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Take a Look: Economic Stagnation is EVERYWHERE!

Editor — Sun, 12 Jun 2011 07:02:50 +0000

The Great Stagnation of 2011

[The economic news is not very encouraging these days. Everywhere I've looked, and I've looked at 10 different indicators (surveys, polls and indexes), things appear to be either down or stagnant. Let me be more explicit.] Words: 1058

So says Econophile, Jeff Harding, (www.dailycapitalist.com) in excerpts from an article* which Lorimer Wilson, editor of www.munKNEE.com (It’s all about Money!), has further edited ([ ]), abridged (…) and reformatted below for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. Harding goes on to say:

1/2. Philadelphia Fed Survey and the Empire State Manufacturing Survey

Both the Empire State Fed and the Philadelphia Fed manufacturing surveys reported substantial drops in economic activity:

The Philadelphia dropped 7.7% (the first drop since September) and NY dropped 7.8% (the first drop since November). The weakness was in new orders and inventory accumulation, things that you don’t want to see decline. Separately, the inventory-to-sales ratio increased 0.8%, a small but negative indicator.

3. Index of Industrial Production

The index of industrial production as announced by the Fed was flat in May, up 0.1%, but the year-over-year trend was still declining:

[While] all production is aimed at consumer consumption, looking at consumption alone is not as good an indicator of real organic economic growth as is the production side of the economy…[because] production usually leads consumption out of an economic slump, not the other way around. The Fed’s and the Administration’s attempts at monetary and fiscal stimulus haven’t worked because of their misplaced emphasis on consumption. They don’t examine the issue of why people aren’t consuming…The keys to new economic growth are savings, debt reduction, and the liquidation of malinvested projects. People aren’t going to spend until they feel they are economically secure and there aren’t a lot of reasons right now for them to feel secure – and the data shows it.

4. Retail Sales

Retail sales for May came out slightly negative (-0.2%), but that is a bit misleading. Here is the chart:

The trend has been flat-to-negative since January, 2011. For several reasons economists like to strip out auto sales, a big ticket item that may skew the data. Doing that, excluding autos, retail sales were up 0.3%. Again the data is confusing because the excluding auto data still includes gasoline sales which were up 22.3% YoY. Gains were seen in health care, building materials, miscellaneous retailers, and non-store (Internet) retailers.

5. Producer Price Index

The PPI and CPI reports also came in last week. Starting at the producer level, the PPI increase moderated to a 0.2% gain (core, excluding energy and food, up 0.2%) but the year-over-year trend was still up 7.0% in May (excluding energy and food, up 2.1%). The PPI has been declining since January, 2011, but the rate of increase is still high:

6. Consumer Price Index

The May CPI also was up 0.2%, slightly less than in April, but still a strong upward trend as shown in this YoY chart (up 3.2% YoY):

Excluding energy and food, it was up 0.3% for the month, and 1.5% YoY. Apparel, shelter, new vehicles, and recreation were all up, but energy and gasoline were down along with airline fares, tobacco, and personal care. This price inflation may seem mild to the casual observer, but it is the trendline that is important.

7. The Misery Index

The Misery Index was created back in the 1970s and is described thusly:

It is simply the unemployment rate added to the inflation rate. It is assumed that both a higher rate of unemployment and a worsening of inflation both create economic and social costs for a country. A combination of rising inflation and more people out of work implies a deterioration in economic performance and a rise in the misery index.

The Index is now at 12.16. To put this in perspective, it was at its highest, 20.76 during the Carter Administration, and hasn’t been this high since 1983 (it declined after Reagan was elected). Its lowest points were 3.53 during the Eisenhower Administration (1953) and again during the Clinton years, 6.05 in 1998. This has resulted in a decline in consumer confidence.

8. Economic Confidence Index

The Gallup Economic Confidence Index declined 9 points in the past two weeks (ending June 12):

9. The Reuters/Univ. of Michigan consumer sentiment poll reflected a similar decline.

10. Small Business Optimism Index

The National Federation of Independent Business’ (NFIB) Small Business Optimism Index declined again, for the third straight month:

“Corporate profits may be at a record high, but businesses on Main Street are still scraping by,” said NFIB chief economist Bill Dunkelberg [going on to say] “For the third month running, several key economic indicators continued their downward tumble.

