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Global Outlook and Adjustments 

Global Push to Beat Economic Downturn European central banks cut their key interest rates sharply, and Democrats readied a plan to inject $60 billion to $100 billion into the sagging U.S. economy. European central banks cut their key interest rates sharply, and Democrats readied a plan to inject $60 billion to $100 billion into the sagging U.S. economy, as leading industrialized nations tried anew to stave off a global downturn now predicted to be the worst since the end of World War II. The Bank of England surprised markets by lowering its key lending rate by one and a half percentage points, to a 54-year low of 3% from 4.5%, in its biggest cut since 1992. The European Central Bank cut its key rate for countries that share the euro currency by a half percentage point, to a two-year low of 3.25%, while Switzerland's central bank also cut its main target rate by a half-point in an unusual between-meetings move. In Seoul early Friday, the Bank of Korea lowered its main interest rate for the third time in a month. The International Monetary Fund urged nations to go further by turning to fiscal measures, such as boosting spending and cutting taxes, to prevent a world-wide tailspin in economic growth. The IMF put out a new global forecast Thursday predicting that the economies of the world's "advanced economies" -- 31 nations including the U.S., Western Europe and Japan -- would contract by a combined 0.3% in 2009. That would be the first year those economies shrank as a group since the IMF was founded in 1945. Thus far, aggressive loosening of monetary policy around the globe has done little to ease market concerns or buoy growth. Partly that may be a matter of timing. Interest-rate reductions can take between six to 18 months before they have a measurable effect on economic activity, economists estimate. But monetary policy also may be insufficient to tackle today's global credit crunch, in which financial institutions are wary of lending. The aversion of borrowers and lenders to taking risks can swamp the stimulative effect of interest-rate cuts, which are meant to reduce borrowing costs for banks and businesses.
IMF Slashes World Growth Forecasts Again

Will Dollar Lose Global Reserve Currency Status? A key factor driving financial crises is extreme trade imbalances between nations; debt gets accumulated partly as a result of financing a trade deficit. For smaller countries, a vicious spiral can ensue which ends in recourse to the IMF. In 1944, the US was the world's biggest creditor, and imposed a system that placed the whole burden of maintaining the balance of trade on deficit nations; there would be no limits on the trade surplus that exporters could accumulate. The entire post-war economic infrastructure, including the World Bank and the IMF dates from this conference, and is now crumbling in the face of a sudden reversal of historic trade and savings imbalances. The US would long ago have had to make dramatic economic adjustments had it not been for the dollar's special status as the world's reserve currency, in which commodities are priced and in which foreign countries have to hold currency balances at the IMF. China, which for all the media hype barely makes it into the top 100 countries by GDP per capita, has been hugely subsidizing US borrowing and consumption. The trade surplus countries have had to buy over $5 trillion dollars in US bonds in recent years to stop their currencies (China, the Gulf States and 40 other countries have dollar linked currencies) rising. This had the effect of inflating the recent US credit bubble by artificially forcing down bond yields; this whole mess has at its root an excess of savings and mercantilist growth policies in Asia. China is now in economic meltdown, as a growth model based on chronically unproductive over-investment and marginally profitable manufactured exports begins to unravel, as I warned it would back in March and repeatedly since. The World Bank's latest China Quarterly makes sobering reading, and can be downloaded here. The near collapse of the global banking system this year is the culmination of a series of dangerous imbalances that have build up over many years, notably consumer leverage levels reaching 350% of GDP in the US. Goldman estimates that the US private sector’s financial balances (private borrowing net of private investment) will reverse from a deficit of 4% of GDP in 2005 to a surplus of around 10% of GDP at the end of 2009 ie the US private sector will go from being a net borrower to a big net saver. At the same time the current account deficit will swing from a 5-6% deficit to balance or even small surplus. I've long argued that US consumer demand will tumble by 6-7% points of GDP and revert to long term averages after the boom of recent years; the best policy can achieve is to make the process orderly. The implications for trade surplus countries in Asia are grim. The global liquidity engine, whereby China and the oil-exporters provide (subsidized) financing to the US to sustain its trade deficit and their exports, will come shuddering to a halt in coming months.

