Will the US Recession lead to Global Slowdown? What Role for China and India?

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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

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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

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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.

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US Imports and Consumption
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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

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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

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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 Chinas 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

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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.

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Foreign Exchange Transactions
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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-branchescollaborate 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.

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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?

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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

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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.

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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.