Job market indicators continued to deteriorate, anticipating very weak job creation and a higher unemployment rate.
Capital spending plans and inventory investment plans all weakened and remain at recession levels.
Inflation continues to rise [which is] a notable business concern for owners who are raising their own prices at the fastest pace seen in years.

Driving the economic uncertainty [is the fact that] one in four owners still report weak sales as their top business problem (followed by taxes and regulations and red tape [while] only 3 percent cite financing).

The most important thing among these data was the lack of capital spending: Capital spending remains historically low in spite of very low interest rates and all sorts of expensing incentives. Fifty percent of firms reported making capital expenditures over the past six months, and the percent of owners planning capital outlays in the next 3 to 6 months fell 1 point to 20 percent, a recession level reading.”

What does all this mean? It means that the foundry of job creation for one-half of the new jobs created in America, small businesses, are stalling out again because of all the factors discussed above. Also, I wouldn’t expect a lot of job growth from the multinationals as not even a declining dollar can offset the cooling-off of demand from money-stimulated countries like China, India, and Brazil.

Conclusion

Consumers aren’t going to save our economy from stagnation [which] will continue along with inflation…[and their is still] a likelihood of QE3.

*http://dailycapitalist.com/2011/06/20/the-great-stagnation-of-2011/

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Editor’s Note:

The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.

Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above.

Nouriel Roubini: How to Avoid a Double-Dip Global Recession

Editor — Wed, 23 Jun 2010 07:30:13 +0000

There is an ongoing debate among global policymakers about when and how fast to exit from the strong monetary and fiscal stimulus that prevented the Great Recession of 2008-2009 from turning into a new Great Depression. Germany and the European Central Bank are pushing aggressively for early fiscal austerity; the United States is worried about the risks of excessively early fiscal consolidation. Words: 957

Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com, provides below further reformatted and edited excerpts from Nouriel Roubini’s (www.project-syndicate.org) original article* for the sake of clarity and brevity to ensure a fast and easy read. Roubini goes on to say:

Policymakers are damned if they do and damned if they don’t
If they take away the monetary and fiscal stimulus too soon – when private demand remains shaky – there is a risk of falling back into recession and deflation. While fiscal austerity may be necessary in countries with large deficits and debt, raising taxes and cutting government spending may make the recession and deflation worse.

On the other hand, if policymakers maintain the stimulus for too long, runaway fiscal deficits may lead to a sovereign debt crisis (markets are already punishing fiscally undisciplined countries with larger sovereign spreads). Or, if these deficits are monetized, high inflation may force up long-term interest rates and again choke off economic recovery.

The problem is compounded by the fact that, for the last decade, the U.S. and other deficit countries – including the United Kingdom, Spain, Greece, Portugal, Ireland, Iceland, Dubai, and Australia – have been consumers of first and last resort, spending more than their income and running current-account deficits. Meanwhile, emerging Asian economies – particularly China – together with Japan, Germany, and a few other countries have been the producers of first and last resort, spending less than their income and running current-account surpluses.

Overspending countries are now retrenching, owing to the need to reduce their private and public spending, to import less, and to reduce their external deficits and deleverage. But if the deficit countries spend less while the surplus countries don’t compensate by savings less and spending more – especially on private and public consumption – then excess productive capacity will meet a lack of aggregate demand, leading to another slump in global economic growth.

What should policymakers do?
1. In countries where early fiscal austerity is necessary to prevent a fiscal crisis, monetary policy should be much easier – via lower policy rates and more quantitative easing – to compensate for the recessionary and deflationary effects of fiscal tightening. In general, near-zero policy rates should be maintained in most advanced economies to support the economic recovery.

2. Countries where bond-market vigilantes have not yet awakened – the U.S., the U.K., and Japan – should maintain their fiscal stimulus while designing credible fiscal consolidation plans to be implemented later over the medium term.