Developed Economies: Europe, Japan

Europe Tips Into Recession  Most of Europe officially fell into recession in the latest quarter as U.S. consumers and companies showed fresh signs of distress, according to data released Friday -- increasing the pressure on global leaders holding an emergency summit on the financial crisis this weekend in Washington. The recession is the first for the euro zone -- the 15 countries that now use the euro currency -- since the shared currency was launched in late 1999. The combined economy of the countries, which rivals that of the U.S. in size, shrank 0.2% in the third quarter for its second straight quarter of decline. The euro-zone announcement came a day after Europe's biggest national economy and the world's fourth-largest, Germany, announced its own recession. Japan, the No. 2 economy, will disclose early Monday morning in Tokyo whether it has technically slid into recession or narrowly averted it. The Asian financial center of Hong Kong also announced Friday that it was in recession. Major global economic institutions in recent days have forecast a recession spreading across the world's developed countries in the coming months. The shared gloom will not necessarily translate into agreement this weekend among leaders of the so-called Group of 20 nations, where China, India, Brazil, Mexico, South Africa and other rising forces are meeting with traditional economic powerhouses including the U.S., Japan, Germany and the U.K. Most economists doubt the summit will yield any new rescue plans. Most of Europe's major countries are sliding for a number of different reasons. But much of the slump is traceable to the financial crisis that originated in the U.S., and which directly affected some European financial institutions that bought securities backed by shaky American home loans. World Economic Graphic

Japan's Economy Slides Into First Recession Since 2001; GDP Shrinks 0.4% Japan's economy, the world's second largest, entered its first recession since 2001 last quarter and the government and economists say conditions may get even worse. Gross domestic product shrank an annualized 0.4 percent in the three months ended Sept. 30, the Cabinet Office said today in Tokyo. Economists predicted the economy would grow 0.1 percent after contracting a revised 3.7 percent in the previous period. The slowdown may deepen as the global financial crisis hurts exports, prompting companies from Toyota Motor Corp. to Canon Inc. to slash profit forecasts and cut investments. Japan has the lowest interest rates among the 20 biggest economies and public debt that exceeds 180 percent of GDP, limiting the government's ability to stimulate growth. Growth in China, which became Japan's biggest customer in July, slowed to 9 percent last quarter, the weakest since 2003. Quarter-on-quarter, Japan's economy shrank 0.1 percent, today's report showed. Capital spending fell 1.7 percent from the previous three months, compared with economists' expectations of a 2 percent drop. Net exports subtracted 0.2 percentage point from growth after imports outweighed an increase in shipments abroad. Exports rose 0.7 percent, less than the 1.2 percent expected. Imports climbed 1.9 percent as oil surged to a record in the quarter. Economists predicted a 1.5 percent gain. Still, Japan will probably suffer less than its biggest counterparts after companies shed debt and streamlined labor forces following the bursting of the property and asset bubble in the early 1990s. Asia's biggest economy will shrink 0.1 percent next year, according to the Organization for Economic Cooperation and Development, less than the 0.9 percent and 0.5 percent contractions in the U.S. and Europe.

Emerging Economies

The Coming Crunch The global credit crunch has now hit emerging economies, including those in Asia, which many had hoped or expected to be able to "decouple" from developed economies. There will be no escape, and even worse, the super typhoon that is now battering emerging markets will in turn deepen the global recession. The global credit contraction will affect emerging markets in several ways. First, their exports and imports (of raw materials) will fall as excess demand is eliminated in the over-leveraged rich economies of Europe and North America. There will also be a reduction in capital flows to developing economies in all forms (credit, portfolio investment and foreign direct investment) as a result of deleveraging. At the same time, household and corporate wealth will be destroyed as a result of falling liquidity supply from both domestic and foreign sources. Those emerging economies with large foreign-currency bank loans and liabilities face debt deflation, while many corporations in Asia will find it difficult to grow because they are unable to roll over their excessive foreign loans and bonds. Many emerging-market current accounts will turn from surplus to deficit, private capital inflows will drop precipitously and residents will run down their assets and take their capital out. So these economies will have a huge external financing problem next year. Their foreign exchange reserves will fall sharply along with their currencies and financial assets. Most emerging markets don't have sufficiently robust domestic demand to offset the impact of falling exports as well as an overhang of surplus capacity in the export sector. Their domestic economies are just too small. In China, for example, the consumer accounts for only 36% of demand and investment for 42%, much of it export-related. In the U.S., the figure for the consumer is 70%.Emerging-market exports were not the only beneficiary of excess credit growth. Capital flows were just as important. Excess liquidity flooded into these economies in the form of portfolio and FDI inflows. This boosted currencies and bloated domestic money supply and credit. In turn, this drove up asset prices and so created more wealth and more demand. Unsurprisingly, the private sector in these countries spotted the opportunity to borrow cheap money in weak currencies and built up massive amounts of dollar and yen debts and foreign exchange derivative liabilities.

