American Recessional? The Crisis of Globalization Ottawa, February 23, 2009

The end of the Age of Leverage

The end of the Age of Leverage At peak, U.S. consumption was 72% of GDP Pre-bubble norm 1975 to 2000: 67% But income from labor didn’t keep pace Net equity extraction from 3% of disposable personal income in 2000 to 9% in 2006 From 1997 to 2008 amount of debt required to generate $1 of GDP grew from $2.50 to $3.50 Net national saving declined and then turned negative So U.S. had to rely on capital imports $3bn of capital inflows each business day

At peak, U.S. consumption was 72% of GDP

Pre-bubble norm 1975 to 2000: 67%

But income from labor didn’t keep pace

Net equity extraction from 3% of disposable personal income in 2000 to 9% in 2006

From 1997 to 2008 amount of debt required to generate $1 of GDP grew from $2.50 to $3.50

Net national saving declined and then turned negative

So U.S. had to rely on capital imports

$3bn of capital inflows each business day

Global imbalances

Fuelled a property bubble and bust

Not Great Depression 2.0 … Yet

Not Great Depression 2.0 … Yet GDP declined at annual rate of 14% 1929-33, c/w -3.8% in 2008-IV and est. -1.6% this year Inflation -8% YoY at worst in GD, but CPI YoY 0% in January 09 and +1.7% excluding energy and food Though CPI Oct-Dec annualized rate -12.7% Unemployment peaked at 25% in GD c/w 7.2% and likely max. of 11% Stock market down 86% in GD, but only ~45% since October 07

GDP declined at annual rate of 14% 1929-33, c/w -3.8% in 2008-IV and est. -1.6% this year

Inflation -8% YoY at worst in GD, but CPI YoY 0% in January 09 and +1.7% excluding energy and food

Though CPI Oct-Dec annualized rate -12.7%

Unemployment peaked at 25% in GD c/w 7.2% and likely max. of 11%

Stock market down 86% in GD, but only ~45% since October 07

But a Great Recession … House prices down 25% from peak and falling 13.6m homeowners underwater Savings rate up from 0.7% to 3.6% Sept-Dec U.S. banks (17% of lending) are in freefall Projected losses on unsecuritized loans $1.1trn + securities write-downs ~$700bn = $1.8trn (Roubini) FDIC insured banks’ capitalization $1.3trn; investment banks’ $110bn after TARP recap of $230bn Securitization markets (22% of lending) have collapsed 2008 c/w 2007 US commercial MBS -95%; US student loan ABS -47%; US auto ABS -45%; US credit card ABS -24%

House prices down 25% from peak and falling

13.6m homeowners underwater

Savings rate up from 0.7% to 3.6% Sept-Dec

U.S. banks (17% of lending) are in freefall

Projected losses on unsecuritized loans $1.1trn + securities write-downs ~$700bn = $1.8trn (Roubini)

FDIC insured banks’ capitalization $1.3trn; investment banks’ $110bn after TARP recap of $230bn

Securitization markets (22% of lending) have collapsed 2008 c/w 2007

US commercial MBS -95%; US student loan ABS -47%; US auto ABS -45%; US credit card ABS -24%

The new policies Term Asset-Backed Securities Loan Facility (TALF) to revive securitization with up to $1trn Public Private Investment Fund (PPIF) to buy up to $1trn of bank assets American Recovery and Reinvestment Act (ARRA) $787bn ~5.5% of projected GDP Homeowner Affordability and Stability Plan (HASP) $275bn to reduce interest payments for 7-9 million homeowners

Term Asset-Backed Securities Loan Facility (TALF) to revive securitization with up to $1trn

Public Private Investment Fund (PPIF) to buy up to $1trn of bank assets

American Recovery and Reinvestment Act (ARRA) $787bn ~5.5% of projected GDP

Homeowner Affordability and Stability Plan (HASP) $275bn to reduce interest payments for 7-9 million homeowners

