Personally, I was more worried about deflation, and I still am.

TO BE NOTED: From Employment, Interest, and Money:

"A Long Way to Inflation

Most of the media seem to have interpreted today’s lower-than-expected increase in the producer price index as good news. I’m not so sure. If you were worried that 5% inflation was just around the corner, then naturally you will have felt relief. Personally, I was more worried about deflation, and I still am. The inflation risk, if it exists at all, is in the distant future, and you could even argue that deflation in the short run increases the risk of high inflation in the long run. It’s hard for me to see how falling prices today are good news at all. And prices – excluding food and energy – did fall in May according to the PPI.

You might worry about energy and commodity prices feeding through to the broader price level. I’m worried about that too, but not in the way you might think. Undoubtedly some of that feed-through is already happening, and it hasn’t been enough to keep core producer price growth on the positive side of zero. I’m worried about what happens when commodity prices (1) stop rising (which they must do eventually) and/or (2) start falling again (which they may well do if the recent increases have been driven largely by unsustainable forces such as stockpiling by China). If core prices are already falling, and only energy prices are keeping the overall PPI inflation rate positive, what happens when energy prices stop rising?

What worries me particularly is that about 70% of the costs of production go to labor, and the forces of deflation work very slowly in the labor market. The data that are coming out today are only the tip of the iceberg. We’re already seeing evidence of the loss of upward inertia in compensation. Wage growth is decelerating, and, based on all historical experience, the deceleration is likely to continue – in this case, to continue to the point where it becomes deflationary.

I’m not talking about what will happen in the next 6 months; I’m talking about what will happen over the next 5 years. “Green shoots” – however green they may be – do not presage an imminent end to deflationary wage pressure. And they certainly don’t presage the beginning of inflationary wage pressure. Consider everything that has to happen before the wage pressure reverses and becomes inflationary:

1. Output must stabilize.
   
   
2. Output must start growing.
   
   
3. Output must grow faster than trend productivity.
   
   
4. Firms must slow layoffs to the normal rate.
   
   
5. Firms must remobilize slack full-time employees (workers who are still on the full-time payroll but aren’t being asked to produce much, because businesses have been trying to reduce inventories).
   
   
6. Firms must bring part-time employees back to full time. (This recession in particular has been characterized by the tendency to reduce hours rather than laying off employees.)
   
   
7. Hiring (which has been falling rapidly) must stabilize.
   
   
8. Hiring must rise to the point where it equals the normal rate of layoffs, to get total employment to start rising.
   
   
9. Hiring must become rapid enough that employment starts to grow faster than the population.
   
   
10. Hiring must become rapid enough that employment growth is faster than the sum of the population growth & labor force re-entry. In other words, net hiring has to be fast enough to absorb all the workers who will start looking for jobs again once there are more jobs around to look for.
    
    
11. The unemployment rate must start declining.
    
    
12. The unemployment rate must decline by 4 or more percentage points, which, by historical experience, will take a matter of years.
    
    
13. Firms must start competing for labor.
    
    
14. Firms must start raising wages.
    
    
15. Firms must raise wages faster than trend productivity growth.

Maybe – just maybe – we have already reached step 1. Step 2 may be just around the corner. There is no evidence thus far that we are approaching step 3. As for steps 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, and 15......that show may come to town eventually, but...I don’t see much need to start reserving tickets in advance.



DISCLOSURE: Through my investment and management role in a Treasury directional pooled investment vehicle and through my role as Chief Economist at Atlantic Asset Management, which generally manages fixed income portfolios for its clients, I have direct or indirect interests in various fixed income instruments, which may be impacted by the issues discussed herein. The views expressed herein are entirely my own opinions and may not represent the views of Atlantic Asset Management.

