The Crisis is not over.

Easing of the current situation but bleak prospects

Paper to be published in the Russian magazine Ekspert in October 2009

Jacques SAPIR

Director, CEMI-EHESS

The economic situation is now giving worldwide signs of improvements. It would be however premature to consider the crisis as over. If the recession is now easing somewhat in different countries, this trend could be short lived. The fundamentals of most Western economies are still bad and there are no signs of a general amelioration. What is more very few seems to have been done to solve the bank crisis and most spectacularly in the USA where the Obama’s administration has failed hopes. Such a situation is presenting Russia with a considerable challenge.

In the USA, where unemployment rate has reached 9.7{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} in August 2009, the rate of increase in the number of unemployed persons is easing. But there will be no reversal of the trend before the end of the year. At best one could expect stabilization by the first quarter of 2010. The US GDP has been falling since the mid-2008 with four consecutive quarters of production decline, making it the longest contraction of the after war period. It is to expend by 2.2{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} to 2.9{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} for the third quarter of 2009. This has prompted the chairman of the FED, Mr.Ben Bernanke, to announce the end of the recession. This is however premature.

In the housing market, there has been some rebirth of interest mostly linked to the very sharp prices drop of the previous year and a similar sharp drop in interest rates. However, for a majority of household there has been too a trend toward de-leveraging and an increase of savings. The number of “delinquent” mortgages had reached 9.12{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}. It will certainly continue to grow up, may be to 15{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}. This is to have an impact on the banking system Federal Reserve efforts to bring down borrowing costs to revive the housing market and help the economy are stalling. The Home Equity Extraction effect, which was supplying total demand with a yearly 3{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} increase has dried up by the end of 2007 and is not reborn. A negative wealth effect has been predominant since the Lehman Brothers induced liquidity crisis. Consumer credit fell by 10 percent at an annual rate in July to $2.5 trillion, according to a Federal Reserve report. The $21.6 billion drop was the sixth consecutive decrease, making it the longest series of declines since 1991.

Most US growth has been driven by the rebuilding of inventories, and by some measure, affecting the car-making industry. Consumer spending likely rose 1.7 percent this quarter. The government’s “cash for clunkers” program increased spending and had an impact on payrolls.

But, rebates ended on August 24th and consumer spending rose because of these rebates. If that explained the rebuilding of inventories in the car-making industry, it is not a situation that will be sustainable and consumption is to stagnate or even decline again in coming months.

Sources: US Bureau of Economic Analysis

For 2010, the production is to be supported mostly by Government expenditures with a GDP 13.6{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} deficit for FY-2009 and a probable one of 8{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}/9{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} for FY-2010[1] Exports too are slightly increasing as the US Dollar is now gliding down compared to the Euro and the Yen. But internal consumption will still be oriented downwards. The resulting growth is to be very small if any. If nothing is to change, the US economy will not regain its 2007 level before 2011 at best, and will keep an unemployed percent of its workforce of about 10{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} to 11{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}, in official numbers[2].

Japan is certainly among developed economies the one who had contracted most spectacularly. The fall of exports has been particularly felt and has induced a sharp drop of GDP. The Bank of Japan is still keeping its interest rates at 0.1{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} as deflationary trends looms over the Japanese economy[3].

Fourth-quarter GDP was revised to a 13.5 {9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} decline from 14.4 {9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}. That’s still the worst contraction since the government began keeping records in 1955. Capital spending fell 8.9 {9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} compared with a preliminary 10.4 {9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} and exports fell 26{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}. The decline may represent the low point for an economy forecast to expand this quarter as demand from China, which knows a strong growth and where the government is spending $586 billion on roads, hospitals and housing, helps stabilize exports. Leaner inventories allow manufacturers to increase output.

The recession has shown signs of easing. Still, with factories sitting idle and profits falling, companies are slashing investment and jobs, casting doubt on whether the revival will last. The change in government has led to a return of consumer confidence. But, the risk of a deflation is still looming and the economy may slip back into the kind of deflationary malaise that caused wages to fall by about 10 percent in the decade through 2005. The rise of the Yen against the US Dollar is not speaking well about a prompt recovery of the Japanese industry.

In Europe, the situation is too quite depressing. The European Union has done a significant effort to cope with the banking crisis, but not for boosting its economy.

In Great-Britain, the situation of the real estate market has stabilized a bit, but after some really spectacular drop in prices. The GDP is to fell by 5{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} this year. The Bank of England Governor said that households will keep feeling pain from the recession as the economy embarks on a “highly uncertain” recovery[4]. Consumers are struggling to pay off record debts of 1.5 trillion pounds ($2.5 trillion and nearly GDP 110{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}) of debt. Unemployment, currently at a 14-year high with 7,9{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}, is increasing fast. Actually, sales for August at non-food stores fell by 0.6 {9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} on the month, led by textile, clothing and footwear, the statistics office said. That outweighed a 0.7 {9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} increase in food sales. But, the worse is still to come. The retailer forecasts a drop of 3.5 percent to 6.5 percent in same-store sales for the year. It expects declines in that revenue through at least mid-2010 as public spending cuts hurt employment and tax increases reduce disposable income.