(Out of the) ballpark figures CBO estimated deficit to be $1.2trn (8.3%) before stimulus package so could go to $1.4trn this year (~10%) Total exposure of taxpayer: ~$9.7trn Federal Reserve, Treasury Department and Federal Deposit Insurance Corporation have already lent or spent almost $3trn over past 2 years and pledged to provide up to $5.7trn more if needed $1trn in stimulus packages, ~$3trn in lending and spending and $5.7trn in agreements to provide aid (Bloomberg)

CBO estimated deficit to be $1.2trn (8.3%) before stimulus package so could go to $1.4trn this year (~10%)

Total exposure of taxpayer: ~$9.7trn

Federal Reserve, Treasury Department and Federal Deposit Insurance Corporation have already lent or spent almost $3trn over past 2 years and pledged to provide up to $5.7trn more if needed

$1trn in stimulus packages, ~$3trn in lending and spending and $5.7trn in agreements to provide aid (Bloomberg)

Who pays? At height of the credit boom, 50% of all borrowing by US households and non-financial businesses was financed by foreigners, with Asian central banks playing the lead role Chinese reserves ~$2.3trn of which $1.7trn in USD Last year Chinese holdings of Treasuries rose 15% to ~ $700bn But quarterly pace of accumulation in China’s foreign exchange reserves plunged 74% last year In November China was a net seller of $9.2bn of Treasuries China’s foreign reserves will increase by only $177bn this year, down from ~$415bn last year Total Chinese outflows in the fourth quarter of 2008 were as much as $240bn

At height of the credit boom, 50% of all borrowing by US households and non-financial businesses was financed by foreigners, with Asian central banks playing the lead role

Chinese reserves ~$2.3trn of which $1.7trn in USD

Last year Chinese holdings of Treasuries rose 15% to ~ $700bn

But quarterly pace of accumulation in China’s foreign exchange reserves plunged 74% last year

In November China was a net seller of $9.2bn of Treasuries

China’s foreign reserves will increase by only $177bn this year, down from ~$415bn last year

Total Chinese outflows in the fourth quarter of 2008 were as much as $240bn

The perils of protection Geithner’s accusation of “currency manipulation” at his confirmation hearing Over the 2005–07 period, fully 45 pieces of anti-China trade legislation were introduced in the US Congress, tho’ not passed Stimulus package’s “Buy America” provision and the restriction on H-1B visas for new NY bank hires All a little worrying when 80%+ of Canada’s exports go to the U.S.

Geithner’s accusation of “currency manipulation” at his confirmation hearing

Over the 2005–07 period, fully 45 pieces of anti-China trade legislation were introduced in the US Congress, tho’ not passed

Stimulus package’s “Buy America” provision and the restriction on H-1B visas for new NY bank hires

All a little worrying when 80%+ of Canada’s exports go to the U.S.

Geopolitical implications?

1. Even faster Chinese catch-up?

2. Like £, $ to lose reserve status?

But God still watches over …

1. Crisis could slow catch-up

2. And dollar has rallied

Along with US Treasuries

Why? It’s not just a global crisis

It’s a crisis of globalization

And that hits others harder It’s an unfair world: The American crisis hurts others more than it hurts America Because the U.S. retains “safe haven” status, despite its fiscal problems Which is because of its relative political stability in an increasingly unstable world Which gives it maximum fiscal and monetary room for maneuver

It’s an unfair world: The American crisis hurts others more than it hurts America

Because the U.S. retains “safe haven” status, despite its fiscal problems

Which is because of its relative political stability in an increasingly unstable world

Which gives it maximum fiscal and monetary room for maneuver

But worse for allies than rivals? U.S. -1.6% Eurozone -2.0% Germany -2.5% Japan -2.6% UK -2.8% Canada -2.8%* Asian NICs -3.9% China +6.7% India +5.1% Middle East +3.9% Sub-Sahara +3.5% Russia -0.7% C&E Europe -0.4% (all figures are IMF forecasts for 2009 % change in real GDP)