Posted by Andy Harless "

We just have to accept that the future cannot be foreseen in the way many governments and businessmen would like

TO BE NOTED: From the FT:

"Green shoots and dud forecasts

By Samuel Brittan

Published: May 14 2009 22:13 | Last updated: May 14 2009 22:13

We have been told by that usual bringer of bad tidings, George Soros, that the “economic freefall” has stopped. The normally cautious president of the European Central Bank, Jean-Claude Trichet, has identified a slowing down of the rate of decrease in gross domestic product and, in some cases, “already a picking up”. The Organisation for Economic Co-operation and Development composite leading indicator shows at least a slight uptick. The admittedly highly erratic Easter UK retail sales figures show an actual increase and surveyors report more property inquiries. Financial commentators talk of “green shoots” and one of them has even suggested that the recession came to an end in April. So – Bank of England dissenting – everything is all right and we can get back to normal life.

Except that it isn’t. It is perhaps unfair to cite the continuing horrifying rise in unemployment in so many countries. For that is admittedly a lagging indicator. A better reason for being suspicious is that so much of the new optimism is associated with a very recent recovery in equities. These lost up to half their value in the key US and UK markets, but have come less than a third of the way back since early March. Paul Samuelson once said that the stock market had predicted eight of the last five recessions. The same might be said of recoveries.

There is also a little matter of arithmetic. UK GDP is estimated to have fallen at an annualised rate of 7.4 per cent in the first quarter of 2009. So it is as well that the rate of decline is itself declining. A more specific factor is that a drop in stocks much amplifies any recession. As the Bank of England inflation bulletin explains: “De-stocking only reduces GDP growth if the fall in stock levels is larger than the fall in the previous period.” When this no longer happens the recession looks less draconian; but it does not mean that it is over.

In fact, I have never shared the gloom-and-doom, end-of-capitalism attitude to the credit crunch. Injecting public funds into failing banks was not the best way to bolster demand and credit, especially as governments have relied upon these very same bankers to advise them. Critics on the left and right agree on this matter and are largely right. Nevertheless, governments and central banks have probably injected enough cash into the world economy to prevent the worst from occurring. Sound money commentators fret about the difficulties of withdrawing the stimuli in time. They should equally worry about the danger of withdrawing them too soon. One reason why US unemployment remained so high in the New Deal period is that a premature monetary tightening and attempt to balance the budget aggravated a new recession in 1937.

There has been much discussion about whether the present recession will be V-shaped, which is what national authorities would like; W-shaped, in which a modest recovery would be followed by a further downturn; or L-shaped, in which output stops falling but we crawl along at the bottom without getting back to normal trend growth. Having exhausted suitable letters of the alphabet, commentators talk of bath-shaped and hook-shaped recessions as well.

The truth is that we do not know. To me the most dispiriting aspect of current discussion is the way in which both governments and their critics still cling to national income forecasts, known in the trade as “NIF”. The value of such forecasts is not to be judged by their average record over several years, but by whether they signal problems and opportunities in advance of turning points. Here their record is abysmal. At the beginning of 2007 both national and international mainstream forecasters looked ahead to a golden period of good growth with low inflation, oblivious to the credit crunch that was to hit us later the same year. This should have been the coup de grâce, but it was not. There is no solution in putting wide ranges of error on the predictions – what one economist called “giving them wings”. New Bank of England charts show a range of between minus 2 per cent and plus 6 per cent for output growth in 2011 and 2012, which is honest but useless.

I recently heard a well-known forecaster say that the only valid question is which forecasters to go by and what methods they should use. Not so. New mathematical theories of chaos and complexity provide insights into why forecasting is so problematic but do not provide alternatives. We just have to accept that the future cannot be foreseen in the way many governments and businessmen would like.

Let me end with a simple illustration. The weather in summer in north-west Europe is known to be highly variable. Somebody going away for a fortnight in that part of the world would find it helpful to have a day-by-day prognosis of temperature, rainfall, sunshine, wind conditions and so on. But apart from the first day or two it cannot really be done. Rather then rely on long-term weather bureau predictions, it is safer to take an umbrella or raincoat and a warm pullover as well as sunglasses and a sunshade, even at the cost of slightly heavier luggage. Now apply this homely little story to economic policy.

More columns at www.ft.com/brittan
www.samuelbrittan.co.uk"

The US grew rapidly in the 1950’s and 1960’s with a relatively heavily regulated banking system. Why not again?

