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Economic Outlook

Rolling Recessions Bring Bernanke, King, Trichet Monetary-Policy Paralysis Recessions are threatening to crash over the world economy in waves, as one country after another turns down a year after the onset of the global credit crisis. Such rolling recessions pose a quandary for central bankers Ben S. Bernanke, Jean-Claude Trichet and Mervyn King: If the whole world were clearly slumping, they'd be united in cutting interest rates. Instead, with some countries still booming, they can't ignore the inflation threat. Paralyzed between slowing growth and accelerating prices, U.S. and European policy makers this week are set to fall back on keeping rates unchanged. A lot's at stake. If central bankers leave rates too low, they risk stoking global inflation that's already projected by the International Monetary Fund to be the fastest in nine years. Keep rates too high and the world could fall into its first recession since 2001-2002. In the past, when the U.S. economy weakened, the rest of the world usually followed quickly, and inflation eased as demand for oil and other commodities fell. U.S. recessions in 1990-1991 and 2001 brought global growth down by half, sending fuel prices tumbling. That didn't happen this time. The world expansion barely slowed last year and oil prices surged, even as the U.S. economy shrank in the fourth quarter. Only now -- two years after the U.S. housing boom went bust -- is the slowdown spreading worldwide and the price of oil showing signs of receding. The world may avoid a recession, deemed by economists to be global growth of 3 percent or less, and still end up with what Allen Sinai, chief economist at Decision Economics in New York, calls a ``witches' brew'' of ailments: declines in the housing and stock markets, a credit crunch and commodity-driven inflation. The energy and credit crises may have permanently weakened the global economy by making production and investment costlier. Deutsche Bank AG economists say long-term growth may fall to 4 percent from 5 percent. While the world rebounded from its last slump to record the strongest expansion since the 1970s, Richard Berner, co- head of global economics for Morgan Stanley in New York, says that ``growth will have to stay weaker for longer'' this time if central banks are to curb inflationary pressures. ``Investors should consider these developments as a regime change,'' Berner says. The U.S. risks a relapse after bouncing up in the second quarter as consumers spent some of their $91 billion in tax rebates. ``I don't see recovery'' on the horizon, says Harvard University's Martin Feldstein, who serves on the National Bureau of Economic Research committee that determines when recessions start and end.

• Only Luck Can Save the U.S. Economy , A Slow-Mo Economic Meltdown

• Revisions matter. So do levels The 1.9% SAAR growth rate in 2008Q2 [BEA] is widely viewed as a positive [0]; and the fact that GDP growth remained, in this advance release, above zero is a positive. However, when taken with the annual revision, one sees some interesting aspects. Not only was growth in 2007Q4 negative, albeit slightly; the revisions put 2008Q2 real GDP below what the final estimate for 2008Q1 GDP was: $11692 versus $11701. Future revisions will definitely occur to the 2008Q2 figure, and indeed the figures back to 2006Q1 will be again revised come next July.

• The Expansion: Retrospect and Prospect, Whine-Free The graph clearly indicates that GDP is now substantially below (4%, in log terms) where it was at this time in the previous expansion. It is 12% below the corresponding level in the 1982-00 expansion. I also plot the implied level of GDP assuming the mean forecast from the WSJ survey for GDP is realized. In that case, by 2009Q2, output will be 7% below the corresponding level in the previous expansion.

• Oil prices, autos, and the U.S. economy It's instructive to compare what's currently happening to the auto sector and the U.S. economy with what we saw in the wake of the 1990 oil shock. Sales of light trucks manufactured in North America, which category includes the once almighty SUV, remain deeply depressed, with July sales down 26% compared with last year. In terms of the effect on GDP, the contribution of motor vehicles and parts to real GDP fell by $15 billion between 1990:Q3 and 1990:Q4 and an additional $15 billion between 1990:Q4 and 1991:Q1. That corresponds to about 0.2% of GDP each quarter, or a hit to the annual growth rate of real GDP of about 0.8% each quarter.