U.S. -1.6%

Eurozone -2.0%

Germany -2.5%

Japan -2.6%

UK -2.8%

Canada -2.8%*

Asian NICs -3.9%

China +6.7%

India +5.1%

Middle East +3.9%

Sub-Sahara +3.5%

Russia -0.7%

C&E Europe -0.4%

(all figures are IMF forecasts for 2009 % change in real GDP)

1. The indebted Anglosphere Canada Australia Britain USA

Canadian virtue: Its own reward Banks leveraged at 18 to 1, compared with U.S. banks 26 to 1 12 years of budget surpluses Home prices down ~12% No mortgage interest deduction, no non-recourse loans But 80% of trade is with U.S. Canada now contracting faster than U.S.

Banks leveraged at 18 to 1, compared with U.S. banks 26 to 1

12 years of budget surpluses

Home prices down ~12%

No mortgage interest deduction, no non-recourse loans

But 80% of trade is with U.S.

Canada now contracting faster than U.S.

2. A tale of two Asias Japan’s industrial output down 23% since September Collapse of Chinese demand plus strong ¥ NICs: Singapore to contract 5%, S. Korea by 4% Exports, net of import content, are two-thirds of GDP in Hong Kong and Singapore, half for Malaysia and Thailand, one-third for South Korea and Taiwan China to grow ~6.7% 20m rural migrant workers, 15 per cent of the total, have lost jobs China’s stimulus: fiscal deficit of 111bn yuan in 08 But export reliance (36% of GDP) makes China vulnerable India will grow 5.1% More Slumdog Millionaires?

Japan’s industrial output down 23% since September

Collapse of Chinese demand plus strong ¥

NICs: Singapore to contract 5%, S. Korea by 4%

Exports, net of import content, are two-thirds of GDP in Hong Kong and Singapore, half for Malaysia and Thailand, one-third for South Korea and Taiwan

China to grow ~6.7%

20m rural migrant workers, 15 per cent of the total, have lost jobs

China’s stimulus: fiscal deficit of 111bn yuan in 08

But export reliance (36% of GDP) makes China vulnerable

India will grow 5.1%

More Slumdog Millionaires?

3. The centrifugal Eurozone IMF says European and British banks have 75% as much exposure to U.S. toxic assets as American banks themselves, yet write-downs have been $738bn in the U.S.: just $294bn in Europe In January 2009, yield spreads on 10-year Portuguese, French, Belgian, Greek, Spanish, Italian, Irish and Dutch bonds over benchmark German Bunds reached highest level since 1999 West European banks provided three-quarters of the $4.7 trillion in cross-border loans to the Baltic countries and Eastern Europe Exposure to eastern Europe is ~80% of Austrian GDP

IMF says European and British banks have 75% as much exposure to U.S. toxic assets as American banks themselves, yet write-downs have been $738bn in the U.S.: just $294bn in Europe

In January 2009, yield spreads on 10-year Portuguese, French, Belgian, Greek, Spanish, Italian, Irish and Dutch bonds over benchmark German Bunds reached highest level since 1999

West European banks provided three-quarters of the $4.7 trillion in cross-border loans to the Baltic countries and Eastern Europe

Exposure to eastern Europe is ~80% of Austrian GDP

Europe’s bank nightmare

4. Eastern Europe’s crisis

The political consequences … Not only Canada … Greece, Iceland, Thailand Feb. 22: Latvia’s four-party coalition government resigned after two parties called for Prime Minister Ivars Godmanis to step down

Not only Canada …

Greece, Iceland, Thailand

Feb. 22: Latvia’s four-party coalition government resigned after two parties called for Prime Minister Ivars Godmanis to step down

The bluffer: Putin at Davos “ There was a serious malfunction in the very system of global economic growth – namely, when one regional center endlessly prints money and reaps the benefits … “… the excessive dependence on what is basically the only reserve currency is dangerous for the world economy. So it would be reasonable to stimulate a process of getting a number of strong reserve currencies. “… The unipolar pattern of the world economy that is completely outdated by now must be replaced by a new system based on cooperation of several big centres. … “ Let us be frank: provoking military-political instability and other regional conflicts is also a convenient way of deflecting people’s attention from mounting social and economic problems. Regrettably, further attempts of this kind cannot be ruled out.”

