Recession Fades in Australia on Confidence, China

The Reserve Bank of Australia recently held rates at 3.0%. The cost of borrowing compares to 0.5% in the UK. 1.0% in the Euro-Zone and the 0.0% to 0.25% band in the US.

Whilst the RBA’s monetary policy hints at a 2009 recovery their accompanying comments leave no-doubt Australia will be one of the first G20 nations to exit recession and return to growth. The RBA confirmed downside risks have diminished and recent upgrades to Chinese GDP would help the wider region and Australia to enjoy healthy growth in 2010. Interestingly, the RBA took the time to highlight its cautious confidence in a US recovery but suggested the Euro-Zone remained behind the curve. The sentiment mirrors the thoughts of the IMF in their July World Outlook Update.

The Australian Central Bank also cited fast improving domestic consumer confidence and a pick-up in housing with a healthy number of first-time buyers joining the market. Also highlighted is an absence of labour cost inflation further helping the RBA to keep rates on hold for now rather than tightening monetary policy possibly too early and thereby threatening the recovery. On a more cautious note the willingness of companies to borrow remains subdued despite the 3.0% interest rate, low by Australia’s historical standards.

In summary the combination of fast rising consumer confidence, recovering commodity demand from China and continued domestic monetary and fiscal support suggests the pace of the Australian recovery will remain intact. The International Monetary Fund’s recent upgrade to its GDP forecast also reassures with a revised prediction of a modest -0.5% contraction in the current year and growth of 1.5% for 2010.

EWA to 18th July 2009

IMF Offer Hope for 2010 Return to Growth

The International Monetary Fund (IMF) has released a World Economic Outlook update with revised 2009/10 output predictions. The July 10th publication is a timely follow-up to the comprehensive and excellent April 2009 report, which in great detail highlighted the failings within the banking sector (which prompted a global recession) and offered readers a number of common sense, and academically robust solutions to prevent a re-occurrence.

The latest IMF outlook is cautiously optimistic. Of significant interest is the revised output forecasts for 2009 relating to developed and emerging nations. Recovery expectations have been uniformly lowered for developed countries, and predominately raised for emerging nations (Mexico a notable exception).

On cursory examination with world output predicted to fall by -1.4% in the current year pessimists can legitimately cite a global recession, but closer inspection provides some surprises and indeed reinforces hopes that 2010 will most definitely close the door on the most serious economic challenge since the Great Depression.

Revised output expectations, by country or region for 2009, are below with strongest output detailed first:

China 7.5%
Emerging Asia 5.5%
India 5.4%
Middle East 2.0%
Africa 1.8%
Brazil -1.3%
World -1.4%
US -2.6%
Euro-Zone -4.8%
Japan -6.0%
Russia -6.5%
Mexico -7.3%

The revised world forecast for 2010 offers 2.5% output growth, year-on-year, with only the Euro-Zone predicted to stay in recession, albeit it by a modest -0.3%.

The IMF cites recent massive fiscal and monetary government stimulus as the primary reason for the 2010 growth prediction. Keen eyed observers would be forgiven for interpreting the IMF message as an implication the European Central Bank and Euro-Zone authorities have acted with insufficient haste and action in tackling the recession. A review of ECB monetary action over the past 18 months supports that implication.

Clearly emerging countries have generally faired better than developed nations, except for Mexico and Russia for country specific reasons. Mexico has suffered disproportionately following the swine flu pandemic whilst Russia entered the global recession as the “least favored” trading partner following a number of commercial, energy and geo-political disputes with key commerce partners. Russia’s inability to diversify its economy away from oil and gas also created a slump in the face of fast falling energy prices.

Overall the IMF report does imply a very high probability of a widespread return to economic growth late in 2009 or early 2010. Bearish equity investors, who have convinced themselves that risky assets are poised to return to March lows on the back of doomsday economic predictions, may have revisit their price targets.