Consumer Spending Falls as Inflation Surges Consumer spending, after adjusting for inflation, fell in June as shoppers were hit with the biggest increase in prices in nearly three decades. The Commerce Department reported Monday that consumer spending dipped by 0.2 percent in June, after removing the effects of higher prices, the poorest showing since a similar drop in February. The higher prices reflected a big surge in gasoline costs and helped to drive an inflation gauge tied to consumer spending up by 0.8 percent in June, the biggest increase since a 1 percent rise in February 1981. The big rise in inflation ate up a part of the billions of dollars in stimulus payments delivered during the month. Personal incomes rose by a tiny 0.1 percent in June following a giant 1.8 percent increase in May. The performance of incomes were skewed by how the department accounts for the billions of dollars in stimulus payments that have been made over the past three months. Those payments totaled $1.9 billion in April, when the program was just getting started, then $48.1 billion in May and $27.9 billion in June. Those payouts made incomes and after-tax incomes soar in May compared to April but weaken in June since the level of June payments was lower than they had been in May.Consumer spending before removing inflation rose by 0.6 percent in June after a big 0.8 percent increase in May. Much of that spending went to pay higher prices for gasoline and other items, however. Removing inflation, spending edged up by a more modest 0.3 percent in May and fell by 0.2 percent in June.

Future Looks Bleak for Jobs Although companies didn't shed as many jobs as expected in July, losses are likely to accelerate as macroeconomic weakness creeps deeper into companies across sectors. The U.S. economy got mostly bad news on Friday as the July unemployment rate jumped to 5.7%, with young people bearing the brunt of the losses. The level was higher than expected by economists, who were looking for 5.6% on average, although the number of jobs actually lost was not as severe as expected, coming it at 51,000 instead of the predicted 72,000.Still, coming a day after a troubling weekly unemployment report, the figures cast a pall.In an interview with Reuters on Friday, Mohamed El-Erian, the co-chief executive of Pacific Investment Management, said the credit crisis "morphed into a deepening economic weakness" that he expects will accelerate. "We now have three balance sheets all coming under pressure at the same time: housing, consumers and the financial sector," he said."Overall, the pace of employment growth indicates the economy is settling into a troubling malaise," said Peter Morici, a professor at the University of Maryland School of Business and a columnist for Forbes.com. Even though the economic stimulus plan boosted consumer spending in May and enabled gross domestic product to increase 1.9% in the second quarter, retail sales fell in June and aren't likely to rebound in July.

• Looming Job Cuts Continue to Climb: Report Challenger, Gray & Christmas, an outplacement consultancy firm, said Monday that planned job cuts announced by employers in July jumped 26% to 103,312 from 81,755 announced in June. That's up 141% from a year ago, when employers announced planned job cuts totaling 42,897. The July figure marks the second-highest number of planned job cuts this year, rivaling the May reading that showed 103,522.

Economic View: Three Strikes Against Consumers ONE of the spookiest features of the current economic crisis is the way everything seemed to go wrong at the same time. In 2007, as if some kind of secret signal went out among them, housing prices accelerated their decline while the prices of oil and food rocketed higher. These changes were abrupt, as they slammed into the economy with little forewarning of even bigger price shocks just ahead. The pain from any one of these price increases would have been bad enough. But experiencing all three simultaneously doomed the business expansion under way since the end of 2001. That the housing crisis also served to ignite the calamities in the world of credit made the problems only harder to overcome. The numbers are striking. From May 2007 to May 2008, the price of food jumped by 5.1 percent, double the annual rate from 1991 to 2006. Home prices show a similar disconnect. During the two years ended in December 2006, home prices jumped 43 percent. But in 2007, home prices fell 10 percent, and the pace of decline has accelerated this year. In the case of oil, the price at the end of 2006, at $62 a barrel, was only $3 more than it was a year earlier. Over the course of 2007, however, oil zoomed to $92 from $62; by mid-2008, it was up an additional $40. These extraordinary shifts in tempo were, for the most part, unanticipated. Yes, the explanation for the explosion in food and oil prices — global demand exceeding the growth in global supplies — was apparent in the three or four years that preceded this crisis. Yet why were there no price shocks then? As a result of these exceptional conditions, we have no guidelines to follow. We are in uncharted territory. Most of the attention has focused on the cracks and groans from the financial sector, as banks totter at the edge of failure and where credit has been so hard to come by. Some banks are even uneasy about lending to one another — an astonishing rupture of normal conditions. Nevertheless, the therapy must focus on the household sector, wrestling with the triple blows of high home prices, oil prices and food prices. Nothing will turn the economy around until we can restore some sense of hope and security among consumers — perhaps even as food and oil remain painfully expensive.

