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Goldman Sachs: Half The World’s Economy Threatened By Recession

Talk about an attention-grabber. Yesterday, Bloomberg’s Simon Kennedy wrote:

Goldman Sachs Group Inc. said countries that account for half of the world’s economy face a recession a year after the credit crisis began.

The U.S., Japan, the 15-nation euro area and the U.K. are “either in recession or face significant recession risks in the months ahead,” Goldman’s London-based international economist Binit Patel said in a report to clients today…

“Continued robust, albeit slowing, growth in China and the rest of the emerging markets” will deliver world growth of 3.6 percent next year after 3.9 percent in 2008, said Patel, who estimates emerging markets account for the other 50 percent of the world economy.

Bloomberg’s Kennedy added:

A year since the U.S. housing slump sparked about $500 billion in credit market losses for banks globally, the world’s largest economies are all stumbling as rising borrowing costs combine with record commodity prices to sap growth. The U.S. is close to a recession and France, Germany and Japan all contracted in the second quarter.

“And The Winners Are…”

Source:

“Goldman Sachs Says Half of the World Economy Faces Recession”
Simon Kennedy
Bloomberg, August 21, 2008

Merrill Lynch Economist Warns Of Multiple U.S. Recessions

According to the Financial Post (Canada) from July 9, David Rosenberg, the chief North American economist at Merrill Lynch, is warning of the possibility of not one U.S. economic recession, but a series of them. The Post’s Jacqueline Thorpe wrote:

Rosenberg has consistently held one of the more pessimistic views on Wall Street, arguing the housing slump and credit crunch will exact a heavy toll on U.S. consumer spending. He believes the data will eventually show the recession started in January.

But he adds it’s not the peak-to-trough decline in real GDP that’s important but the duration. Trouble is, the duration could be Japanese-like (about a decade).

Just like Japan, he says a series of rolling recessions is possible for the next three to five years, making it extremely difficult to time the market. Japanese equities got trashed through the process. At the 1998 post-bubble lows, Japanese bank, construction, real estate and transport stocks were all down 80%, retail stocks were down 50%. The only place to hide was bonds, notes the bond bull.

Rosenberg told the Canadian publication:

We are nervous that we have ended up following in Japan’s footsteps due to the inept fiscal response to the problem. A temporary tax rebate from Uncle Sam to buy iPods tackles a real estate deflation and credit crunch as effectively as the LDP’s (Liberal Democratic Party) “solution” in the early 1990s to build bridges and pave river beds that nobody needed.

The Vapours, “Turning Japanese” (1980)
YouTube Video Link

Source:

“Rosenberg on strike, fed up trying to pinpoint U.S. recession”
Jacqueline Thorpe
Financial Post (Canada), July 9, 2008

Next Stop, Depression?

Back on March 29, ABC News’ David R. Francis talked about the economic forecast of Robert Parks, a finance professor at Pace University and former chief economist at three Wall Street firms. So, what’s so special about Parks that ABC News would be covering him? According to Francis, Parks is predicting that there is more than a 60% chance the United States will enter into an economic depression.

Even though the Federal Reserve has been cutting interest rates to stimulate the economy, Francis wrote:

Mr. Parks, however, doubts the cuts will do much to boost the economy. Rather, he sees a further steep fall in housing prices, continued major deficits in the federal budget and in the international trade balance, a tumbling dollar, and a weak stock market leading to a genuine depression with 30 to 35 percent unemployment, greater poverty, more loss of homes, plunging bond and stock prices, even some starvation.

Mother and child during Great Depression

Source: FDR Presidential Library & Museum

He also noted that Parks says he has never predicted a depression before.

The economist thinks that it’s a mistake to rely on money supply growth to help alleviate present economic conditions. Francis wrote:

As Parks sees it, Washington and Wall Street are mostly counting on Fed additions to the money supply to revive the free market and right the economy.

“Automatic recovery is in no way a reliable concept,” he warns, especially if deflation (falling prices) has begun. He recalls warning of the economic damage that the bursting real estate and stock market bubbles would wreak in Japan: That nation suffered stagnation from 1990 to 2001.