TO BE NOTED: Via the Economist's View:

The “New Normal” for Growth

by Kenneth Rogoff

Cambridge – Markets are bubbling over signs of “green shoots” in the global economy. An increasing number of investors see a strong rebound coming, first in China, then in the United States, and then in Europe and the rest of the world. Even the horrible growth numbers of the last couple quarters don’t seem to discourage this optimistic thinking. The deeper the plunge, the stronger the rebound, some analysts say.

Perhaps these optimists are right. But how strong an expansion can one reasonably expect when the worst is finally over? Is the “new normal” going to be the same as the “old normal” of the boom years from 2002 to 2007?

I have trouble seeing how the US and China, the main engines of global growth for two decades, can avoid settling on a notably lower average growth rate than they enjoyed before the crisis.

Let’s start with the US, the epicenter of the financial crisis, and still the most important economy in the world. In the best of worlds, the US financial sector will emerge from the crisis smaller and more heavily regulated. Not to worry, some economists, say. The US grew rapidly in the 1950’s and 1960’s with a relatively heavily regulated banking system. Why not again?

Sure, but the early post-war financial sector wasn’t called upon in those days to support nearly as diverse and sophisticated an economy as it is today. If authorities set the clock back several decades on banking regulation, can we be so sure they will not also set the clock back on income?

US consumption, the single biggest driver of global growth, is surely headed to a lower level, on the back of weak housing prices, rising unemployment, and falling pension wealth. During the boom, US consumption rose to more than 70% of GDP. In the wake of the crisis, it could fall down towards 60%.

And what about the major political shift the US has experienced? Tired of go-go growth, voters now look for more attention to addressing environmental concerns, health-care issues, and income inequality. But achieving these laudable goals will be expensive, coming on top of the giant budget deficits the US is running to counter the financial crisis. Higher taxes and greater regulation cannot be good for growth.

True, there is room to run the government more efficiently, especially in the areas of education and health care. But will these savings be enough to offset the burden of a significantly larger overall government? I hope so, and certainly the Obama administration is a breath of fresh air after the stunning ineptness of the Bush-Cheney years. But governments all over the world are always convinced that their expansions can be substantially financed by efficiency gains, and that dream usually proves chimerical.

Chinese growth is set to slow over the longer run, as well. Even before the financial crisis, it was clear that China could not continue indefinitely on its growth trajectory of 10% or more. Environmental and water problems were mounting. It was becoming increasingly clear that as China continued to grow faster than almost anyone else, the rest of the world’s import capacity (and tolerance) could not keep up with China’s export machine. China was becoming too big.

With the financial crisis, the Chinese economy’s necessary adjustment towards more domestic consumption has become far more urgent. True, even as exports have collapsed, the government has managed to prop up growth with a huge spending and credit expansion. But, while necessary, this strategy threatens to upset the delicate balance between private- and public-sector expansion that has underpinned China’s expansion so far. The growing role of the government, and the shrinking role of the private sector, almost surely portends slower growth later this decade.

Europe, too, faces challenges, and not just from the fact that it now has the worst downturn of the world’s major economic regions, with Germany’s government warning of a surreal 6% decline in GDP for 2009. The ongoing financial crisis will almost surely slow the integration of the accession countries in Central and Eastern Europe, whose young populations are the single most dynamic source of growth in Europe today.

Not all regions will necessarily have slower economic expansion in the decade ahead. Assuming continuing reforms in countries such as Brazil, India, South Africa, and Russia, emerging markets could well fill some of the growth gap left by the largest economies. But, in all likelihood, after years of steadily revising up its estimates of trend global growth, the International Monetary Fund will start revising them down.

Even after the crisis, global growth is almost certain to remain lower than the pre-crisis boom years for some time to come. This change may be good for the environment, for income equality, and for stability. Governments are right to worry about the quality of growth, not just its speed. But when it comes to tax and profit estimates, investors and politicians need to reorient themselves to the “new normal” – lower average growth.

Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.