In Germany, we have a significant improvement of the business climate, but one relying much more on expectations than on realities.

In the industry the contraction shock led by falling exports as generated a very strong move of curtailing inventories. There has been a distinct sense of overshooting. There is now a correction and the German GDP is to grow for the 3rd and the 4th quarter of 2009. Still, the

drop of GDP is to be of at least 5{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} for 2009, one of the worst figures in Europe.

In manufacturing the business climate is less unfavourable than in the previous month but with still difficulties in the car-making sector where the upper-hand products have difficulties

to find customers. In construction the business climate has brightened somewhat. With regard to future business, their caution remains largely unchanged.

Although the retailers are again slightly more dissatisfied with their current business situation,

they are less pessimistic regarding business developments in the coming six months. This is probably linked to the unemployment situation. However the global situation is far to be a good and German bank are highly exposed to the east-European risk.

German industry is to suffer much from the Euro overvaluation with the Euro worth of more 1.45USD and could expand only at the detriment of its foreign partners, and most precisely of

its neighbours[5].

In France, where we expect a drop of GDP of -2{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}/-2,2{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}, the economic situation has been supported by a similar “cash-for-clunker” policy than in the USA. It avoided too strong a drop

in the car-making industry but to the detriment of consumption in 2010. The process of cutting inventories has been particularly sharp during the first months of 2009. This process is

however easing and this had led to some burst of activity. In the same time automatic stabilizers (social benefits) have avoided household demand to drop too fast.

Nevertheless, competition from low-cost countries, and specifically non-Euro European countries is increasing and is to lead in coming months to a new wave of delocalization which

is to lead to some rise in unemployment but probably not before the end of the year. Small and medium sized industrial enterprises are devastated by a combination of reduced demand and more stringent conditions for bank credits.

This leads us to the Mediterranean countries of the EU. In Spainthe number of unemployed

people reached 17{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} this summer and is still growing to reach probably over 20{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} by end year.

In the house-building industry we are down to a 100,000 house a year tempo, when we have been at 1 million a year in 2007. Public debt, which has been one of the lowest in Europe is now increasing fast. The GDP is however to fall by “only” -4{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}. This is most certainly the result of aggressive stimulus measures taken both by the general government and by government of provinces. However, the crisis is to severely tasks these budgets and by 2010 the GDP fall is again to be between -1.5{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} and -2.5{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}.

Greececertainly looks like a basket case. Income, be they from shipping or tourism, is usually coming in US dollar. Expenditures are made in Euro. The current undervaluation of the US Dollar is then hitting the country particularly hard. General elections of October 4th are to lead to a return of PASOK (Socialist party). It is to be seen what will be the policy of the new government, but chances of Greece, which has been rated A-, of staying in the Eurozone are pretty small.

Italy, with a government debt of over GDP 100{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} and still increasing and a recession of GDP

-4.5{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} could then be the next country to be tested. It recently issued bond futures on its public

debt[6], something having been discarded with the entry in the Eurozone, in 1999.

The issue of the public debt is then to be included in short to mid-term forecasts. There is a global trend of government debt increase all across the board.

This increase has been most spectacular among countries having by 2007 a relatively low level of debt. It has been truly spectacular for Ireland and Spain. But even in countries where the Government debt was larger the increase has been quite fast, as in the USA. What is more, the level of Households and Enterprises debt is to be included here.

If household have reduced their debt, by intent or through the policies of banking sectors, enterprises have increased their levels of indebtedness because of the crisis.

The issue is then twofold. First, there is to be a strong deflationary pressure if all countries are

trying to reduce their debt levels at the same time. This would certainly make the crisis to be longer. Second, the total level of the US debt is not just to be of 91{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} in 2010 but one has to add at least 176{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163} of Household and Enterprises debt, for a total of 267{9ef37f79404ed75b38bb3fa19d867f5810a6e7939b0d429d6d385a097373e163}. This is to exert a strong pressure on the US Dollar if only because of the amount of the debt brutally issued.

All indicators are showing that the current easing of economic conditions in developed countries is not the harbinger of things to come. The current rally on stock markets seems to be more linked with speculation than on hard facts.

This has distinct consequences for developing countries, and most notably for Russia. It would be foolhardy to bank on a prompt recovery in the West, and particularly in the EU, to pull the Russian economy. China has made what is probably the best decision it could by opting for the development of its internal market. The Chinese growth, and possibly the Indian one, is to be beneficial to Russia, particularly in helping stabilize commodities price, but not enough to help foster growth at a high level. Only emulating China and developing the internal market, probably combined with some degree of protection, could allow Russia to exit fast from the crisis.