Source:

“Are We Heading Into a Depression?”
David R. Francis
ABC News, March 29, 2008

Turning Japanese

I was afraid this would happen. Back in 2005, I read an article on the Investment U website entitled “The Real Estate Bubble End Result: Is a Bust Headed This Way?” On March 28, 2005, Dr. Steve Sjuggerud talked about the Japanese housing bubble that popped in the late eighties, and the prospect of a housing bust in the United States. Sjuggerud wrote:

The first thing that concerns me is the basic economics. It’s reaching a point where most people can’t afford the median home. The second thing that concerns me is the strong belief that prices can’t fall. The Japanese thought the same thing in the late 1980s when their real estate bubble burst, and they’re still suffering terribly…

I checked the results of data on Japanese real estate going back to the 1950s (as far back as data in English exists), and I found that, with the exception of 1975, Japan home prices never had a losing year… Never that is, until the bubble burst and the bust followed. And with it, 17 straight years of pain…

Dr. Sjuggerud brought up the following example:

A guy in central Tokyo who borrowed $500,000 to buy an apartment still owes the full mortgage today, but his apartment has lost 80% of its value. A $500,000 mortgage on a $100,000 apartment… now that’s a bad place to end up.

Tracy Griffith: Sushi Queen

Three years on, and we may be heading towards that “bad place.” Earlier today, Reuters reported that more than 30% of U.S. homeowners who bought in the last two years owe more on their mortgage than their house is currently worth, according to housing market research company Zillow. Chris Sanders wrote in “Third of recent buyers owe more than home’s value: report” that 39% of homebuyers from 2006, who placed a median 10% down payment on the property, are now underwater (owing more than the house is worth). 30% of those who purchased homes in 2007 also have negative home equity, Zillow said in its quarterly home value report. Overall, less than 1% of all American homes are underwater at this point in time.

Stan Humphries, Zillow vice president of data and analytics, told Reuters:

With consecutive declines over the past five quarters, we haven’t seen the housing market bottom yet, and it may very well get worse before things get better. Even many markets that have been largely insulated from recent declines, like some in the Pacific Northwest, reported notable value declines in the fourth quarter.

The fourth-quarter Zillow report covered 125 metro markets and 67 million homes.

Banks May Write Down Additional $300 Billion

Yesterday, global strategy consulting firm Oliver Wyman said in a new study that an additional $300 billion in write-downs related to the U.S. subprime mortgage meltdown may be announced by banks before the crisis is over. Back on January 18 I noted that write-downs had already surpassed $100 billion. In a press release picked up by Yahoo! Finance yesterday, John Colas, Managing Director and head of the North American Corporate Strategy Practice at Oliver Wyman, said:

The credit crisis is unlikely to resolve itself before the end of this year. We also see strong likelihood of price corrections in emerging markets and this combination will extend the value loss and turbulence witnessed in 2007.

The management consultancy said in its “State of the Financial Services Industry” report:

We expect a stormy 2008. While governments, central banks and regulators scramble to address the aftermath of the sub-prime fallout, several other crises are mounting.

These other disruptions include:
• A significant slowdown in European real estate markets, especially in Spain and the UK
• The continued weakening of the U.S. dollar
• A collapse in commodity prices
• A fall in Chinese and Indian stocks

The financial services industry should expect “turbulent conditions for 2008 and beyond.” Oliver Wyman predicted that American banks are especially at risk. From its 2008 report:

North American financial services firms will have a tough year. Market uncertainty, combined with further write-downs and expected home-price and loan-volume declines, implies more squeezes on earnings. Banks most likely will have to increase loan-loss reserves.

In North America last year, the financial sector lost 13% in market value, second only to Japan. In contrast to the United States, the value of financial companies in Canada grew 12%.

For the first time since 2002, the global market value of the industry fell, according to the annual report. Controlling for exchange rates, the industry lost 7% of its market value last year. While $300 to $400 billion was gained in red-hot emerging markets last year, financial institutions lost more than $1 trillion in mature economies.

Stock Markets Fall Around The Globe

Returning to work on Monday is hardly ever fun. Losing a ton of money makes it even worse. While American financial markets were closed in remembrance of Martin Luther King, Jr., stock markets around the world were being hammered.