Copyright: Project Syndicate, 2009.
www.project-syndicate.org"

if the Geithner-Summers-Bernanke strategy of low-balling the scale of the banks' problems and inviting speculators to bail them out actually worked

TO BE NOTED: From HuffPo:

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Robert Kuttner

Co-Founder and Co-Editor of The American Prospect

Posted May 10, 2009 | 07:10 PM (EST)

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Collateral Damage and Double Standards

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Read More: Ben Bernanke, Economy, Gop, Stress Tests, Wall Street, Wall Street Crisis, Zombie Banks, Politics News

I recently spoke at a Federal Reserve conference in Chicago, on financial regulation. The keynote speaker was Ben Bernanke. Chairman Bernanke was unable to leave Washington, so he spoke live, via a giant TV screen, giving his speech a fittingly Orwellian cast.

This was the day that the results of the so called stress tests were released. Not surprisingly, Bernanke was upbeat, since restoring confidence was the whole political point of the stress-test exercise. No major bank was insolvent, and the 19 largest banks collectively needed to raise only about $75 billion in additional capital, although their losses might total as much as $599 billion. Citigroup, queen of the Zombie Banks, remarkably enough, was said to need only $5.5 billion in additional private capital. You could almost make up that paltry sum with executive bonuses.

At one point in his remarks, Bernanke, recounting just how rigorous the stress tests were, explained that "More than 150 examiners, supervisors, and economists" had conducted several weeks of examinations of the banks. That kind of let the cat out of the bag. If you do the arithmetic, that is about seven supervisors per bank, and all of the stress-tested 19 banks were hundred-billion and up outfits. When an ordinary commercial bank, say a $10 billion outfit, undergoes a far less complex routine examination of its commercial loan portfolio, it involves dozens of examiners.

So the stress test was not a set of rigorous examinations at all, but a modeling exercise using the banks' own valuations of their assets. The most serious outside observers think the hole in the banks' balance sheets is much larger than $75 billion or even the Fed's worst-case estimate of $599 billion in losses. The International Monetary Fund estimates the hole as more like 2.7 trillion dollars, and informed economists like Nouriel Roubini put the number at as much as 3.6 trillion.

Why is the Fed low-balling the problem? The hope is that by keeping the banks afloat for a few more months, and trying to entice private capital back to the table, the recovery in other parts of the economy will spill over onto the banks. But the greater likelihood is that weakened banks will continue dragging down the rest of the economy.

Despite talk of "green shoots," - economic indicators not being quite as bad as expected, and the stock market up - most of the news is still pretty grim. Unemployment was up in April by "only" 539,000 jobs. Home foreclosures keep rising, with a total of eight million projected this year. Manufacturing is dead in the water. The administration's voluntary (to the banks) mortgage relief program will address only a fraction of the problem; and 12 Senate Democrats voted with the banking industry to deny bankruptcy judges the ability to modify the terms of a mortgage as a last resort - thus killing the one proposed stick in a program that is all carrots.

I also recently spoke at a convention of industrial construction companies. These are the people who build and maintain factories, power plants, and do other heavy industrial construction. I asked a room full of hundreds of executives how many saw signs of improvement in their order books. Not a single hand went up. Then I asked how many had had projects deferred because of difficulty getting financing. About two thirds of the people in the room raised their hands.

My guess is that the Obama administration will be back next fall, asking Congress for the money and authority to do the bank rescue right, after the current policy proves inadequate to restore the banking system and the economy to health. That would mean taking the insolvent banks into receivership, deciding how much public capital was required and where to get it, and then returning the banks to private ownership. Better late than never, but it's a pity to waste six months.

Chatting with the bankers in attendance at the Fed conference, mostly bankers from the heartland of the Midwest, I encountered resentment bordering on fury at the double standard. The big Wall Street banks are getting propped up with literally trillions of dollars in aid from the Treasury and the Federal Reserve, while community bankers that stuck to their knitting and did not go in for the sub-prime swindle are suffering collateral damage. That's a pun, by the way.