Urgent Credit Reform Needed to Ease Recessions

In a recent article “Stimulus Package Rebuilding Same Myth of Debt Fueled Economic Growth” I suggested sustained economic growth could only be achieved if excess money supply over and above the real economic worth of society was applied to new investment, rather than consumption or financial transactions. I also suggested in a following article “Two Asset Classes in Times of Turmoil: Risky and Risk-Free” that the incorrect allocation of excess money supply to financial transactions and consumption created at best a zero-sum scenario for the global economy with the increase in demand for goods and assets leading to inflation and price bubbles, not sustained real economic growth. The article concluded that investors, in the current environment of increased global economic synchronisation, had little opportunity to protect the nominal value of their risky asset portfolios as the correlation between most risky assets, gold a notable exception, increased sharply in times of economic and financial turmoil.

In the third and final article of the series, I will draw on extensive International Monetary Fund research which clarifies the reasons why systematic failure in the financial sector causes recessions to be longer, more severe and more contagious across international borders.

The IMF analysed 122 country specific recessions since 1960 across a sample of 21 advanced economies. Some countries, Ireland, Sweden, Norway, Japan and Canada entered only three recessions during the 50 year period. Switzerland and Italy suffered nine each. New Zealand led the sample with 12 instances of at least two consecutive quarters of economic contraction (the official definition of a recession). The US and UK suffered six and five recessions respectively.* Not surprisingly when the US was in recession the contraction had significantly more impact globally and during five of the six US recessions, more than ten of the 21 sampled countries also fell into recession.

Also provided by the IMF were details of the average duration of recessions, recoveries and expansionary periods since 1960. A recovery is defined as the length of time the economy takes to re-capture the GDP output level of the previous peak. Including contractions prompted by a financial crisis the average recession lasted 3.64 quarters. The average recovery period was 3.22 quarters and the average expansionary period lasted 21.75 quarters. Analysing only the contractions caused by systematic financial failure, the average length of recessions increased to 5.67 quarters. The recovery period also lengthened to 5.64 quarters on average. Interestingly the period of economic expansion following a financial crisis recession also increased to 26.40 quarters, possibly due to the introduction of much needed economic reform which inevitably follows systematic failures.

My wording clearly implies a financial crisis causes a recession to be deeper and longer. But could it be the case that deeper recessions cause a financial crisis? The IMF kill off this suggestion.

The fund researched credit availability, consumption, employment levels, nominal wages, house prices and equity prices in the expansionary periods leading to recessions and a clear and disturbing pattern emerged. Prior to a financial crisis recession (relative to other recessions); credit was more freely available, consumption was higher, the employment rate was higher, nominal wages were higher and house and equity prices were at more inflated levels. Unfortunately, unemployment levels took longer to improve as well following a financial crisis. The IMF went further and highlighted a strong relationship between country specific deregulation of credit markets and the depth and severity of the following recession. To put it simply, if you unleash cheap money and easily available credit you will get a very nasty recession when the bubble bursts.

The above findings support my more simplistic analysis which suggested debt, and its misallocation, above all other reasons is the cause of both the boom and bust economic cycle and the severity of the current global recession.

The IMF concluded its research with a discussion relating to the effectiveness of monetary and fiscal stimulus. Non financial recessions responded better to monetary intervention. Financial crisis recessions responded better to fiscal stimulus. In all instances the recovery was accelerated when both fiscal and monetary action was taken, rather than just one of the two. There was no evidence that monetary easing or fiscal stimulus delayed or damaged a demand led recovery.

The solution is clear, fundamental reform of credit markets is urgently required including the introduction of legislation limiting the availability of debt for speculative financial transactions and consumption in periods of economic expansion. My conclusion would be vulnerable in isolation, but combined with the IMF research it’s increasingly hard to argue against massive reform of credit markets.

*The US actually suffered seven occasions of at least two consecutive quarters of economic contraction but two separate instances in the early 1980’s were so close, I have defined them as being part of the same prolonged recessionary period.