Indexes in Japan, China, Hong Kong, India, South Korea, and Singapore fell at least 3%. Indian stocks were punished severely, dropping nearly 11% at one point in the trading session before finishing off more than 7%. The Australian and New Zealand stock markets have now experienced losing sessions for 11 and 13 days, respectively.

Photo from DailyHaHa.com

The carnage in equities spread to Europe. The pan-European Dow Jones Stoxx 600 index ended down 5.4% at 309.67. At one point earlier in the trading session, the index earlier reached a low of 308.69, which was the largest one-day percentage drop since the September 11 terrorist attacks. The index has lost around 23% from its mid-2007 high of 400.99. The French CAC-40 index ended the day down 6.8% to 4,744.45. The German DAX 30 index was down 7.2% to 790.19. The U.K. FTSE 100 index declined 5.5% to 5,578.20.

Making its way to the Americas, the global sell-off spread to Canada and Latin America. The S&P/Toronto Stock Exchange composite index sank 4.7% to end the day at 12,132.14. Brazil’s Bovespa fell 6.6% to 53.694, and Mexico’s Bolsa index declined 4.8% to 25,444.

According to MarketWatch today, losses from financials were largely to blame after U.S. bond insurers came under attack by a ratings agency, and the proposed economic stimulus plan from President Bush failed to convince investors that it would be enough to prevent a recession in the United States. The stock sell-off occurred after the worst weekly performance on Wall Street for five years.

All eyes are now turned to Wall Street, which resumes trading Tuesday. As of this afternoon, the Dow Jones Industrial Average futures contract was down 520 points to 11,586, the Nasdaq futures were down 76.25 to 1,773.25, and the Standard & Poor’s 500 futures had fallen 60.3 to 1,265. According to MarketWatch:

If futures contracts traded on a day when U.S. stocks weren’t even due to open are anything near accurate, then markets will be in for a major decline on Tuesday, with concerns about bond insurers and the health of financial institutions dragging markets lower.

Father of Reaganomics: Nothing Can Be Done To Save Economy

This morning I came across an interesting article by Paul Craig Roberts in the Coastal Post. Who is Dr. Roberts? He is an economist who served as an Assistant Secretary of the Treasury in the Reagan Administration, and is known as the “Father of Reaganomics.” Outside of the public sector, he was a former editor and columnist for the Wall Street Journal and Business Week.

What initially caught my eye was the title of the article- “The Impending Destruction Of The U.S. Economy.” No use beating around the bush. But he did manage to beat up the Bush administration and other policymakers in Washington for their mishandling of the U.S. economy. Dr. Roberts wrote:

Hubris and arrogance are too ensconced in Washington for policymakers to be aware of the economic policy trap in which they have placed the U.S. economy. If the subprime mortgage meltdown is half as bad as predicted, low U.S. interest rates will be required in order to contain the crisis. But if the dollar’s plight is half as bad as predicted, high U.S. interest rates will be required if foreigners are to continue to hold dollars and to finance U.S. budget and trade deficits.

Which will Washington sacrifice, the domestic financial system and overextended homeowners or its ability to finance deficits?

The answer seems obvious. Everything will be sacrificed in order to protect Washington’s ability to borrow abroad. Without this, Washington cannot conduct its wars of aggression, and Americans cannot continue to consume $800 billion dollars more each year than the economy produces.

Nice job, Washington!

However, this line of credit is threatened. According to Roberts:

No country wants to hold a depreciating asset, and no country wants to acquire more depreciating assets. In order to reassure itself, Wall Street claims that foreign countries are locked into accumulating dollars in order to protect the value of their existing dollar holdings. But this is utter nonsense. The U.S. dollar has lost 60 percent of its value during the current administration. Obviously, countries are not locked into accumulating dollars…

Japan and China - indeed, the entire world - realize that they cannot continue forever to give Americans real goods and services in exchange for depreciating paper dollars. China is endeavoring to turn its development inward and to rely on its potentially huge domestic market. Japan is pinning hopes on participating in Asia’s economic development.

The dollar’s decline has resulted from foreigners accumulating new dollars at a lower rate. They still accumulate dollars, but fewer…

Foreigners have continued to accumulate dollars in the expectation that sooner or later Washington would address its trade and budget deficits. However, now these deficits seem to have passed the point of no return.

