Friday, January 9, 2009

Roubini In '09

Speaking of the last post and how on the economic disaster "nobody anywhere was smart enough to figure it out" according to the Dickster down there, Nouriel Roubini's outlook into 2009 is even more dismal than his proven predictions in 2008. (emphasis moi)
Last year’s worst-case scenarios came true. The global financial pandemic that I and others had warned about is now upon us. But we are still only in the early stages of this crisis. My predictions for the coming year, unfortunately, are even more dire: The bubbles, and there were many, have only begun to burst.

The prevailing conventional wisdom holds that prices of many risky financial assets have fallen so much that we are at the bottom. Although it’s true that these assets have fallen sharply from their peaks of late 2007, they will likely fall further still. In the next few months, the macroeconomic news in the United States and around the world will be much worse than most expect. Corporate earnings reports will shock any equity analysts who are still deluding themselves that the economic contraction will be mild and short.

The happy-face financial media is still talking about a late 2009 recovery. You believe them? I don't. Roubini doesn't. Nobody should. It's not going to happen. Why? This.
Severe vulnerabilities remain in financial markets: a credit crunch that will get worse before it gets any better; deleveraging that continues as hedge funds and other leveraged players are forced to sell assets into illiquid and distressed markets, thus leading to cascading falls in asset prices, margin calls, and further deleveraging; other financial institutions going bust; a few emerging-market economies entering a full-blown financial crisis, and some at risk of defaulting on their sovereign debt.

Certainly, the United States will experience its worst recession in decades. The formerly mainstream notion that the U.S. contraction would be short and shallow—a V-shaped recession with a quick recovery like the ones in 1990–91 and 2001—is out the window. Instead, the U.S. contraction will be U-shaped: long, deep, and lasting about 24 months. It could end up being even longer, an L-shaped, multiyear stagnation, like the one Japan suffered in the 1990s.

In other words, in a best-case scenario, we're looking at recovery in first quarter 2010. Worst-case...several years of economic stagnation stretching into 2012 or well beyond.
As the U.S. economy shrinks, the entire global economy will go into recession. In Europe, Canada, Japan, and the other advanced economies, it will be severe. Nor will emerging-market economies—linked to the developed world by trade in goods, finance, and currency—escape real pain.

What constitutes a “recession” will depend on the country in question. For China, a hard landing would mean annual growth falls from 12 to 6 percent. China must grow by 10 percent or more each year to bring 12 to 15 million poor rural farmers into the modern world. For other emerging markets, such as Brazil or South Korea, growth below 3 percent would represent a hard landing. The most vulnerable countries, such as Ecuador, Hungary, Latvia, Pakistan, or Ukraine may experience an outright financial crisis and will require massive external financing to avoid a meltdown.

And as bad as all that is, the real problem is still a massive deflationary maelstrom that sucks down the global economy for years.
For the wealthiest countries, a debilitating combination of economic stagnation and deflation might happen as markets for goods go slack because aggregate demand falls. Given how sharply production capacity has risen due to overinvestment in China and other emerging markets, this drop in demand would likely lead to lower inflation. Meanwhile, job losses would mount and unemployment rates would rise, putting downward pressure on wages. Weakening commodity markets—where prices have already fallen sharply since their summer peak and will fall further in a global recession—would lead to still lower inflation. Indeed, by early 2009, inflation in the advanced economies could fall toward the 1 percent level, too close to deflation for comfort.

This scenario is dangerous for many reasons. A number of central banks will be close enough to setting interest rates of zero that their economies fall into a triple whammy: a liquidity trap, a deflation trap, and debt deflation. In a liquidity trap, the banks lose their ability to stimulate the economy because they cannot set nominal interest rates below zero. In a deflation trap, falling prices mean that real interest rates are relatively high, choking off consumption and investment. This leads to a vicious circle wherein incomes and jobs are falling, with demand dropping still further. Finally, in debt deflation, the real value of nominal debts rises as prices fall—bad news for countries such as the United States and Japan that have high ratios of debt to GDP.

We've already reached the liquidity trap stage. The Fed's target rate is effectively zero now, and can go no lower. Despite that rate cut and mortgage rates at 50 year lows, there's no buyers because they can't afford to buy, and sellers have lost so much money on selling that they're paralyzed. The deflation trap is already underway as well, banks are refusing to lend and real interest rates on credit aren't moving anywhere as financial companies desperately are trying to stay afloat with liquid cash in an illiquid world, and the only way they can try to do that is to keep their rates and fees as high as possible.

But it's that last one there -- the debt deflation -- that's going to be the real killer in 2009. Deflation means the value of debt rises in real terms, and the US financial system is all about debt. If you owe money on a car or house, you still owe the money, but deflation means the debt is worth more...and that you owe more in real terms. That means credit firms are even less inclined to loan money to people because they owe more and can't pay off what debt they've already racked up...creating more of a credit crunch and a deflationary debt spiral.

And let's not forget the housing and now commercial real estate markets are continuing to plummet, causing massive deflationary pressure as well. The Japanese Stagnation scenario is becoming more and more likely every month.

2009 is going to flat out suck.

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