China's Inflation Is Harder to Control Than Web: William Pesek The most important reminder that China isn't evolving as hoped concerns economic policy. The yuan last week had its biggest weekly loss since China scrapped its dollar peg in 2005. On July 25, the Politburo, the Communist Party's top decision-making body, left little doubt that the currency gains of recent years are over for now. It said China will focus on ``steady'' growth after the economy expanded at the slowest pace since 2005 in the second quarter. The politics of such a shift are clear enough; the economics of it are less persuasive. Part of China's rationale is reducing so-called hot-money flows. As the yuan appreciates, it can attract capital inflows that pump up the money supply. That has increased risks for Asia's second-largest economy. If China expects to control things, it will have to make its monetary policy consistent with exchange-rate policy. That means lower domestic interest rates, which could cause new problems.

Credit and Finance Problems

Housing Lenders Fear Bigger Wave of Loan Defaults The first wave of Americans to default on their home mortgages appears to be cresting, but a second, far larger one is quickly building. Homeowners with good credit are falling behind on their payments in growing numbers, even as the problems with mortgages made to people with weak, or subprime, credit are showing their first, tentative signs of leveling off after two years of spiraling defaults. The percentage of mortgages in arrears in the category of loans one rung above subprime, so-called alternative-A mortgages, quadrupled to 12 percent in April from a year earlier. Delinquencies among prime loans, which account for most of the $12 trillion market, doubled to 2.7 percent in that time. The mortgage troubles have been exacerbated by an economy that is still struggling. While it is difficult to draw precise parallels among various segments of the mortgage market, the arc of the crisis in subprime loans suggests that the problems in the broader market may not peak for another year or two, analysts said. Defaults are likely to accelerate because many homeowners’ monthly payments are rising rapidly. The higher bills come as home prices continue to decline and banks tighten their lending standards, making it harder for people to refinance loans or sell their homes. Of particular concern are “alt-A” loans, many of which were made to people with good credit scores without proof of their income or assets. Fifth Third's Richter Sees More `Pain' for Financials

Citigroup Reports Loss on Credit-Card Securitization as Customers Pay Late Citigroup Inc. reported its first loss since at least 2005 on credit-card securitizations, signaling that risks may be growing in a business that generated $3.5 billion of revenue in the past three years. The biggest U.S. credit-card lender lost $176 million in the second quarter packaging card loans into securities, the company said in an Aug. 1 regulatory filing. The New York-based bank completed fewer deals and was forced to mark down its own $9 billion stockpile of the debt instruments and other stakes the company amassed while selling them to investors. Led by Chief Executive Officer Vikram Pandit, 51, Citigroup manages about $202 billion of credit-card loans worldwide, about $111 billion of which have been turned into securities and sold, according to the filing. Delinquencies on the securitized portion have jumped by 16 percent since the end of last year to $2.16 billion as of June 30, Citigroup said. The firm's results may portend similar losses for rivals. Banks and other card issuers ``are predicting higher net charge-off rates across the credit-card industry,'' said Meghan Crowe, a Fitch Ratings analyst who tracks credit-card issuers including American Express Co., Capital One Financial Corp. and Advanta Corp. ``Things have been worse than anticipated.''  7/18 Sunshine Says Citigroup Has `Massive Problems'