Faced with the realization that the twin deficits will not be addressed, will foreigners finally stop accumulating dollars and/or significantly reduce dollar holdings, causing a dollar crash?

Dr. Roberts explained why the twin deficits could no longer be fixed:

The sharp decline in the dollar has not closed the trade deficit by increasing exports and decreasing imports. Offshoring prevents the possibility of exports reducing the trade deficit, and Americans are now dependent on imports (including offshored production) for which there are no longer any domestically produced alternatives. The U.S. trade deficit will close when foreigners cease to finance it.

The budget deficit cannot be closed by taxation without driving up unemployment and poverty…

In the 21st century, the U.S. economy has been driven by consumers going deeper in debt. Consumption fueled by increases in indebtedness received its greatest boost from Fed chairman Alan Greenspan’s low interest rate policy. Greenspan covered up the adverse effects of offshoring on the U.S. economy by engineering a housing boom. The boom created employment in construction and financial firms and pushed up home prices, thus creating equity for consumers to spend to keep consumer demand growing.

This source of U.S. economic growth is exhausted and imploding. The full consequences of the housing bust remain to be realized. American consumers lack discretionary income and can pay higher taxes only by reducing their consumption. The service industries, which have provided the only source of new jobs in the 21st century, are already experiencing falling demand. A tax increase would cause widespread distress.

The old-school Republican had this to say about our precarious position:

Superpower America is a ship of fools in denial of their plight. While offshoring kills American economic prospects, “free-market economists” sing its praises. While war imposes enormous costs on a bankrupt country, neoconservatives call for more war and Republicans and Democrats appropriate war funds, abroad….

We have arrived at the point where it is no longer bold to say that nothing now can be done. Unless the rest of the world decides to underwrite our economic rescue, the chips will fall where they may.

Recession Outlook Goes Beyond Psychology

While reading a Bloomberg piece by Caroline Baum earlier today, I noticed that the senior U.S. economist at JPMorgan Chase & Co., Jim Glassman, said that the Fed yesterday “could have put an end to this recession discussion, which is a psychological thing right now.” Psychological? Maybe. But the prospect of an economic recession in the United States looks to be based on more than just fear. Take the latest Wall Street Journal survey of economists, for example. On Monday, the Journal said that of the 52 individuals polled:

…the economists, on average, now put the chances of a recession at 38%, the highest in more than three years, and up from 33.5% in November. They also reduced forecasts for U.S. economic growth across the board. They expect the nation’s gross domestic product to grow at an annualized rate of 0.9% this quarter, down from 1.6% in the previous survey, with six economists expecting either a negative or a flat reading. Three economists project an economic contraction in the first quarter, with the average growth forecast at 1.5%, down from 1.9% in November.

Kathleen Camilli of Camilli Economics, “the most pessimistic forecaster in the survey,” according to the Journal, said she sees “the internal dynamics of the U.S. economy deteriorating into recession” this quarter. “Growth will be negative this quarter, nonfarm payrolls will be revised down, and from what I can see, personal-consumption expenditures are rapidly slowing,” the economist added. Also among the bear camp, Ramachandra Bhagavatula, a managing director at New York hedge fund Combinatorics Capital LLC, said:

What is happening is that household net worth is not growing by leaps and bounds — if anything it is going down — [which means] people actually have to start saving out of their current income. That has negative effects on spending growth. In many ways, I think the next five years in this economy could look like Japan after 1990. The big [growth] you got in variety of asset classes — financed by borrowing because of extraordinarily low rates — will come out. When you look at the economic landscape, stock prices are too high, house prices are too high, and you put all the pieces together and the size of the adjustment needed seems reasonably large. How many years does it take? Who knows? It doesn’t necessarily mean we have five years of recession — maybe just 3-4 quarters of recession.

Echoing such sentiment, economists at Morgan Stanley said Monday that the U.S. economy will likely go into recession in 2008. MarketWatch noted that Morgan Stanley is the first major Wall Street firm to predict a recession. Chief economist Richard Berner and U.S. economist David Greenlaw in an updated forecast on the firm’s Global Economic Forum web site said that domestic demand is expected to fall 1% annualized over the next three quarters with zero growth in gross domestic product and a 5% to 10% drop in corporate earnings. For the full year, Morgan Stanley sees 1% growth.