3. Over-saving countries like China and emerging Asia, Germany, and Japan should implement policies that reduce their savings and current-account surpluses. Specifically, China and emerging Asia should implement reforms that reduce the need for precautionary savings and let their currencies appreciate; Germany should maintain its fiscal stimulus and extend it into 2011, rather than starting its ill-conceived fiscal austerity now; and Japan should pursue measures to reduce its current-account surplus and stimulate real incomes and consumption.

4. Countries with current-account surpluses should let their undervalued currencies appreciate, while the ECB should follow an easier monetary policy that accommodates a gradual further weakening of the euro to restore competiveness and growth in the eurozone.

5. In countries where private-sector deleveraging is very rapid via a fall in private consumption and private investment, the fiscal stimulus should be maintained and extended, as long as financial markets do not perceive those deficits as unsustainable.

6. While regulatory reform that increases the liquidity and capital ratios for financial institutions is necessary, those higher ratios should be phased in gradually to prevent a further worsening of the credit crunch.

7. In countries where private and public debt levels are unsustainable – household debt in countries where the housing boom has gone bust and debts of governments, like Greece’s, that suffer from insolvency rather than just illiquidity – liabilities should be restructured and reduced to prevent a severe debt deflation and contraction of spending.

8. The International Monetary Fund, the European Union, and other multilateral institutions should provide generous lender-of-last-resort support in order to prevent a severe deflationary recession in countries that need private and public deleveraging.

9. In general, deleveraging by households, governments, and financial institutions should be gradual – and supported by currency weakening – if we are to avoid a double-dip recession and a worsening of deflation.

10. Countries that can still afford fiscal stimulus and need to reduce their savings and increase spending should contribute to the global current-account adjustment – via currency adjustments and expenditure increases – in order to prevent a global shortage of aggregate demand.

Failure to implement such coordinated policy measures – to sustain global aggregate demand at a time when deflationary trends are still severe in advanced economies – could lead to a very dangerous and damaging double-dip recession in advanced economies. Such an outcome would cause another bout of severe systemic risk in global financial markets, trigger a series of contagious sovereign defaults, and severely damage the growth prospects of emerging-market economies that have so far experienced a more robust recovery than advanced countries.

*http://www.project-syndicate.org/commentary/roubini26/English

Editor’s Note:
- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
- Permission to reprint in whole or in part is gladly granted, provided full credit is given.
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Austrians vs Keynesians, Republicans vs Democrats: Both Groups Have Diametrically Opposed and Irreconcilable Economic Views

Editor — Sun, 21 Mar 2010 12:29:12 +0000

It is understandable why there is such a major divide between Republicans and Democrats in America when one examines their diametrically opposed, and seemingly irreconcilable, Keynesian and Austrian economic views.

Below are edited [ ] and reformatted excerpts from an article* by Sterling T. Terrell (www.mises.org) in which he explains the different approaches to fiscal policy and why he thinks one approach is better than the other based on research on the subject:

[Republican Party - Conservative - Austrian Economic Philosophy]
The government has no money of its own. It has only the power to tax and spend the money of others. There can only be a transfer that takes place, not a creation of wealth: jobs in X are gained, but jobs in Y are lost. However, this transfer is actually a loss. Taxing away a person’s ability to fulfill his own wants and then providing him with things he may not care about makes him worse off. This process condescendingly supposes that individuals cannot decide for themselves what they need.

[Democratic Party - Liberal - Keynesian Economic Philosophy]
If the economy is “too slow” then the government should lower interest rates and increase government spending. If the economy is “overheated,” the government should raise interest rates and decrease government spending. Increased government spending, [i.e. economic stimulus,] will act as a fiscal multiplier in that one dollar in government spending, once it filters through the economy, will make GDP increase by more than one dollar.

Research Findings
Research** done by Ethan Ilzetzki, Enrique Mendoza, and Carlos Vegh, covering data from 45 countries from 1960 to 2007, has determined that “it depends” on the size of the fiscal multiplier. Furthermore, the size of the fiscal multiplier critically depends on:

1. Key characteristics of the economy:
a) closed versus open,
b) predetermined versus flexible exchange rate regimes,
c) high versus low debt.