HSBC Says Growth in Asia Will Slow This Year, First-Half Profit Fell 29% HSBC Holdings Plc, Europe's biggest bank by market value, reported a 29 percent drop in first-half profit as bad loans rose in the U.S. and said emerging markets may grow more slowly this year. Net income for the six months ended June 30 fell to $7.7 billion, or 65 cents a share, from $10.9 billion, or 94 cents, a year earlier, the London-based company said today in a statement. That beat the $7.3 billion average estimate of 11 analysts surveyed by Bloomberg. HSBC put $10.1 billion this year into loan-loss reserves, adding to charges of $17.2 billion in 2007 and $10.6 billion in 2006 for bad loans. While the bank's profit rose in Europe, Latin America and most of Asia, Chairman Stephen Green said the outlook is ``highly challenging'' as emerging markets grow ``with less momentum'' than before. HSBC's so-called core Tier 1 capital -- a measure of financial strength that shows a bank's ability to withstand losses -- fell to 8.8 percent as on June 30. Capital stood at 9.3 percent at the end of 2007, compared with 7.3 percent at Edinburgh-based Royal Bank of Scotland Group Plc, company reports show. HSBC reported a loss in the North American unit and declining profit in Hong Kong. Pretax profit rose in the rest of Asia, Latin America and Europe. ``In Asia, compared with the buoyant conditions of last year, it is apparent that corporate activity in some sectors is slowing and demand for equity-related and wealth products has reduced as equity markets have declined,'' Green said in the statement.

Bear's Cayne Near Death in Sept.- Former Bear Stearns Chief Executive James Cayne came close to dying last September from sepsis triggered by a severe prostate infection, Fortune Magazine reports on Monday on its website. And though he survived his own brush with death, the veteran trader admitted he did not know how to save his 85-year-old firm, which collapsed six months later as Bear was unable to navigate the credit crisis that ultimately sparked a run on Bear by clients and investors. "The options were limited," Cayne told Fortune in its August 18 edition. Bear posted its first-ever quarterly loss in December, shortly after his return from the hospital. "When you become roadkill, when you happen to have lost some weight and you're not really healthy, but you know one thing -- you know that you have worked your ass off and you're not smart enough to know the answer -- that's tough," he said. Finally the bank's woes, combined with stories that Cayne was frequently out on golf and bridge outings, caught up with him. Cayne was forced to relinquish his CEO role in January, but remained chairman. "I didn't stop it," Cayne acknowledged, speaking of his role in the firm's demise. "I didn't rein in the leverage." Fortune observed the firm left itself vulnerable because it relied too heavily on overnight "repo" financing from banks and funds.In the firm's final days, Cayne said he was in the dark about Bear's weakened state. He was playing at a Detroit bridge tournament when trading clients began fleeing in March and did not know the depth of the firm's cash crisis until March 13. It wasn't until he returned to Bear's New York offices on March 15 that he learned the Federal Reserve had arranged a bailout and that JPMorgan was its only savior. Cayne resigned himself to JPMorgan's offer of $2 a share. "I felt nothing," he said of the sale that cost him $1 billion, leaving his net worth at about $600 million. "You got a bad grade on your test. That's it. No appeal. I felt sad for me and sad for my Bear Stearns family."

