Saturday, December 13, 2008

Why Global Economy Will Not Recover Next Year?

While the full-blown effect from global economy meltdown yet to be fully felt, there are already some economists that preach for global economy recovery by mid of 2009. However, I’m sort of pessimistic with their views. Here we will look at several global economic indicators particularly those from US, UK & the rests of Europe, Japan, China & India

These are my arguments:

(1) Recession had just begun. Recession is generally defined as fall in real GDP for 2 successive quarters. In US, the data shows that American economy have shrunk by 0.3% officially in the 3rd quarter. It is very unlikely that the data will turn around for the good in 4th quarter or even the 1st quarter of 2009 given the worsening economic outlook. Germany had also been announced as technically in recession. In fact the worst is yet to come. More companies are shedding employment. The future of US automakers together with millions of other jobs is still on the line. Hardly any recession will recover in months. We have seen the 1929 Great Depression, recession after the Barber Boom, recession after the Lawson boom, Asian financial crisis, Japan’s Great Depression. None of them take months to fully recover

(2) Dow Jones will suffer huge fall in weeks to come. This has to do with the future of GM, Ford & Chrysler. The officials from Big 3 had declared again & again that they only have matter of weeks before going under. The current administration highly rejected the proposal to bail out automakers. We are highly uncertain of the situation, not before 20th January 2009 when Obama swears in. However, market often reacts differently. Due to herd mentality, traders ‘want to believe’ that the Big 3 ‘will actually collapse’. Overreaction may send the Dow Jones plunging to another record low level in nearest future. Market around the world will likely react similarly: Hang Seng, Nikkei & other major indices. More wealth will be wiped off

(3) Record unemployment. In period of recession, it is very common to see firms firing workers. In such period, fall in private consumption will translate to lower profits for firms. They will no longer need to produce so many outputs, thus laying off idling workers. In October, unemployment in US is standing at 6.5%, the highest level in 14 years high. It could be more than 10% early next year if Detroits file for bankruptcy. The accounted for nearly 500, 000 workers. But there are many industries that rely on Big 3 particularly spare part suppliers. As such unemployment could be magnify to millions

(4) Consumption continues to fall. Consumer confidence falls to record low. Stresses built up in the system over unemployment, fall in average monthly disposable income, shrinking nest eggs & freefall in house prices. In UK itself, disposable income tumbled for more than 70% of households. All these translate to falling consumption. Over job insecurity & falling income, people dare not to take up any financial commitments at the moment. Meanwhile banks have never been so frugal. Number of mortgage approvals dropped significantly, leading to fall in demand for housing. As such prices of houses fall too leading to negative equity. People will feel inferior & poorer.

As both UK & US economy are consumption driven, this leads to a large fall in AD. Through negative multiplier effect this may lead to several round of fall in AD in months to come. This is my strongest argument as to why global economy is unlikely to recover by 2nd quarter of 2009

(5) Not much room for monetary policy & fiscal policy. In US interest rate is standing at 1%. For UK is 2% while Japan is 0.3%. It does not take a genius to see that there is not much space to further rely on monetary policy to put the economy back to pieces. Meanwhile, US government national debt as % of GDP is 73%, ballooning to unprecedented level. In UK, debt is still manageable at about 43% but still high though. In Japan, the figure is 194% of their GDP. Although they can still manipulate government spending, it is ought to be done cautiously. Japan is an excellent example of failures in policy. Despite proactive measures, its economy remain stagnant for a decade

(6) Increase in oil prices. OPEC will hold its meeting on 17th December in Algeria & I’m very optimistic for a larger cut in production of oil this round. It could be of 2 millions barrels a day. Some OPEC members are large lobbyists such as Nigeria & Iran. They are called the price hawks mainly because of their economy which is less diversified & heavily depending on revenue from oil. Demand for oil is inelastic (PED less than 1). As such, cut in production will lead to increase in price which subsequent boost its total revenue (P x Q). It’s annoying that some of the members claim that the oil price should stay at $70 at such a period. Whatever is the decision, oil price is estimated to increase by less than $5 & this could more or less dampen the effort of economic recovery

(7) Strong dollar & yen. Investors around the world have decided to withdraw their capital from emerging economies & Europe. In period of global recession, US economy will always be deemed as the most stable & vibrant. As such this creates the demand for dollar causing it to rise to a record level of $1.50 to £1. Meanwhile the end of yen carry trade has caused the resurgence of yen against many other currencies. Yen carry trade is the practice of borrowing in yen (cheap to borrow in yen) to invest in other countries that yield higher interest rates, taking advantage of the differential in rates offered. However, vibrant dollar & yen means relatively more expensive to import from these two. As such the demand for exports will fall, causing a fall in AD & thereby hurting the real economy

(8) Slowing capital inflow. Capital inflows to developing countries are estimated to fall by 50% due to credit squeeze next year, fuelling the fear that emerging economies are not spared from the crisis. This had been the prime pillar that supports the strong performance in NICs (Newly Industrialised Countries) in the past 5 years. Lesser capital inflow necessarily means fall in number of new firms set up. As such there will be lesser new jobs. There is also no clear indicator that credit crunch issue will resolve in near future. Banks have been reluctant to approve financing & pass on rate cuts. The logic is, if they pass on the rate cut in the form of cheaper borrowing, it means they will have to cut savings rate too in order to preserve their profit margin. If savings rate is low, they will fail to recapitalise & create additional loan

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