Because of the huge losses to the FDIC's insurance fund, small and medium sized healthy banks are having to pay increased premiums. And while the Fed and the Treasury are being extremely gentle in letting the big money-center banks like Citi value their distressed securities with great charity and forbearance, the community banks are having their loan portfolios examined with fine-tooth combs. With regulators breathing down their necks, and fewer sure-thing businesses in a position to borrow, the community banks are being made to raise their lending standards, contributing to the vicious circle of reduced business activity and reduced credit.

Why had the administration made this perverse alliance with Wall Street, and decided to prop up large zombie banks rather than taking them into receivership and getting on with it? You could blame it on campaign finance, or you could blame it on the quirk of history that Obama, once he became the nominee, decided to hire the Wall Street-oriented Clinton economic team.

The most hopeful and elegant theory I've heard is that for now, Obama's main political project is to let the Republicans self-destruct; co-opting Wall Street (for now) is part of that game plan. He'll get around to reforming Wall Street next year. Even Roosevelt had to take things one step at a time, as public opinion moved. The Second New Deal was more radical than the first. I've often said that Obama is smarter than I am, and if he is politically shrewd enough to have come up with that strategy, hats off to him. I'm also a Red Sox fan, and anything is possible. But for the moment, it looks more like a case of political expediency and even political capture.

I could excuse all that if the Geithner-Summers-Bernanke strategy of low-balling the scale of the banks' problems and inviting speculators to bail them out actually worked. But the greater likelihood is that the economy will tread water at best for the remainder of this year, losing both precious time and political credibility in America's heartland.

Robert Kuttner is co-Editor of The American Prospect and a senior fellow at Demos. His recent book is Obama's Challenge: America's Economic Crisis and the Power of a Transformative Presidency."

It is almost a zero-sum game: the government or the bondholders?

TO BE NOTED: From the NY Times:

"Talking Business
Same Data, Conflicting Forecasts

By JOE NOCERA

So where were we?

In the month since I last wrote in this space, there has been a surge of financial optimism. Banks that are supposed to be in deep trouble have reported profits (though there were a few too many accounting gimmicks for my taste). Some of them, like Goldman Sachs and JPMorgan Chase, are talking about wanting to give back their government bailout money. Bank stocks, moribund not so long ago, have been rising a bit. Other economic indicators suggest that, if the economy hasn’t exactly turned around, at least the pace of decline is slowing. There has been talk of “green shoots” from the Federal Reserve chairman, Ben Bernanke, and “glimmers of hope” from President Obama.

So perhaps the better question to ask this week is where are we? Can we come out of our financial fallout shelters yet, or are there more economic bombs still to drop? Will the results of the stress tests, due out next week, make things better or worse? Have the Obama administration and the Federal Reserve managed to stop the bleeding? Can we start breathing a little easier?

Because Wednesday was the 100th day of the Obama presidency, you could scarcely turn around without bumping into people at a conference or symposium asking, more or less, those same questions. This week, I dropped in on a few of them.

•

Wednesday morning, the Regency Hotel, New York. A liberal group called the Franklin and Eleanor Roosevelt Institute is holding a breakfast in which the featured speakers are the Columbia University economist (and Nobel laureate) Joseph Stiglitz, the M.I.T. economist (and Nobel laureate) Robert Solow, and the former Senate Banking Committee chief economist, Robert Johnson.

Mr. Stiglitz, though a supporter of the president, has been a vocal critic of the administration’s response to the banking crisis, and he doesn’t let up here. “Obviously, I think there is a better way to deal with the crisis,” he says. “Banks made bad loans, and the question is: who is going to pay for those losses? It is almost a zero-sum game: the government or the bondholders?”

He goes on to suggest that the government should stop trying to protect bondholders and instead force them to convert their debt into equity. This would help bolster the banks’ capital without tapping any further into taxpayers’ funds. It is also an idea that the Treasury Department stiffly opposes, fearing that it will create a new round of bank panic, and make it even harder for banks to raise private capital.

Mr. Solow, meanwhile, criticizes the stimulus package as too small. “The drop in consumer spending was too big, and probably couldn’t be filled with a good $800 billion package, and this one was festooned with things that weren’t going to stimulate spending soon.”