Fitch lowers credit outlook on emerging economies Fitch Ratings on Monday lowered the sovereign credit rating outlooks for six emerging market economies to reflect higher risks to creditworthiness stemming from the global financial crisis and economic slowdown. The outlooks on the long-term foreign currency ratings for South Korea, Mexico, Russia and South Africa, were revised down to "negative" from "stable," Fitch, one of the three major international credit ratings agencies, said in a release. A negative outlook means there is a greater chance of the actual credit rating being downgraded. Outlooks on Chile and Malaysia, meanwhile, were lowered to "stable" from "positive," the agency said. South Korea's A+ rating is four notches below Fitch's highest of AAA and six notches above "speculative" grade, generally regarded as "junk." Russia, Mexico and South Africa are all rated BBB+, three levels above "speculative." Chile is at A, and Malaysia is at A-. "The profound shift in the global economic and financial outlook pose significant real economy and policy challenges for emerging markets," David Riley, head of Fitch's Global Sovereign Ratings Group, said in a statement. Riley said that policymakers in emerging economies have less room for mistakes than their counterparts in advanced countries, though are in a better position to deal with the current challenges than at any time in the past. "Nonetheless, the risks of economic and financial stress that could undermine sovereign creditworthiness have risen and that is reflected in the prospective ratings actions taken today," he said.

Stopping the rot JUST another week’s news in eastern Europe: Latvia, after vehement denials, starts talks with the IMF; Bulgaria loses €220m ($286m) in promised payments from the European Union because of its failure to tackle corruption; and the European Bank for Reconstruction and Development cuts its growth forecast for the region by half. But the good news is that worries of a huge meltdown, from the Baltic to the Black Sea, now look overblown. The most likely outcome is several years of low or no growth, with bigger hiccups in countries that have the shakiest financial systems and biggest imbalances. The outside world (ie, the IMF, the EU and the European Central Bank) is ready to help when necessary and—more usefully—even before problems hit markets. The ECB has opened a €10 billion credit line to Poland, which saw its currency, the zloty, fall sharply earlier this month. Hungary’s central bank was even able to cut its interest rates by half a point from the 11.5% rate that it set last month, as part of a $25 billion international bail-out. And foreign banks have stood by their subsidiaries in the ex-communist countries. It was their risky lending that inflated the property bubbles, now popped, and also financed huge current-account deficits in such places as Latvia and Bulgaria. The biggest worries are now focused on Bulgaria and Romania, the poorest and worst-governed new members of the EU. The Bulgarians have their hands tied by a currency board that pegs the lev rigidly to the euro. That rules out devaluation to restore competitiveness, which is a concern as exports sag. It also removes a potential buffer, because the central bank cannot adjust interest rates. A current-account deficit worth a quarter of GDP looks alarming. At least Bulgaria’s fiscal position is strong. The state has little foreign debt and runs a budget surplus. That should allow it to increase public spending as the economy slows.

Making a Jester Out of Medvedev We all learned from the Russian media how President Dmitry Medvedev arrived in Washington for the Group of 20 summit and offered his ideas on how to build a new global financial system. What the media did not report, however, is that Russia has been essentially evicted from the G8 as the West has reached a consensus that Russia has no place in the elite club of developed, wealthy and democratic nations. For the past eight years, the Russian economy was like a huge colander. With oil prices above $100 per barrel, petrodollars flooded into the colander with amazing force. As long as oil prices remained high, it seemed as if the colander could actually hold water. Unfortunately, the sharp drop in oil prices cut off the flow coming into the colander, and we discovered that it doesn't hold water after all. There were other major leaks as well. Dollars have fled Russia at the rate of $3 billion to $7 billion per week. It is useless to try to stop this outflow because the dollars are being sent abroad by the very people who were the most active in drilling the holes in the colander in the first place. There's nothing the government can do about the problem either. If it gives money to the banks, they'll just send it overseas. If it doesn't give them money, there will be a catastrophic liquidity crisis and the interbank interest rates will reach astronomical levels. To make matters worse, the government's reserves are streaming out of the colander, but the Kremlin is only worried about choosing which oligarchs should get a slice of the bailout pie. How can the Kremlin solve the problem of its leaking colander? Find a scapegoat. Who would be the best scapegoat? Russia's new, young president. The plan to frame Medvedev is clear from the haste with which he proposed changing the Constitution. What will follow over the next year is easy to predict. First, the ruble will collapse in early 2009 -- or at the latest when the country's gold and foreign currency reserves run out. When this happens, someone will have to explain to the people why all the money that had been amassed in the state colander over the past eight years vanished in only a few months.
$57 Bln Spent on Ruble in 2 Months, Investors Spooked By Halts In Trading
Moscow Times Running Log on the “Crisis”

China: Fragile Giant ?