2. The type of aggregate being considered:
a) government consumption,
b) government investment.

As such, policymakers would be well -served by taking into account a given country’s characteristics in evaluating the benefits of any fiscal stimulus package.

Conclusion
The findings of Ilzetzki, Mendoza, and Vegh suggest that in a country such as the United States the fiscal multiplier is virtually zero and, therefore, in addition to fiscal policy taking away the freedom to choose, robbing X to hand it to Y, and penalizing the very people that improve our lives, it also fails empirically.

Fiscal policy, the attempt to use government outlays and revenue to better the economy, simply does not work either a priori or in practice – but the Austrians already knew that.

*http://mises.org/daily/3950
**http://econweb.umd.edu/~vegh/papers/multipliers.pdf

Buffett, Russell and Hoisington: Deflation or Inflation?

Editor — Tue, 16 Mar 2010 14:11:21 +0000

“Unchecked greenback emissions will certainly cause the purchasing power of currency to melt.” says Warren Buffett. Words: 982

In the following edited excerpts from the original article* Cam Hui (www.questfunds.com) puts forth the case for both inflation and deflation by the likes of Richard Russell, Warren Buffett and Van Hoisington:

The Case for Deflation

1. De-leveraging
There are many analysts making the case for a Japanese 1990s style prolonged period of deflation. One of the more prominent spokesmen of this view is Hoisington Investment Management. Simply put, Hoisington believes that we are in a de-leveraging cycle, and de-leveraging means deflation. Their case for deflation can be summarized in the following way:

- US debt to GDP has gone sky high, indicating that borrowing capacity is stretched. Much of that borrowing went to pump up asset prices. Even though asset prices have fallen, the debt remains. The endgame is obvious: we need time to pay off all of the excess debt and that process is highly deflationary.

- Credit creation is falling dramatically. The economy cannot recover unless banks are willing to lend to businesses and households. Otherwise, where does growth come from?

- Monetary policy is pushing on a string. Inflation is considered to be a monetary phenomenon. When Helicopter Ben prints too much money, theory suggests that too much money chasing too few goods and services ignites inflation. Hoisington argues that increasing the money supply will not result in inflation because banks aren’t lending. All of the newly printed dollars are winding up in bank reserves and doesn’t get pushed into the real economy. Therefore inflation will stay tame until banks begin to lend again and start a new credit cycle.

- Fiscal stimulus won’t work either. One of the major problems on the expenditure side is that the government sector is smaller than the private sector. Moreover, increasing government spending would mean either the government must either raise taxes or borrow funds in the financial markets that would have otherwise gone to the private sector, which is counterproductive.

- The American consumer’s balance sheet is extremely weak and over-levered. It will be a while before the consumer can resume his profligate ways, assuming a new frugality doesn’t take hold. If the consumer doesn’t spend, then where will growth come from?

To the above points, I would also add the following:
- US capacity utilization is falling and capacity utilization leads core CPI by about a year, according to Albert Edwards of SocGen.

- The Eurozone won’t be a source of global growth near-term. Europe is undergoing its own de-leveraging cycle as widespread defaults from Eastern European loans become a reality.

(See the Hoisington case at http://www.investorsinsight.com:80/blogs/john_mauldins_outside_the_box/archive/2009/01/19/thegreat-
experiment.aspx)

2. Too Much Debt
- Debt to GDP has gone sky high…Credit creation is falling dramatically…Consumer balance sheets are very weak, making them unlikely to spend. Capacity utilization is falling and capacity utilization leads CPI by about a year. Source: Societe Generale

The Case for Inflation

1. Massive Fiscal and Monetary Stimulus
In a New York Times op-ed (see http://www.nytimes.com/2009/08/19/opinion/19buffett.html _r=2&scp=2&sq=buffett&st=cse) Warren Buffett warned that:

- “enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.” Buffett was saying, in so many words, that all of the money being printed today is unlikely to ignite inflation because of the lack of lending. However, Americans will have to eventually pay the price for all this government spending and monetary stimulus.

- once we start to see signs of a recovery, “slowing [the stimulus] down will require extraordinary political will. With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap.”