“ There was a serious malfunction in the very system of global economic growth – namely, when one regional center endlessly prints money and reaps the benefits …

“… the excessive dependence on what is basically the only reserve currency is dangerous for the world economy. So it would be reasonable to stimulate a process of getting a number of strong reserve currencies.

“… The unipolar pattern of the world economy that is completely outdated by now must be replaced by a new system based on cooperation of several big centres. …

“ Let us be frank: provoking military-political instability and other regional conflicts is also a convenient way of deflecting people’s attention from mounting social and economic problems. Regrettably, further attempts of this kind cannot be ruled out.”

Why he’s bluffing Russia will run out of reserves in just 14 months if it keeps spending them on currency intervention at current pace

The real challenge? Wen at Davos “ The crisis has fully exposed the existing international financial system and governance structure defects. … [It is necessary to] increase the voice and representation of developing countries in international financial organizations and actively fulfill its [sic] role in the maintenance of international and regional financial stability.” (Wen Jiabao at Davos) “ Whether China will continue to buy [U.S. bonds], and how much to buy, should be in accordance with China’s needs, and depend on the safety and protection of value of foreign exchange.” (Wen Jiabao at weekend)

“ The crisis has fully exposed the existing international financial system and governance structure defects. … [It is necessary to] increase the voice and representation of developing countries in international financial organizations and actively fulfill its [sic] role in the maintenance of international and regional financial stability.” (Wen Jiabao at Davos)

“ Whether China will continue to buy [U.S. bonds], and how much to buy, should be in accordance with China’s needs, and depend on the safety and protection of value of foreign exchange.” (Wen Jiabao at weekend)

Or maybe not “ Except for US Treasuries, what can you hold? Gold? You don’t hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option. We hate you guys. Once you start issuing $1 trillion-$2 trillion … we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.” (Luo Ping, a director-general at the China Banking Regulatory Commission, Feb. 11)

“ Except for US Treasuries, what can you hold? Gold? You don’t hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option. We hate you guys. Once you start issuing $1 trillion-$2 trillion … we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.” (Luo Ping, a director-general at the China Banking Regulatory Commission, Feb. 11)

The People’s Daily , Feb. 20, 2009 “ China and US have become stakeholders in terms of bilateral trade, a common destiny to share fortunes. Niall Ferguson, a US professor coined the term ‘Chimerica’. ‘Chimerica is a fantasy country that I dreamt up a couple of years ago. It’s the economy you get when you add together China plus America,’ said Ferguson. “… vividly common interests have tied China and US closer and closer together [and] the bilateral ties have gained more and more global importance and influence. … Generally speaking, China-US relations will be following a period of chillness before heading towards normalization.”

“ China and US have become stakeholders in terms of bilateral trade, a common destiny to share fortunes. Niall Ferguson, a US professor coined the term ‘Chimerica’. ‘Chimerica is a fantasy country that I dreamt up a couple of years ago. It’s the economy you get when you add together China plus America,’ said Ferguson.

“… vividly common interests have tied China and US closer and closer together [and] the bilateral ties have gained more and more global importance and influence. … Generally speaking, China-US relations will be following a period of chillness before heading towards normalization.”

Conclusion It’s tempting to interpret this crisis as the end of the “American century” But the United States may in fact be in a stronger position than we think because of the asymmetric impact of this crisis The catch is that the crisis hits U.S. allies harder than rivals This may encourage a tougher policy from China and Russia But U.S. mustn’t confuse a Great Recession with an American Recessional

It’s tempting to interpret this crisis as the end of the “American century”

But the United States may in fact be in a stronger position than we think because of the asymmetric impact of this crisis

The catch is that the crisis hits U.S. allies harder than rivals

This may encourage a tougher policy from China and Russia

But U.S. mustn’t confuse a Great Recession with an American Recessional