Monday, December 15, 2008

Anni Horribili-- 2008-2009

Annus Horribilis Peaks In Anxiety For Global Economy

By Rich Miller and Simon Kennedy | 15 December 2008

Dec. 15 (Bloomberg)— This was the year the global economy fell apart. Next year may not be that much better, as policy makers try to put the pieces back together[!?!] [[I think he means, continue to put fingers in the dike to keep it from collapsing. Trying "to put the pieces back together" is still a ways off yet!: normxxx]]

All the bulwarks crumbled: Investment banks went bust and credit evaporated. U.S. consumer spending crashed, pushing Detroit automakers to the brink of bankruptcy. And growth in China and other emerging markets nosedived.

The world economy has
"suffered a cardiac arrest," says Mohammed El-Erian, co-chief executive officer of Pacific Investment Management Co., the Newport Beach, California-based manager of the world’s biggest bond fund.

The damage is so immense and widespread, the most that central banks and governments can hope for next year may be to stop further deterioration and set the stage for recovery in 2010. Failure may heighten the danger of deflation and near-depression.

"We will be very lucky if we reach the bottom in 2009," Harvard University professor Martin Feldstein said in a Bloomberg Radio interview Dec. 9. The trouble is that policy makers have already taken significant steps to combat the crisis— from cutting interest rates at an historic pace to committing hundreds of billions [[TRillions, actually: normxxx]] of dollars to battered banks. So far, they’ve failed to quell the turbulence in the markets or turn their economies around.

That’s prompting officials to dig deeper into their 'tool' boxes. Investors are betting that Federal Reserve Chairman Ben S. Bernanke and his colleagues will cut the overnight interest-rate target to a record-low 0.5 percent or less at a two-day meeting that began today. The Fed may also discuss other unorthodox measures beyond rate cuts, such as buying [[longer term: normxxx]] Treasury securities, to get credit flowing.

Pushing The Limits

With monetary policy pushing the limits of what the central bank can do, incoming President Barack Obama pledges "the single largest new investment" in roads, bridges and public buildings since Dwight D. Eisenhower’s administration a half-century ago, in a bid to trigger growth and create jobs. The government is essentially trying to save capitalism from the capitalists— something that can’t be accomplished quickly. After piling into risky assets, from subprime mortgages to junk bonds, investors and financial institutions have turned tail and are reluctant to lend even to creditworthy borrowers.

"The financial markets have frozen up entirely," says Barry Eichengreen, an economics professor at the University of California at Berkeley.

Breakdown Trigger

The trigger for the breakdown was the bankruptcy of Lehman Brothers Holdings Inc. on Sept. 15 [[which egregious error should be chiselled on Hank Paulson's tombstone: normxxx]]. The decision by Treasury Secretary Henry Paulson and Bernanke to allow Lehman to fail— after rescuing Bear Stearns Cos. and mortgage lenders Fannie Mae and Freddie Mac— shocked investors and financial firms and led to an abrupt contraction of credit worldwide [[and probably the worst six weeks in the credit and stock markets on record, as Wall Street vainly tried to "disentangle" Lwehman's many financial commitments and obligations: normxxx]].

That has left governments and central banks to fill the hole by investing capital in banks and guaranteeing their liabilities, and in the U.S., providing a backstop to the $1.7 trillion commercial-paper market companies rely on for daily funding. "Letting Lehman fail was supposed to restore market discipline by showing that not all large firms would be saved," says Dino Kos, a former senior Fed official and now a managing director at Portales Partners in New York. "Paradoxically, since Lehman, everybody has been bailed out, everybody has been 'saved' or merged out of existence with taxpayer help."

Abrupt Shift

The abrupt shift from greed to fear has turned the economy on its head. The U.S. Treasury last week sold four-week bills at an effective zero-percent interest rate— even as it announced that the government’s budget deficit swelled to a record $401.6 billion in the first two months of this fiscal year. The U.S. stock market has plummeted, wiping out $7.6 trillion of investor wealth, with the Dow Jones Wilshire 5000 index dropping 44 percent from a record high in October 2007. Other markets have also fared badly, with the MSCI World Index of stocks in 23 developed countries down 47 percent.

John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, likens watching the markets to viewing the iconic shower scene in Alfred Hitchcock’s "Psycho" when the heroine gets knifed to death. "You could almost hear the soundtrack of screeching violins during televised financial news— but this time it was your assets that were going down the drain," Silvia says.

Writedowns And Losses

Much of the financial-services industry followed. Institutions worldwide have recorded almost $705 billion in writedowns and credit losses so far this year and have announced 217,070 job cuts. Highly leveraged investment banks disappeared, some into mergers, after investors pummeled their shares. "There’s no more Wall Street," Alan "Ace" Greenberg, former chief executive officer of Bear Stearns, said in a Dec. 8 Bloomberg Television interview. "That model just doesn’t work." [[Well, there are no more investment banks; but Wall Street's still there— and, in the goodness of time, will scheme again to the detriment of all but a few.: normxxx]]

On Main Street, inflation fears have given way to worries about deflation— a broad and sustained decline in prices and wages— as global growth collapses and commodity prices tumble. Unemployment in the U.S. is surging, with employers cutting payrolls at the fastest pace in 34 years last month.