Global economy depends on China The Beijing government knew how to fight its last big slowdown: Spend big on infrastructure. Its solution this time won't be so simple, and we all have a lot at stake. China is in a perfect position -- to fight the previous economic war. Unfortunately, this global economic slowdown is a lot different from the one China battled so successfully in 1997-98. In that crisis, big increases in spending on infrastructure ensured that China's economy rebounded quickly from the downturn caused by the Asian currency crisis. This time, though, infrastructure spending won't be enough. To prevent a slump in growth to 7% -- that's a slump when your economy has been growing by better than 11% a year -- in 2009 China will have to get the country's consumers to spend. That's a much tougher job, especially because the Beijing government has been almost uniformly unsuccessful in recent years in stimulating consumer spending. The duration and the depth of the current global slowdown -- which is deep enough to qualify as a recession in the United States, Europe and Japan -- and the long-term health of the global economy after this slowdown hinge on China's ability and willingness to fight this new war. When economists began predicting that growth would drop to 8% -- or lower -- in 2009, the government reversed course. China needs growth of 7% just to generate enough jobs to absorb increases in new workers from population growth and migration to the cities from the countryside. Economic growth of 7%, moreover, wouldn't do anything to reduce the country's supply of unemployed and underemployed workers. With the country already experiencing a rising level of domestic protest caused by the growing gap between incomes in the cities and the country, letting the economy slow further was just too risky. Why less spending on infrastructure in what is arguably a much more dangerous crisis? Two reasons, China experts say. First, the country has invested so much in infrastructure over the past decade -- and has already allocated plenty for infrastructure in its 2006-10 plan -- that it's hard to find new infrastructure projects that provide decent returns on the investment. China has watched carefully as Japan has repeatedly failed to jump-start its economy, despite massive spending on infrastructure, because so much of that spending went to politically motivated, make-work projects without benefit to the national economy. China doesn't want to go down that road.Second, the big gains, long term and short term, are on the consumer side of the economy. Beijing will get more bang for its stimulus yuan by investing in the consumer economy rather than by investing in more infrastructure. Even before this crisis, Beijing knew that the economy's problems were on the consumer side. China's consumers make up just 40% of that country's economic activity; in the U.S., consumers constitute about 65% of the economy. The consumer sector contributed just 20% of China's growth in 2007 compared with a 35% contribution from exports. That imbalance has left China overly dependent on exports. The slowdown in the economies of the country's biggest trading partners is projected to cut China's export growth to 10% in 2009 from 21% in 2008. That's frightening to the Beijing government because the global boom that just ended left many China industries with huge overcapacity. Many sectors face a massive shakeout of their most inefficient companies -- and a huge loss of jobs -- unless the Beijing government can find a way to increase demand.
Global financial crisis will hurt China much more than the US, If you only read one thing on China this fall …, China downturn deepens

China stimulus plan fuels hope for new investment Investors welcomed China's multibillion-dollar stimulus package but analysts said Monday the plan will depend on Chinese companies to supply a big share of the spending. Stock markets in Japan, Hong Kong and mainland China soared after Sunday's announcement of the 4 trillion yuan, or $586 billion, package as Beijing joined moves by governments around the world to cushion the blow of the global slowdown. The plan calls for higher government spending on roads, airports and other infrastructure, tax deductions for exporters and bigger subsidies to the poor and farmers. Spending on health and education will be increased, as well as on environmental protection and high technology. But it also depends on corporate investment and promises bank lending for rural projects, smaller companies and consumers. "I don't believe a fiscal stimulus alone is enough to keep growth going. I see it as the jump-starting of a car. Corporate investment and bank lending are the fuel that will be necessary to keep it going," said UBS Securities economist Tao Wang. Beijing might supply one-quarter of the announced spending, or 1 trillion yuan ($145 billion), with the rest coming from increased investment by Chinese state companies, bank lending or bond sales by local authorities for individual projects, said Ting Lu, a Merrill Lynch economist.
China's new reality: Economic boom is slowing

