Double-dip risk?
18 Feb 10
Stephen Roach, chairman of Morgan Stanley Asia recently wrote a column for
Bloomberg Markets in which he explored the risk and likelihood of double-dip for
the global economy. This article was distributed by Alphen Asset Management.
Policy makers have been successful at putting in a bottom to the most wrenching crisis and recession of the post-World War II era. Yet there are four key reasons to remain sceptical about the vigor and sustainability of any rebound in the global economy.
First, the financial crisis itself is far from over. The latest International Monetary Fund estimates put the potential for worldwide writedowns of toxic assets at approximately $3.4 trillion; so far, realized markdowns have been only about half that amount. This points to further earnings impairments for financial institutions and concomitant restraints on their lending capacity.
Second, the breadth of this global recession was staggering. At its low point in March 2000, 75 percent of the world's economies were contracting. Typically, the figure is closer to 50 percent.
Third, the demand side of the global economy is likely to be restrained by a protracted pullback of the overextended American consumer. The consumption share of the U.S. economy is likely to fall by five full percentage points of gross domestic product. This should reduce trend growth of real consumption from the almost 4 percent pace of the pre-crisis decade to 1.5 percent to 2 percent during the next three to five years. No other consumer in the world is capable of filling this void.
Fourth, the supply side of the global economy suffers from massive imbalances, especially China-centric developing Asia. While, on the surface, post-crisis resilience of the Chinese economy has been impressive, it turns out the 95 percent of the 7.7 percent GDP growth realized in the first three quarters of 2009 was concentrated in the fixed-investment sector, which already accounts for an unheard-of 45 percent of GDP.
By compounding its existing imbalances, to say nothing of funding this stimulus by a record surge of state-directed bank lending, China risks a serious misallocation of capital and a worrisome deterioration of bank loan quality.
Considering these powerful head winds, I expect trend growth in world GDP to average about 2.5 percent during the next three years - the weakest recovery of the modern era. Such an outcome would be very close to the so-called stall speed for a $70 trillion global economy, meaning that a shock could easily trigger a relapse, or the dreaded double dip.
Two potential shocks would play right into the vulnerability of the post-crisis recovery, the first being a failed exit strategy from the Great Stimulus. Policy makers are not lacking in tools or tactics to withdraw the extraordinary fiscal and monetary stimulus that has been put in place to save the world.
Unfortunately, they are lacking in political will. The odds are high that the U.S. Federal Reserve will once again embrace a so-called asymmetrical exit strategy - quick to slash the federal funds rate in a crisis but slow to normalize in a recovery. That is a setup for more bubbles and yet another crisis.
A second possible shock would be heightened trade frictions and protectionism, especially a Washington-led outbreak of China bashing. With the U.S. unemployment rate likely to remain higher than 9.5 percent heading into the midterm congressional elections in November, the Chinese currency issue has once again become a bipartisan lightning rod.
If Washington imposes trade sanctions, the Chinese would undoubtedly reduce their appetite for dollar-denominated assets, with severe implications for the dollar and probably real long-term interest rates in the U.S.
No one can predict shocks. But the theory of the double-dip is very clear in one important respect: Shocks can deal lethal blows to anemic recoveries. That remains a real risk in this still-fragile post-crisis climate. In contrast to the denial prevalent in today's ebullient financial market climate, I would assign about a 40 percent chance to a global double dip at some point in 2010.