- the price to be paid would likely be an uncontrolled decline in the US Dollar: “Unchecked greenback emissions will certainly cause the purchasing power of currency to melt.”

2. Falling US Dollar
The United States is in the enviable position of being the issuer of a major reserve currency. For central bank reserve managers, the only other realistic reserve currencies are the euro and perhaps the Yen. All other currencies are too illiquid to be serious contenders for major reserve status.

Given the profound troubles that Europe faces with its banking system and the continuing problems in Japan, the US Dollar is unlikely to fall significantly against either the euro or the Yen. Pressures on the US Dollar would show up as rising commodity prices – which translates to inflation.

3. Higher Interest Rates
Long-time analyst Richard Russell, publisher of the Dow Theory Letters since 1958, put the dilemma more succinctly:

- The US national debt is now over $11 trillion dollars. The interest on our national debt is now $340 billion. This is about at 3.04% rate of interest. In ten years the Obama administration admits that they will add $9 trillion to the national debt. That would take it to $20 trillion. Let’s say that by some miracle the interest on the national debt in 10 years will still be 3.09%. That would mean that the interest on the national debt would be $618 billion a year or over one billion a day. No nation can hold up in the face of those kinds of expenses. Either the dollar would collapse or interest rates would go through the roof.

*http://www.qwestfunds.com/publications/newsletters_pdf/newsletter_november_2009.pdf (Qwest Investment Management Corp. is an investment firm which specializes in identifying, structuring and managing investment products focused in the natural resource sector.)

Crisis and Aftermath: Economic Outlook and Risks for the US

Editor — Sun, 28 Feb 2010 19:28:40 +0000

This boom will be pleasant while it lasts. It might go on for a number of years, in much the same way many people enjoyed the 1920s. Be that as it may, we have failed to heed the warnings made plain by the successive crises of the past 30 years, and this failure was made clear during 2008–09. The most worrisome part is that we are nearing the end of our fiscal and monetary ability to bail out the system. Words: 2261

In further edited excerpts from his testimony* submitted to the Senate Budget Committee hearing on “Crisis and Aftermath: The Economic Outlook and Risks for the Federal Budget and Debt” Simon Johnson, senior fellow at the Peterson Institute for International Economics (www.piie.com) and a professor at MIT, went on to say:

In 2008–09 we were lucky that major countries had the fiscal space available to engage in stimulus and that monetary policy could use quantitative easing effectively. In the future, there are no guarantees that the size of the available policy response will match the magnitude of the shock to the credit system.

A. Expectations
1. A major sovereign debt crisis is gathering steam in Europe, focused for now on the weaker countries in the eurozone but with the potential to spill over also to the United Kingdom. These further financial market disruptions will not only slow the European economies but will also cause the euro to weaken and lower growth around the world.

2. There are some European efforts underway to limit debt crisis to Greece and to prevent the further spread of damage but these efforts are too little and too late. Portugal, Ireland, Italy, Greece, and Spain (PIIGS) will all come under severe pressure from speculative attacks on their credit.

3. Another Lehman/AIG-type situation lurks somewhere on the European continent, and again G-7 (and G-20) leaders are slow to see the risk. This time, given that they already used almost all their scope for fiscal stimulus, it will be considerably more difficult for governments to respond effectively if the crisis comes.

4. Investors will scramble in such a situation for the safest assets available i.e. “cash,” which means short-term US government securities. It is not that the United States has anything approaching a credible medium-term fiscal framework, but everyone else is in much worse shape.

5. Net exports have been a relative strength for the US economy over the past 12 months but this is unlikely to be the case during 2010.

6. The US consumer is beset by problems including a debt overhang for lower income households, a soft housing market, and volatile asset prices. The saving rate is likely to fall from 2009 levels but remain relatively high. Residential investment is hardly likely to recover in 2010, and business investment is too small to drive a recovery.

7. On a Q4-on-Q4 basis, the United States will struggle to grow faster than 2 percent. This within-year pattern will likely involve a significant slowdown in the second half although probably not an outright decline in output. The effects of fiscal stimulus will begin to wear off by the middle of the year, and without a viable medium-term fiscal framework, there is not much room for further stimulus other than cosmetic “job creation” measures.

