in a void in aggregate demand.
    In the third paragraph from the bottom, he uses the analogy comparing developing nations to a “spindly-legged baby giraffe, having lots of upward potential but still striving for balance after a series of missteps, the most recent of which was the Asian crisis over a decade ago. And so they produce for export, not internal consumption, and in the process leave a gaping hole in what is known as global aggregate demand.”
    From the graph below, I will explain what he means.

    Measuring the standard of living and the quantity of consumption and net exports, in the past the global economy will be at equilibrium at point E, where demand meets supply. But, with the developing nations producing for exports, increasing the supply schedule, S*, and not internal consumption, they will be at point E*, making that the new equilibrium. But, for the economy to get to point B, the developing nations will have to start spending/ borrowing to increase consumption.
    But, as Mr. Gross states also then says “consumption when brought forward must be financed, and that financing is a two-way bargain between borrower and creditor. When debt levels become too high, lenders balk and even lenders of last resort”, then he says “despite the introduction of 3 billion new consumers over the past several decades in “Chindia” and beyond, there is a lack of global aggregate demand or perhaps an inability or unwillingness to finance it.”

    As shown on the graph, with the quantity of banks being constant and not wanting to lend and “bulking” and with growth in the population of new consumers, who probably would want to spend, face the high cost of borrowing, at i*, due to a disequilibrium between borrowers and lenders, which then reflects the lack of global aggregate demand and unwillingness to finance it.
    Though nobody can predict the future and can say whether this "new normal" will be really a new normal, I still believe it is something to keep in mind. Since there is still alot of uncertainty in the global market and countries looking out for their own self interest, it will be dificult to figure out a sound solution that can bring the market out of this inept times.



    Disclosure: no position
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