Later, at a brief press conference, I ask Mr. Stiglitz how he would grade the new administration’s efforts. To my surprise, he says, “Compared to what went before, I would say it’s an A plus plus.” Then he lapses back into his complaint about the administration’s coddling of bondholders. I then put the same question to Mr. Solow, who says he thinks the administration has done “extraordinarily well” — and then complains that it should be doing more for individual homeowners. Do they really mean it? Or is that “A plus plus” a form of political grade inflation?

•

Wednesday afternoon, the Princeton Club, New York. The American Society of Magazine Editors is holding a luncheon panel on the financial crisis, with Allan Sloan of Fortune, Mark Zandi of Moody’s Economy.com, and, er, me. Mr. Zandi is practically overflowing with optimism. “I think the totality of the policy response has been excellent,” he tells me after our panel has finished. “Aggressive. Creative. With a few tweaks it will ultimately work.” He predicts that the stimulus will kick in this summer — though he says that he would have favored a tax holiday. (“If they had eliminated the payroll tax for the second half of 2009,” he says, “it would have been a tremendous boost for both employers and employees.”) He sees a “massive refinancing boom” under way, which will save homeowners $25 billion on mortgage costs, and might prevent a few foreclosures. He thinks the stress test results — according to news accounts, six banks will require more capital — will bring about renewed confidence in the banking system because we’ll finally be able to see what the truth is. He thinks Treasury Secretary Timothy Geithner “has found his footing.”

On the way home, I pick up the latest copy of The Economist. It warns against “the perils of optimism,” and suggests that if we become too complacent about the prospect of better times, it will “hinder recovery and block policies to protect against a further plunge into the depths.” Sigh.

•

Thursday morning, Drexel University, Philadelphia. A group called the Global Interdependence Center is holding a half-day conference on the financial crisis. First up, Christopher Whalen of Institutional Risk Analytics. He has been a scathing critic of the banks. “My friends are all telling their clients the worst is over, it is time to buy,” he says. “My response is: what are you buying?”

He adds that bondholders need to take some pain, and echoes Mr. Stiglitz’s proposal to make the bondholders convert their debt to equity. A month ago, nobody was talking about this. Now it has become the idea du jour.

Nancy A. Bush, a longtime bank analyst, says that the Troubled Asset Relief Program is “the most destructive thing I have ever seen. The government has ensured mediocrity in the banking industry. It has done enormous damage in the eyes of investors, who are no longer sure that a bank is a safe investment anymore.” She calls it the TARP Trap.

Just then, the moderator takes the stage to announce that Chrysler has filed for bankruptcy. So much for optimism.

Next panel: Robert A. Eisenbeis of Cumberland Advisors gives a talk titled “Are things really that bad?” His answer is, no. “We are far from the Great Depression,” he declares, and he has the charts to prove it. When measures like gross domestic product and corporate profits are charted against other recessions, this one looks pretty bad. But when they are charted against the Great Depression, they look like a piffle. In the depths of the Depression, for instance, G.D.P. dropped by a staggering 50 percent, compared with the current drop of 2 percent or so. “The people who are fear-mongering are not looking at the data,” Mr. Eisenbeis concludes.

He is followed by a funny, fast-talking woman named Diane Swonk, the chief economist at Mesirow Financial. “We’ve gone from a sense of free fall in the fourth quarter of 2008 to a point where we have pulled the ripcord and the parachute has opened. But we don’t know where we are going to land, or whether it is going to be in enemy territory,” she says. “There are three areas where consumer spending has increased,” she remarks at another point. “Guns. Condoms. And alcohol.” In between jokes, she says the deleveraging of America is going to be a painful process.

Finally, the former St. Louis Federal Reserve president William Poole, now a senior fellow at the Cato Institute, gives a keynote speech arguing “too big too fail” is a concept that has done enormous harm. He wants to see some market discipline imposed on the banks — so that if they mess up again, we won’t have to come to their rescue. Who can disagree?

•

Thursday evening, the Metropolitan Museum, New York. The big guns are out tonight, on a panel sponsored by The New York Review of Books and PEN World Voices: Niall Ferguson of Harvard, Paul Krugman of Princeton (and The New York Times), Nouriel Roubini of New York University, former Senator Bill Bradley and George Soros, among others. The Met’s big auditorium is packed.