8. The Federal Reserve will start to wind down its extraordinary support programs for mortgage-backed securities, starting in the spring although this may be delayed to some degree by international developments. The precise impact is hard to gauge, but this will not help prevent a slowdown in the second quarter.

9. On top of these issues, there is concern about the levels of capital in our banking system. The “too big to fail” banks are implicitly backed by the US government, and for them the stress test of early 2009 played down the amount of capital they would need if the economy headed towards a “double-dip” type of slowdown. In addition, small- and medium-sized banks have considerable exposure to commercial real estate, which continues to go bad.

10. Undercapitalized banks tend to be fearful and curtail lending to creditworthy potential borrowers. This may increasingly be the situation we face in 2010.

11. Emerging markets are likely to slow in the second half of the year.

12. Global growth, Q4-on-Q4 within 2010, should be approximately 3%.

13. Over a longer time horizon, we will probably experience a global economic boom, based on prospects in emerging markets. However, with our current global financial structure, this brings with it substantial systemic risks.

B. From Greece to the United States: The Problems Spread
The problems now spreading from Greece to Spain, Portugal, Ireland, and even Italy portend major trouble ahead for the United States in the second half of this year particularly because our banks remain in such weak shape.

Greece, as a member of the eurozone, the elite club of European nations that share the euro and are supposed to maintain strong economic policies, does not control its own currency. This is in the hands of the European Central Bank (ECB) in Frankfurt. In good times, over the past decade, this helped keep Greek interest rates low and growth relatively strong. Under the economic pressures of the past year, however, the Greek government budget has slipped into ever greater deficit, and investors have increasingly become uncomfortable about the possibility of future default. This impending doom was postponed for a while by the ability of banks, mostly Greek, to use these bonds as collateral for loans from the European Central Bank (so-called “repos”). From the end of this year, however, the ECB will not accept bonds rated below ‘A’ by major ratings agencies and Greek government debt no longer falls into this category.

If the ECB will not, indirectly, lend to the Greek government, then interest rates will go up in the future. In anticipation of this, interest rates should rise now. This spells trouble for an economy like Greece or any of the weaker eurozone countries. Paying higher interest rates on government debt also implies a worsening of the budget. These are exactly the sort of debt dynamics that used to get countries like Brazil into big trouble. The right approach for Greece would be to promise credible budget tightening over 3–5 years and to obtain sufficient resources from within the eurozone to tide the country over in the interim.

The Germans, however, have decided to play hardball with their weaker neighbors, in part, because those countries have not lived up to previous commitments. The Germans strongly dislike bailout other than for their own banks and auto companies and the Europeans policy elite loves rules. In this kind of situation, their political process will move at a relatively slow late 20th century pace. In contrast, markets now move in a 21st century global network pace. We are moving towards a full-scale speculative attack on sovereign credits in the eurozone. The equity prices of weaker European banks will come under pressure. Fears about their solvency may also be reflected in higher credit default swap spreads, i.e., a higher cost of insuring against their default.

Brought on by weak fundamentals — worries about the budget deficit and whether government debt is on an explosive path — such attacks take on a life of their own. We should remember, and prepare for, a spread of pressure between countries along the lines of the panic that moved from Thailand to Malaysia and Indonesia, and then jumped to Korea all in the space of two months during 1997.

The US Treasury and the White House apparently take the view that they must stand aloof, waiting for the Europeans to get their act together. This is a mistake. The need for US leadership has never been greater, particularly as our banks are really not in good enough shape to withstand a major international adverse event (e.g., Greece defaults, Greece leaves the eurozone, Germany leaves the eurozone, etc). We subjected our banks to a stress test in spring 2009 but the stress scenario was mild and more appropriate as a baseline. Many of our banks, big, medium, and small, simply do not have enough capital to withstand further losses. As the international situation deteriorates, or even if it remains at this level of volatility, undercapitalized banks will be reluctant to lend and credit conditions will tighten around the United States.