Data source: International Monetary Fund

IMF Analysis of Recessions 1960 to 2009

ECB Decision Makers Prepare for Summer School

Representatives of the G8 are meeting again as I write, to practise the art of talking. The self-described syndicate of “main industrialised countries” have perfected the process of conducting a whirlwind of meetings, agreeing a globally co-ordinated strategy, presenting unity to the world’s press then returning home to focus on their own unique objectives. China and India must be increasingly bemused at being denied a seat at the exclusive G8 table which remains a predominately European and Anglo-Saxon affair. Admittedly Japan is a member, one of the six founding members from the first 1975 meeting, as is Russia which joined in 1991, but the group remains an old-boys club for Europeans and North Americans who cling to the memories of global economic dominance, long faded. Actually, there aren’t eight members at all in the G8. There are nine. The European Union also has membership. For clarity, the complete roll-call consists of the US, UK, France, Germany, Italy, Canada, Russia, Japan and the E.U.

Maybe because the British and French economies have been in relative decline for the longest, eroding their delusions of self-importance, they have most forcefully argued for the inclusion of the five key emerging economic powers, (Brazil, India, China, Mexico and South Africa) into a permanent enlarged forum to replace the G8. Meanwhile, Japan, devoid of oil and commodity resources, has been more than empathetic to the view that the Middle East should be represented. Under such circumstances, it’s easy to see why a Federal Reserve meeting or dare I say a Condoleezza Rice visit to China is actually of more economic significance than the annual G8 photo-shoot.

Cynicism aside, even if G8 action is inevitably absent following the meeting, the leaders still discuss the issues and therefore the agenda, in itself, is worthy of discussion. This weekend’s agenda includes the design of an “appropriate framework” to extract the unprecedented economic stimulus executed in recent months. The inclusion of such a discussion point proves two things. Firstly, the global economy as a whole, is recovering. Secondly, it supports the growing view that inflation is returning and if unchecked may become a real obstacle to stable growth in 2010/11.

The G8 have a major challenge on their hands. Regular readers of this column are well able to identify this. The rate of recovery differs greatly from country to country. China never fell into a recession. Commodity producing regions are already benefiting from fast-rising resource prices. The UK economy apparently returned to positive growth in April. The US economy is still a hit-and-miss proposition, albeit improving by the week, whilst Europe remains the problem child. How can a single global strategy be executed, withdrawing economic stimulus, as whatever pace is chosen for that strategy it will be fundamentally wrong for countries at either extreme of the global economic recovery?

The French, apparently, are trying to kill off any discussion regarding the easing of current stimulus measures, whilst at the other end of the economic spectrum, Canada, is lobbying for support to agree an “exit strategy” fearing inflationary pressures. Meanwhile, the US acknowledges some progress made but is keen to let the stimulus package run for some time yet before drawing excess liquidity out of the financial system.

If you can legitimately blame poor Anglo-Saxon risk controls, within the banking sector, for creating the global recession, it’s equally valid to suggest the European Central Bank (ECB) is at fault for allowing Europe to trail the UK, US and Asia in the global recovery. ECB monetary policy over the past year has been just unforgivable. But don’t take my word for it. Let’s review what the International Monetary Fund (IMF) articulated in their recent European economy review.

The IMF, in the very first paragraph of its June 8th report commented Europe needs to “take further decisive action, especially in the financial sector”. The report progressed, suggesting the European bureaucrats were missing “a proactive strategy” and they should pursue a “cleansing of the financial system without delay”. Unemployed Europeans must be dying of frustration. At least the Americans and British left no monetary stone un-turned in their efforts to stimulate growth. The author of this damning report, the IMF, is rated very highly indeed. The institution is full of quite brilliant economists. With relatively limited power it has competently pursued its primary aim of helping countries improve their macroeconomic and financial infrastructure since its inception in 1944. I would gladly pass European monetary policy control to the IMF immediately, thereby allowing ECB members to attend the excellent London School of Economics summer school course in Introductory Macroeconomics, which I can vouch for, following my attendance nineteen years ago. Of course, I joke, ECB decision makers should be well capable of tackling the intermediate course.