This is doom-and-gloom central. Lots of talk about zombie banks, failures to understand history, regulatory foolishness. Mr. Bradley, who speaks first, suggests that if the government’s plan to save the banks doesn’t work, it should simply buy Citibank — “its current market cap is about $17 billion,” he said — clean it up, and spin it off to the American people in a rights offering. Mr. Ferguson, a provocative historian, keeps saying that the United States is becoming akin to a Latin American economy: “At what point do people stop believing in the dollar as a reserve currency?” he asks ominously.

“The scale of the crisis has overwhelmed the response,” Mr. Krugman says. To the extent there are green shoots, he added, “it means that things are getting worse more slowly.” Mr. Roubini practically scoffs at the notion that we might see positive economic growth in the second half of the year. Mr. Soros says that “we are currently facing a deflationary situation. But when credit restarts, the fear of deflation will be replaced by fear of inflation, and there will be pressure for interest rates to rise.” Something to look forward to, I suppose.

I can’t say that I left the Metropolitan Museum with any more clarity than when I began my little symposia tour. I’d heard some good ideas, and cheery news among the dire forecasts. What it did cause me to realize is that all these smart economists and forecasters are looking at the same set of data, and coming to radically different conclusions based on their politics, their temperament and their idiosyncratic reading of history. Just like the rest of us.

Next week, the results of the stress tests will be unveiled, and we’ll see it all over again. Some of the same people I saw on stage this week will say the tests are a whitewash, while others will claim that they’re an important step on the road to recovery. Both sides will marshal persuasive data and strong arguments, providing plenty of fodder for the next round of conferences.

At least that much is certain."

The world economy cannot go back to where it was before the crisis, because that was demonstrably unsustainable

TO BE NOTED: From the FT:

"Why the ‘green shoots’ of recovery could yet wither

Published: April 21 2009 20:24 | Last updated: April 21 2009 20:24

Spring has arrived and policymakers see “green shoots”. Barack Obama’s economic adviser, Lawrence Summers, says the “sense of freefall” in the US economy should end in a few months. The president himself spies “glimmers of hope”. Ben Bernanke, chairman of the Federal Reserve, said last week “recently we have seen tentative signs that the sharp decline in economic activity may be slowing, for example, in data on home sales, homebuilding and consumer spending, including sales of new motor vehicles”.

Is the worst behind us? In a word, No. The rate of economic decline is decelerating. But it is too soon even to be sure of a turnround, let alone of a return to rapid growth. Yet more remote is elimination of excess capacity. Most remote of all is an end to deleveraging. Complacency is perilous. These are still early days.

As the Organisation for Economic Co-operation and Development noted in its recent Interim Economic Outlook, “the world economy is in the midst of its deepest and most synchronised recession in our lifetimes, caused by a global financial crisis and deepened by a collapse in world trade”. In the OECD area as a whole, output is forecast to contract by 4.3 per cent this year and 0.1 per cent in 2010, with unemployment rising to 9.9 per cent of the labour force next year. By the end of 2010, the “output gap” – a measure of excess capacity – is forecast to be 8 per cent, twice as large as in the recession of the early 1980s.

In the US, the rate of decline of manufactured output compares with that of the Great Depression. Japan’s output of manufactures has already fallen by almost as much as in the US during the 1930s (see chart). The disintegration of the financial system is, arguably, worse than it was then.

If the world experiences a “Great Recession”, rather than a Great Depression, the scale of policy support will be the explanation. Three of the world’s most important central banks – the Federal Reserve, the Bank of Japan and the Bank of England – have official rates close to zero and have adopted unconventional policies. The real OECD-wide fiscal deficit is forecast at 8.7 per cent of gross domestic product next year, with a structural deficit of 5.2 per cent. In the US, the corresponding figures are 11.9 and 8.2 per cent. Governments of wealthy countries have also put their healthy credit ratings at the disposal of their misbehaving financial systems in the most far-reaching socialisation of market risk in world history.