Merrill's John Thain's Change From cockiness to capitulation. From distinction to desperation. From pride to panic. Such is the story of John A. Thain as the chief executive of Merrill Lynch. The question is whether the fear Merrill showed this week in dumping securities for pennies on the dollar — and on terms that did not even foreclose the possibility of further losses — is an indication that the stock market bottom has been reached. A man who rose to prominence at Goldman Sachs, where risk-taking is an art and a source of pride, decided that his new firm had to get its pile of collateralized debt obligations off its books. It had ridden them from 100 cents on the dollar to 22 cents, but now it would unload them for little more than a nickel, with the possibility of getting the rest of the 22 cents later. It would give up any claim to profits from a rebound. Since Merrill is booking this as a sale — an accounting treatment that could seem a little optimistic if Lone Star sends the securities back — it won’t have to go through the painful process of valuing them, and taking more losses, every quarter. It appears that Mr. Thain decided he had been embarrassed enough. That could be the kind of capitulation that will later be seen as marking the bottom of despair on Wall Street. It is Wall Street legend that bottoms are made when the most optimistic give up. The stock market reacted as if Merrill’s move was such a sign, although it gave up many of the gains on Thursday, after a disappointing report on growth in the American economy.

Foreign Markets

Brazil Broken Markets Pit BlackRock Against Mobius as Age-Old Bears Return The 65 days that plunged Brazil into a bear market are reminding investors that Latin America's biggest economy is still an emerging nation. Banco Itau Holding Financeira SA'sRoberto Egydio Setubal says Brazil has been transformed after inflation dropped to 6.1 percent from 6,800 percent in April 1990 and the nation got its first investment-grade rating. Templeton Asset Management Ltd.'s Mark Mobius isn't convinced as interest rates rise at the fastest pace in the developing world and foreign investors sell equities like never before. ``You cannot say the country has changed,'' said Mobius, 71, who oversees about $40 billion in emerging-market equities at Templeton in Singapore. ``The experience they've had in responsible government spending and balanced budgets is relatively short. Inflation was high. We all have to be very mindful that these things can happen again.'' The 66-stock Bovespa Index, which gets almost half its value from producers of energy and raw materials, tumbled 22 percent from a record in May as the central bank increased interest rates in June and July, the current account deficit widened to an all- time high, and economic growth slowed. The benchmark Selic target rate jumped to 13 percent in July from 11.25 percent in April. The sell-off dislodged Brazil as the best-performing market among the world's 20 biggest this year and marked the Bovespa's 13th decline of 20 percent or more since 1997, according to data compiled by Bloomberg and Birinyi Associates Inc., the Westport, Connecticut-based research and money management firm founded by Laszlo Birinyi. The Bovespa, which rose 15 percent through its May 20 peak, is now down 9.8 percent in 2008. Initial share sales dried up after most of 2007's record offerings fell below their debut price. Templeton is among several firms that have become less bullish on Brazil, driving net sales by foreign investors to the highest on record. Net sales by overseas investors totaled 7.4 billion reais ($4.7 billion) in both June and July, data compiled by Sao Paulo-based BM&F Bovespa SA, the world's third-biggest securities exchange, show. Brazil's stock market compared to its BRIC peers

Loonie Losing Wings in Currency Markets as Canada Can't Escape U.S. Slump Currency traders are beginning to realize that for all its riches in oil, copper and lumber, Canada's economy may not be so different than the U.S. after all. While Canadians celebrated last year as the country's dollar reached parity with its U.S. counterpart for the first time since 1976, traders now predict the currency will fall as much as 17 percent through 2009. After soaring 17 percent in 2007, the loonie, as the currency is known because of the aquatic bird on the one-dollar coin, is down 2.8 percent in 2008 amid a shrinking economy and an 13 percent drop in oil prices the past month. It's one of five of the 16 most-widely traded currencies to drop against the U.S. greenback, joining the New Zealand dollar, South Korean won, South African rand and British pound. ``The way energy prices and certain commodities have boomed, many thought we would weather the downturn better,'' said Steve Butler, director of foreign-exchange trading in Toronto at Scotia Capital Inc., a unit of Canada's third-largest bank. ``You've got a pessimistic look at the economy by the market. It's forced a lot of people to rethink that view.'' Canadian Currency Out-Performed By U.S. Dollar