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, $6 trillion in lost housing wealth, combined with
slumping equity valuations will result in the worst consumer recession
since 1980.
• Rate of real Personal Consumption Expenditure dropping to -1.0% by 4Q
2008, led by double-digit declines in consumer durables.
US Imports and Consumption
Imports, Customs Value: Goods
% Change - Year to Year
SA, Mil.$
Retail Sales & Food Services
% Change - Year to Year
SA, Mil.$
30
12.5
10.0
20
7.5
10
5.0
0
2.5
-10
0.0
-20
-2.5
90
95
Sources: Census Bureau, Census Bureau/Haver Analytics
00
05
4
1999:I
1999:II
1999:III
1999:IV
2000:I
2000:II
2000:III
2000:IV
2001:I
2001:II
2001:III
2001:IV
2002:I
2002:II
2002:III
2002:IV
2003:I
2003:II
2003:III
2003:IV
2004:I
2004:II
2004:III
2004:IV
2005:I
2005:II
2005:III
2005:IV
2006:I
2006:II
2006:III
2006:IV
2007:I
2007:II
2007:III/p/
5000
-25000
0
US Bilateral Goods and Services Balance 1999-2007 IIIQ
-10000
0
-10000
Japan
-20000
-5000
-30000
-40000
-50000
-15000
-60000
-20000
India
-70000
China- right axis
-80000
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
China Net Merchandise Trade
200.0
World
United States
150.0
European Union (25)
Russian Federation
Africa
100.0
Asia
Japan
Six East Asian traders
50.0
0.0
1996
-50.0
-100.0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
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.
12,000
Direct Investment in US 2006 QI-2007 QIII
$million
Japan
400
Asia and Pacific
China right axis
10,000
300
India right axis
Hong Kong right axis
200
8,000
100
6,000
0
-100
4,000
-200
2,000
-300
0
-400
I
II
III
IV
I
IIr
IIIp
US Net FDI Flows
4 Q Moving Averages NSA 1995-2007Q2
60,000
Total
Canada
50,000
Asia and Pacific
40,000
Europe
OPEC2
30,000
$ million
20,000
10,000
0
-10,000
-20,000
-30,000
-40,000
Net Non-Resident Acquisition of US Long-Term Securities
1977-2007 monthly data 12 mo moving averages
90000
80000
70000
60000
Total Net
50000
Total Europe
$ million
Total Asia
40000
Total Latin America
30000
20000
10000
0
-10000
-20000
Asian Net Purchases of US Securities
monthly data 12 month moving averages 198/2007
35000
30000
Total Asia
25000
Govt Securities
Equity
20000
$ million
Non-Govt bonds
15000
10000
5000
0
-5000
-10000
China Composition of Acquisition of US Long-Term Securities
1984-2007 (monthly data 12 month moving averages)
14000
12000
Total China
Goverment & Agency
10000
Non-Government
Equity
$ million
8000
6000
4000
2000
0
-2000
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 of
China and other countries in the developing
world.