Talk about a depression is no longer dismissed out of hand, though most economists still consider one highly unlikely. While there’s no technical definition of what makes a depression, New York University economic historian Richard Sylla says it would take a U.S. unemployment rate of 10 percent or more for longer than a year. The rate now is at 6.7 percent [[actually at around 16%, using pre-Clintonian calculations: normxxx]], well below[!?!] the Great Depression peak of almost 25 percent.

Restoring Growth

"We won’t get the contraction for a great depression," says Simon Johnson, former chief economist for the International Monetary Fund who’s now at the Peterson Institute for International Economics in Washington. "We know enough to avoid that[!?!], but we don’t know nearly enough about getting growth back." The Fed’s ability to gun growth is constrained by what economists call a liquidity trap: Banks are hoarding cash even with rates near zero, and consumers and companies are too shell-shocked to borrow.

"We’ve got an economy that is in deep trouble and the Fed has lost traction," says Princeton University Professor Paul Krugman, who won this year’s Nobel Prize for economics.

That is pushing the Fed toward unconventional policies similar to the so-called 'quantitative-easing' strategy Japan used to fight deflation in the early part of this decade. Bernanke said Dec. 1 the Fed may begin buying Treasury securities in a bid to revive the economy by lowering longer-term interest rates. Another option is a public 'promise' to keep short-term rates low for an extended time.

Upending Thesis

The U.S. has exported its woes, complicating the task of reviving growth and upending the thesis of a year ago that other countries would become more independent of the world’s largest economy. Recession now plagues nations from the U.K. to Japan, forcing central banks to follow the Fed toward zero rates. JPMorgan Chase & Co. economists expect benchmark rates in every industrial country to be at 1 percent or less in a year.

Emerging markets early dashed hopes that they would serve as an alternative source of economic power as the industrial nations economies shrink. Chinese industrial production grew in November at its weakest pace in nine years, a report showed today. The IMF is also busy again, lending more in November than it did in the past five years combined, to economies as diverse as Iceland and Pakistan.

Weakest Stretch

Morgan Stanley economists last week cut their outlook for global growth to 0.9 percent next year and 3.3 percent in 2010. That would be the second-weakest two-year stretch since World War II, barely better than the downturn of the early 1980s. [[Anything less than world population growth— 3%— is considered recession.: normxxx]]

Marco Annunziata, chief economist at UniCredit MIB in London, expects "the worst growth figures in many years." He says that "2008 has been the Annus Horribilis for markets, and 2009 is shaping up to be the Annus Horribilis for the economy." Queen Elizabeth II famously used this term— which means horrible year in Latin— to describe 1992, when Windsor Castle was damaged by fire and the marriages of three of her children failed.

Richard Berner, Morgan Stanley’s co-chief economist in New York, says the risk is that policy makers elsewhere lag behind those in the U.S. in coming to the rescue. European Central Bank Executive Board member Juergen Stark said last week that any further reduction in interest rates in the euro-area may be "small" after the bank eased its main refinancing rate this month by 75 basis points to 2.5 percent— the most in its 10-year history.

Steep Decline

Central bankers in some emerging markets remain concerned about inflation, following a steep decline in their countries’ currencies. Brazil’s central bank left its interest rate unchanged at a two-year high of 13.75 percent last week, though it signaled it may be ready to ease next year. On the fiscal front, UBS AG economists calculate a global stimulus of 1.5 percent of gross domestic product has so far been lined up for next year. That’s still short of the more than 2 percent recommended by the IMF.

Germany is resisting demands to spur growth as Chancellor Angela Merkel refuses to bust a budget that will be in balance in 2008 for the first time in 39 years. Raghuram Rajan, a former IMF chief economist and now a University of Chicago professor and adviser to Indian Prime Minister Manmohan Singh, sees an added danger: The steep slowdown in global growth tempts countries into protectionism, the kind of beggar-thy-neighbor approach that helped lead to the Great Depression.

Shrinking Trade

International trade will shrink in 2009 for the first time in more than 25 years, the World Bank said Dec. 9. It sees world trade volumes contracting 2.1 percent next year after growing at an average annual rate of 7.8 percent the last three years. "We’re facing a once-in-a-century problem," says Harvard University professor and former IMF chief economist Kenneth Rogoff. "The global scale and magnitude of it is much greater than those we’ve seen before."

"We’re going to face a deep downturn and slow recovery no matter what we do. The challenge now is to contain it to a couple of years and not a decade."



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