China Losing Luster with U.S. Manufacturers Two years of disastrous quality-control breakdowns, from foul fish and lead-tainted toys to poisoned drugs and dairy products, are taking their toll on China's allure as a manufacturing platform. A new study by supply-chain consulting firm AMR Research found that quality concerns are among the chief reasons U.S. manufacturers are scaling back plans to source more goods from China. Instead, U.S. companies are looking harder at Mexico and other locales closer to home when exploring where to put new capacity. The reasons for the shift suggest serious problems for China's export machine that go far beyond the concerns over rising costs for wages, shipping, and materials that got a lot of attention earlier this year. AMR asked U.S. manufacturers to rate different regions around the world (China and the U.S. were each counted as region unto themselves) on 15 different risks tied to sourcing products for sale in America. Just a few months ago the biggest concerns over China were rising factory wages and the hike in trans-Pacific shipping costs owing to soaring fuel prices. Since then, the 60% plunge in oil prices and a sharp falloff in U.S. imports from China have caused spot freight prices on ocean shipping to crash. Now, the biggest concerns over China are quality and theft of intellectual property (BusinessWeek.com, 4/27/06). Half of respondents to the survey cited China as the biggest source of "risk" for product quality failure. Fifty-seven percent rated China as the biggest risk of intellectual-property infringement. Both categories represented sharp increases from May. No other region was named as the biggest source of risk in those two areas by more than 7% of respondents. In fact, China ranked highest in 9 of the 15 risk factors. Rising labor costs are still an important factor for businesses, with 35% citing China as the leading source of concern. Other risk categories where China ranked highest included regulatory compliance, commodity price volatility, supply-chain security breaches, and information technology problems. The shortage of Chinese managerial talent—long one of the top risk factors during the go-go era that ended last year—has tailed off as a major worry.

Oil and Commodities

OPEC to Try to Halt Oil-Price Decline OPEC members will meet later this month in a bid to halt the tumble in crude prices, amid signs that a global economic slowdown is punishing near-term demand for oil. The news of the meeting, which analysts expect will result in another production cut, came as oil prices hit a 22-month low amid fresh evidence that the world's industrialized economies are in recession and consumers and industries are cutting back on fuel spending. The Paris-based International Energy Agency on Thursday slashed its forecasts for global oil demand, saying it will grow by just 0.1% this year. That is down from last month's projection of 0.5% growth and far below the 1.1% growth rate of 2007. Many analysts think global oil demand will actually contract this year, for the first time since 1983. The IEA, an energy watchdog that advises 28 industrialized countries, said Thursday that consumers and businesses globally are expected to use on average 86.2 million barrels a day this year -- a downward revision of 330,000 barrels from the agency's October report. The IEA also slashed its 2009 world crude demand forecast by 670,000 barrels a day and said consumption next year is expected to grow by a mere 0.4% to 86.5 million barrels a day. The changes in the IEA's forecasts underscore the extent to which a slowing global economy is hurting crude consumption.

Oil recovery? World oil prices could easily fall below $50 a barrel and might even slip toward $40 or perhaps $35, but they will recover and could do so fairly quickly, analysts and economists say. Benchmark U.S. crude futures dropped to a 22-month low under $55 on Thursday as evidence mounted that the deepening recession would have a severe impact on demand, reducing the use of oil by industries and individuals alike. Oil has now fallen more than 60 percent from July's record $147.27 a barrel and is moving close to what is widely considered to be the average operating cost, or "cash cost," for the world's oil major oil companies around $50 a barrel. Many analysts think the market is likely to fall further, breaching the psychological $50 barrier before recovering. "How low prices go is rather random: $50, $40, $35? It could be any of those numbers," said Kevin Norrish, analyst at Barclays Capital in London. "All we would say is that the lower it goes, the further out of equilibrium the market is headed." Driven short-term as much by sentiment in futures markets as rational calculations over fundamental costs for production, many analysts say the oil price is likely to go well beyond the level justified even by a dramatic fall in demand. IEA chief Nobuo Tanaka said on Wednesday the price of oil was already "overshooting" to the downside: "The market is over-reacting," he told Reuters. Analysts liken oil price moves to a weight on a piece of elastic: most of the time it swings within fairly narrow ranges, reacting to signals on supply and demand and other news but occasionally a big shock makes it swing to wild extremes. "Just as on the upside we went too far, so on the downside, we are going too far as well," said Dugdale. Most analysts see prices recovering fairly quickly in the next few months, according to a Reuters poll of 34 analysts last week, which produced an average forecast for WTI next year of $81.30 and almost $90 in 2010. Barclays Capital sees the price for U.S. crude recovering to average almost $78 a barrel in the fourth quarter of this year and bouncing back to more than $105 for 2009.