If the European situation spins seriously out of control, as it may well do in coming weeks, the likelihood of a double-dip recession or significant slowdown in the second half of 2010 increases dramatically.

C. Longer-Run Baseline Scenario
1. Financial Systems
We have built a dangerous financial system in Europe and the United States, and 2009 made it more dangerous. There are three main lessons to be learned from the past 18 months.
a) The fiscal impact of the financial crisis was to increase our federal government debt held by the private sector by around 30–40 percentage points. The extent of our current contingent liability, arising from the failure to deal with “too big to fail” financial institutions, is of the same order of magnitude.
b) Our financial leaders have learned that they can bet the bank, and, when the gamble fails, they can keep their jobs and most of their wealth. Not only have the remaining major financial institutions asserted and proved that they are too big to fail, but they have also demonstrated that no one in the executive or legislative branches is currently willing to take on their economic and political power.
c) The take-away for the survivors at big banks is clear: we do well in the upturn and even better after financial crises, so why fear a new cycle of excessive risk-taking?

2. Emerging Markets
Emerging markets were star performers during this crisis. Most global growth forecasts made at the end of 2008 exaggerated the slowdown in middle-income countries. To be sure, issues remain in places such as China, Brazil, India and Russia, but their economic policies and financial structures proved surprisingly resilient and their growth prospects now look good.

3. Cracks Showing
The crisis has exposed serious cracks within the eurozone, but also between the eurozone and the United Kingdom on one side and Eastern Europe on the other. Core European nations will spend a good part of the next decade bailing out the troubled periphery to avoid a collapse. For many years this will press the European Central Bank to keep policies looser than the Germanic center would prefer.

4. Finance Led Boom
Over the past 30 years, successive crises have become more dangerous and harder to sort out. This time not only did we need to bring the fed funds rate near to zero for “an extended period,” but we also required a massive global fiscal expansion that has put many nations on debt paths that, unless rectified soon, will lead to their economic collapse. For now, however, it looks like the course for 2010 is economic recovery and the beginning of a major finance-led boom, centered on the emerging world.

5. Commodities
The heart of any economic recovery is, of course, the United States and European banking systems which are central to the global economy. As emerging markets pick up speed, demand for investment goods and commodities increases. As such, countries producing energy, raw materials, all kinds of industrial inputs, machinery, equipment, and some basic consumer goods will do well and there will be investment opportunities in those same emerging markets, be it commodities in Africa, infrastructure in India, or domestic champions in China.

6. Chinese Exchange Rate
The Chinese exchange rate will remain undervalued. Our reliance on Chinese purchases of US government and agency debt puts us at a significant strategic disadvantage and makes it hard for the administration to push for revaluation. The existing multilateral mechanisms for addressing this issue — through the IMF — are dysfunctional and will not help. There is a growing consensus to move exchange issues within the remit of the World Trade Organization (WTO), but without US leadership, this will take many years to come to fruition.

7. Savings and Capital Flows
Good times will bring surplus savings in many emerging markets but rather than intermediating their own savings internally through fragmented financial systems, we will see a large flow of capital out of those countries as the state entities and private entrepreneurs making money choose to hold their funds somewhere safe such as major international banks that are implicitly backed by US and European taxpayers. These banks will in turn facilitate the flow of capital back into emerging markets because they have the best perceived investment opportunities. This is the scenario that we are now facing. For example, savers in Brazil and Russia will deposit funds in American and European banks, and these will then be lent to borrowers around the world (including in Brazil and Russia).

8. Soft Landing?
If this capital flow is well-managed, learning from the lessons of the past 30 years, we have little to fear. A soft landing seems unlikely, however, because the underlying incentives, for both lenders and borrowers, are structurally flawed. The big banks will initially be careful — although Citigroup is already bragging about the additional risks it is taking on in India and China – but as the boom progresses, the competition between the megabanks will push toward more risk-taking in part because their compensation systems remain inherently procyclical, and as times get better, they will load up on risk.

We are steadily becoming more vulnerable to economic disaster on an epic scale.

*Source: http://www.piie.com/publications/papers/paper.cfm?ResearchID=1490