Tuesday, July 14, 2009

Crisis not over

According to Tim Lee, the founder of financial economic consultancy pi Economics, (in yesterday’s Financial Times) national savings rates remain too low in most countries that had real estate bubbles, including the US, Eastern Europe, Spain and Turkey. The recourse to external finance (the current account deficit) has been reduced but not because of any increased savings: it results from investment collapse.

While “one can argue that real estate prices have fallen enough, particularly in the US (…) the total market value of US residential property remains high relative to disposable incomes (and) the total of outstanding mortgages has barely declined. It does not seem possible for the housing market crisis to be resolved without a significant decline in mortgages outstanding, which means substantial further credit losses.”

There are then three possibilities: one is that governments and central banks could be creating a new bubble, but this appears unlikely with negative savings rates and poor economic background. A second possibility is inflation that would reduce global indebtedness, but across most of the world, bank credit and money supply have been growing only slowly.

Then if we do not yet have inflation and we cannot have a new bubble there must be more deleveraging and unwinding of the past global credit bubble. This means a very weak global economy with falling stock markets and commodity prices, and falling government bond yields, weak carry trade recipient currencies (e.g. the Australian dollar) and strong funding currencies (mainly the yen and US dollar).

“In short, a troubling return to the markets that we suffered for most of last year.”

This dismal prospect is compatible with the forecast of a “W” recession suggested by many economists, and also with the Michael Mandel hypothesis (in Business Week) about the end of the information technology boom that I referred to in a previous post (“Is the innovation wave ‘passé’?” this blog, June 7, 2009) . With a slower trend of growth, recessions tend to last longer and be more severe, as was well known to the “classical” students of business cycles of the mid-XXth century such as Burns or Schumpeter.

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