Tags: Double | Dip | Recession | Likely | hans | parisis

Double Dip Recession Looks Twice as Likely

Monday, 24 May 2010 08:05 AM Current | Bio | Archive

So, where are we and where are we heading?

Federal Reserve Governor Daniel Tarullo recently told the House Financial Services subcommittee that “a repeat of the global financial crisis that followed the bankruptcy of Lehman Brothers is unlikely from the European debt crisis, but it is not out of the question, either.”

He said that “a deeper contraction in Europe associated with sharp financial dislocations would have the potential to stall the recovery of the entire global economy, and this scenario would have far more serious consequences for U.S. trade and economic growth … if sovereign problems in peripheral Europe were to spill over to cause difficulties more broadly throughout Europe, U.S. banks would face larger losses on their considerable overall credit exposures … solving the crisis rests with the European governments.”

He concluded: “The European bailout plan only buys time and there is a need for real, and likely painful, fiscal reforms in some euro-area countries.”

In my opinion, and here I’m leaving out further geopolitical risks, there is no doubt there are now some parts of the global economy that are seriously at risk of a double-dip recession.

The peripheral countries of the euro zone are prime candidates because of their severe fiscal problems, coupled with their respective losses of competitiveness and dynamic growth that were already in bad shape before the Greek debt crisis erupted. And their situation will have to get worse before it will become better.

Looking at Japan, we see a troublesome, very anemic growth that looks more and more like an economy on its way to a double dip recession, while it still continuously loses its battles with deflation.

Regarding China, we now have indications of an economical slowdown, as wished for by the central government and that has now finally showed up in their weaker Purchasing Managers Index (PMI). We also see unwelcome rising inflation, credit tightening and China’s asset bubble definitively entering a deflation mode.

The U.S. economy, at least in my opinion, is also going to slow down in the second half of the year. Growth that was generated by “rebuilding of inventories” will go away, while the fiscal stimulus is on its long, and maybe slow, way out that could easily become a drag on the U.S. economy.

Economic growth is going to slow down in the most important economies of the world.

Couple that with the fiscal problems that most governments are facing, not only in the euro zone but also in Japan, the United Kingdom and the United States (where there is also regulatory risk because we don’t know how financial reform is going to occur).

The dominant question is: How will governments get their arms around their debt?

Some medium-term solutions are to control spending and to raise the various sources of income. Otherwise, these governments are headed for a full blown fiscal disaster.

Here, I always have to think back to what happened in Brazil during the 1981-92 period where despite having stagnation, inflation remained in the 100 percent zone until the mid-80's, after which it accelerated to more than 1,000 percent per year before reaching a mindboggling 5,000 percent in 1993.

No, we don’t have to go back to the German Weimar hyperinflation experience of the 1920s, where at some point in 1923 banknotes had lost so much value that they were used as wallpaper.

Please don’t misunderstand me, I’m not saying that we could face a similar scenario now, but it’s always good to remember that this kind of nightmare scenario has happened not so long ago.

Yes, if governments end their stimulus too soon they could easily end up back into recession and if they wait too long for exiting they could end up with inflation that could easily occur while they would have to face stagnation.

It’s a situation where you’re damned if you do and you’re also damned if you don’t.

That’s the situation that challenges practically all economically important governments right now.

My fear is that governments will not be able to do the right things like raising their incomes, which would be taxes and other unpleasant things, and cutting their spending.

Anyway, one day, they will have to start practicing fiscal austerity for many years to come and that will cause negative growth in most parts of the world.

Will it become “mission impossible” for many countries in Europe and elsewhere? I’m afraid this could become the case.

For the long-term investor, uncertainty will dominate once again.

Therefore, at least for now, cash and/or cash-equivalent instruments like short-term government bonds of countries like Germany or Canada that don’t have that same kind of debt problems that have put and will put others into severe problems, are already and will continue to be king until uncertainty and fear leave the markets once again and confidence returns.

Before stepping back in, and that could be some time off, I would wait until markets have corrected and stabilized at much lower levels. A timeline for this is impossible to give, but, believe me, you will feel it.

But first, I’m afraid we will have to face another global slowdown again.

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So, where are we and where are we heading? Federal Reserve Governor Daniel Tarullo recently told the House Financial Services subcommittee that a repeat of the global financial crisis that followed the bankruptcy of Lehman Brothers is unlikely from the European debt...
Monday, 24 May 2010 08:05 AM
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