It would be impossible for such activism to have had no effect. We can indeed see partial normalisation of financial markets, with a marked reduction in spreads between riskier and less risky assets (see charts). The FTSE All-World index has jumped by 24 per cent and the S&P 500 by 23 per cent since March 9 2009. Purchasing managers’ indices are picking up (see chart). More broadly, the chances of a manufacturing turnround are high: big falls in demand generate inventory build-ups and collapses in output. The latter are sure to reverse. China’s growth is also rebounding.

We can say with some confidence that the financial system is stabilising and the rate of decline in demand is slowing. But this global recession is different from any other since the second world war. Its salient characteristic is uncertainty.

Consider obvious perils: given huge excess capacity, a risk of deflation remains, with potentially dire results for overindebted borrowers; given the rising unemployment and huge losses in wealth, indebted households in low-saving countries may raise their savings rates to exceptional levels; given the collapse in demand and profits, cutbacks in investment may be exceptionally prolonged and severe; given massive and persistent fiscal deficits and soaring debt, risk aversion may lead to higher interest rates on government borrowing; and given the flight from riskier borrowers, a number of emerging economies may find themselves in a vicious downward spiral of weakening capital inflow, falling output and reductions in the quality of assets.

In short, as Stephen King and Stuart Green of HSBC note in a recent report, the exceptional dynamics of this crisis suggest a healthy scepticism about the timing and speed of recovery. What is most disturbing, moreover, is the scale of the policy action required to halt this downward spiral. This raises the big question: how and when might the world return to normality, with sustainable fiscal positions, strongly positive short-term official interest rates and solvent financial systems? That Japan has failed to achieve this over 20 years is surely frightening.

What I find most disturbing of all is the reluctance to admit the nature of the challenge. In its policy advice, even the OECD seems to believe this is largely a financial crisis and one that may be overcome in quite short order. Even the latter looks ever more implausible: in its latest Global Financial Stability Report, the International Monetary Fund now estimates overall losses in the financial sector at $4,100bn (€3,200bn, £2,800bn). The next estimate will presumably be higher.

Above all, the financial crisis is itself a symptom of a balance-sheet disorder. That, in turn, is partly the consequence of structural current account imbalances. Thus, neither short-term macroeconomic stimulus nor restructuring of balance sheets of financial institutions will generate sustained and healthy global growth.

Consider the salient example of the US, on whose final demand so much has for so long depended. Total private sector debt rose from 112 per cent of GDP in 1976 to 295 per cent at the end of 2008. Financial sector debt alone jumped from 16 per cent to 121 per cent of GDP over this period. How much of a reduction in these measures of leverage occurred in the crisis year of 2008? None. On the contrary, leverage rose still further.

The danger is that a turnround, however shallow, will convince the world things are soon going to be the way they were before. They will not be. It will merely show that collapse does not last for ever once substantial stimulus is applied. The brutal truth is that the financial system is still far from healthy, the deleveraging of the private sectors of highly indebted countries has not begun, the needed rebalancing of global demand has barely even started and, for all these reasons, a return to sustained, private-sector-led growth probably remains a long way in the future.

The world economy cannot go back to where it was before the crisis, because that was demonstrably unsustainable. It is at the early stages of a long and painful deleveraging and restructuring. Fortunately, policymakers have eliminated the worst possible outcomes. But there is much more yet to be done before fragile shoots become healthy plants.

martin.wolf@ft.com

More columns at www.ft.com/wolf

Read and post comments at Martin Wolf’s blog

Copyright The Financial Times Limited 2009"

‘green shoots’ sentiment currently doing the rounds

From Alphaville:

"Quote du jour, Roubini ‘green shoots’ edition Posted by Izabella Kaminska on Apr 21 12:57.

Nouriel Roubini on the ‘green shoots’ sentiment currently doing the rounds:

Related links:
The Susan Boyle Factor - FT Alphaville
Optimistically, pessimistic in the US - FT Alphaville

This entry was posted by Izabella Kaminska on Tuesday, April 21st, 2009 at 12:57 and is filed under Capital markets, People. Tagged with Geen shoots, nouriel roubini, Recession."