Will the US Recession lead to Global Slowdown?

WHAT ROLE FOR CHINA AND INDIA?

Presentation by Jan Kregel,Levy Economics Institute of Bard College

for the IDEAs Conference “India, China and the World Economy, Magnolia Hall, India Habitat

Centre, New Delhi, January 24, 2008

Can Asia Decouple From the US?• What were the drivers of US Growth?– Consumption Demand

• Cheap Credit – Mortgage refinancing, HELOC• Rising Net Wealth – rising house prices

– Investment – Residential Housing- – Rising Net Wealth – Housing, Equity Market– Offset by Current Account deficit

• What are the NegativesNow?– Credit Crunch – Tighter lending Standards– Collapse of Housing Market– Collapse of Consumption demand– Collapse of Equity Prices– Offset by Rising Net Exports – depreciating dollar

The US Recession Outlook• Housing slump to produce a contraction in activity in the first three

quarters of 2008. Downturn led by consumer spending. • GDP to average 0.8% in 2008 and 1.0% in 2009, in spite of $175bn in

fiscal stimulus and monetary easing by the Federal Reserve. • Home prices expected to decline by 15% in 2008 and 10% in 2009, with

more likely. The inventory situation has become intractable• Housing starts decline 30% from current levels, to 700k by end 2008 • Operating earnings down 8.4% from 2007 with little recovery in 2009. • Job losses in the range of 2.5 million, close to the last recession, expected

to push the unemployment rate up, to 5.75% by the end of 2008 and to 6% by early 2009.

• Rising unemployment, $6 trillion in lost housing wealth, combined with slumping equity valuations will result in the worst consumer recession since 1980.

• Rate of real Personal Consumption Expenditure dropping to -1.0% by 4Q 2008, led by double-digit declines in consumer durables.

4

US Imports and ConsumptionImports, Customs Value: Goods

% Change - Year to Year SA, Mil.$

Retail Sales & Food Services % Change - Year to Year SA, Mil.$

05009590

Sources: Census Bureau, Census Bureau/Haver Analytics

30

20

10

0

-10

-20

12.5

10.0

7.5

5.0

2.5

0.0

-2.5

How Can Asia Help?

• Trade–With US, – Intra Regional

• Finance–Financing US Current Account–Financing Recapitalisation of US Financial

System – Sovereign Wealth Funds–Financing Domestic/Regional Expansion

Alternate Explanation of Chinese Export Explosion

• Rapid Rise in Export Unit Values after 2002• No Evidence of Rising Import Prices of

Manufactures into US and EU• Possible Over-invoicing of Exports to

accumulate foreign balances = Disguised Capital Inflows

• Evidence in Investment and Property Boom• Means that Trade Balance is Overstated

How Large is the Deficit?• If 30% of increased export unit value due to disguised capital

inflows then USD $23 billion in 2003, $54 billion in 2004, $95 billion in 2005, and $157 billion in 2006.

• This accounts for much of the rise in fixed investments as a share of GDP that had occurred up to that point.

• But, if no increase in real unit export values after 2002 the disguised inflows are $87 billion in 2003, $199 billion in 2004, $347 billion in 2005 and $529 billion in 2006.

• Then China’s 2006 “actual” current account deficit would be $425 billion, and the cumulative “disguised deficit” since 2003 $847 billion.

• Source: “Is China Really Running a Trade Surplus?”, James K. Galbraith, Sara Hsu, and Li Jianjun, December 30, 2007, The University of Texas Inequality Project UTIP Working Paper 45

Reasons For Capital Imports• The rise in unit export values also occurred in conjunction with an

important change in the rules governing the holding of dollars inside China.

• In October 2002, the central government gave permission for all companies to hold foreign exchange accounts.

• Controls over foreign exchange purchases were relaxed for many businesses, including exporters, while the ability to open foreign exchange accounts was extended to firms outside bonded zones (Lehmanbrown.com, 2002).

• The goal of this measure was to liberalize the current account, facilitating trade and reducing the state presence in credit markets.

• Thus, the regulatory and investment environment was ripe for injecting capital inflows into China.

• Using the trade account to bring in capital was relatively simple over this period. Exporting companies simply had to overbill exports, and foreign exchange could be transferred into the companies’ bank accounts.

Foreign Exchange Transactions

Cyclical Elements in the Chinese Economy• Recently RMB 860 billion in unspecified “irregularities” announced• PBoC Dep. Gov. Liu lists four problems in real estate finance:

– 1. Real Estate credit is growing too fast…– 2. Competition is leading some commercial banks lower lending criteria,

reduce examination steps and relax investigation to increase market share

– 3. Mortgage refinance loans and additional mortgage loans are granted without proper approval…

– 4. Some branches/sub-branches…collaborate with real estate developers and agents to make up loan contracts for real estate developments as housing consumption loans

• Six interest rate rises plus increased Reserves to cut lending• The Olympics will be over in less than a year– the housing boom sooner• The hardest hit stocks Monday and Tuesday were banks because of fears

that mortgage-related losses are much larger than reserves taken• Bank of China was probably the hardest hit -- Last year it reported that it had

$7.95 billion in subprime exposure, and it set aside $473 million for possible losses.

Can US Stop Its Recession

• Monetary Policy– Is it a liquidity crisis or a solvency crisis?– What is a “Minsky Moment”– Can Fed do anything besides lower interest rates?– Inflation Risk

• Fiscal Policy– Size?? $150 billion is not enough– How Fast– Tax or Expenditure Policy?

George Soros on US Recession

• Credit expansion will be followed by a period of contraction, new credit instruments and practices unsound and unsustainable.

• The ability of the financial authorities to stimulate the economy is constrained by the unwillingness of the rest of the world to accumulate additional dollar reserves.

• Until recently, investors were hoping that the US Federal Reserve could do what it takes to avoid a recession

•

George Soros on US Recession 2

• Now realise that the Fed may no longer be able to do so. • With oil, food, other commodities rising and RMB

appreciating faster, the Fed has to worry about inflation. • If federal funds lowered further, dollar would come under

renewed pressure and long-term bonds go up in yield. • Where that point is, impossible to determine. When reached,

the ability of the Fed to stimulate the economy comes to an end.

Soros on India and China• Although a recession in the developed world is

now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend.

• So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise ofChina and other countries in the developing world.