U.S. Recession Will Affect Asia

Stephen Roach, Chairman of Morgan Stanley Asia, gave a speech earlier today in Mumbai, India, where he talked about the U.S.-Asian economic outlook. Roach is well-known on Wall Street as a perennial “bear” on the U.S. economy. In November 2004 (while still Morgan Stanley’s chief economist), he attended a meeting with a select group of fund managers and shocked the audience with his observation that the U.S. had no better than a 10% chance of avoiding an economic “Armageddon”.

On the probability of recession in the United States, Roach told his audience:

I want to make three points with you today in my discussion. Number one, I think the global economy is going to be very challenging over the next couple of years. Unlike the situation of 10 years ago, when global problems were made in Asia, I think global problems will be made in America. I think the risk of a recession in the US in 2008, is high and rising. You don’t want to put any real precision on probabilities like that, but I would say it’s a number. Now that has unfortunately moved above that 50% threshold for 2008.

On how a U.S. recession will affect Asia:

Second point I want to make is, if the US goes into recession, you are going to feel it in Asia, you are going to feel it in India. The fundamentals for Asia are terrific. But Asia as a region, and developing Asia in particular, remains very much an export led region, maybe a little bit less than that for India than typical developing Asian economies. But certainly the case in Eastern Asia and China are on the leading edge of that. So, if the US sneezes, Asia will catch a cold. I don’t believe in global decoupling and I will tell you why as we go through this discussion.

On why he doesn’t believe in the theory of “decoupling”:

I think the thing that worries me the most, and this is where I would really underscore the point for you in India, is that equity markets in this region, including your own, are discounting this optimistic, rosy scenario called decoupling. There is the strong belief that because the US has slowed so far, and Asia hasn’t, that any further slowdown will leave Asia unscathed. Think about it for a second. The slowing that’s occurred in the US right now has been in homebuilding activity. It’s America’s least global sector. You stop building a house in America, there’s almost no impact on Asian exports to the US. The slowing that will be coming over the next year will be in the consumer demand sector, which is America’s most global sector. So, we are going to see the US slowdown go from a domestically driven to a globally driven slowdown. I am sorry, as bullish as I am about Asia, Asia will not be an oasis of prosperity in a softer global demand climate. To the extent that emerging market equities are buyers of the global decoupling thesis, including in your own market right here, I think there could be a significant correction in emerging market equities that certainly could hit the Indian stock market quite hard.

Foreign Investors Dump U.S. Assets

In the midst of the credit market upheaval, overseas private investors sold a record amount of U.S. securities in August. According to the U.S. Treasury Department on Tuesday, the total holdings of equities, notes, and bonds fell a net $69.3 billion, after an increase of $19.5 billion in July. The outflow from U.S. assets was a record high and the first since the financial market crisis back in 1998. The previous record decline of $21.2 billion took place in March 1990.

The monthly net Treasury International Capital System (TIC) flows, which include non-market flows, short-term securities, and changes in banks’ dollar holdings, revealed an outflow of $163 billion in August, compared with an inflow of $94.3 billion in the prior month. Private investors overseas led the outflows, selling a net $141.9 billion in U.S. assets in August.

According to the Wall Street Journal yesterday, official holdings are of greater importance to the foreign-exchange market, given their massive size. Foreign official holdings in Treasuries fell by a net $29.7 billion. The Journal noted that the TIC data “gave no indication that central banks are shunning the greenback in any significant fashion.” Yet, the two largest holders of U.S. Treasury securities reduced their holdings in August. Japan, the largest holder of U.S. government debt, decreased its holdings by $24.8 billion (4%). China, the second-largest holder of Treasuries, lowered its holdings by $8.8 billion (2.2%).

The sell-off of U.S. assets came at a time when China, South Korea, and Qatar joined Singapore and Norway in setting up sovereign wealth funds to invest excess foreign exchange reserves from export revenue to improve returns. Robert Rennie, chief currency strategist at Westpac Banking in Sydney, told Bloomberg yesterday that, “Asian central banks are becoming more conscious of increasing returns. We’re seeing moves to create sovereign wealth funds, which by definition suggest a structural shift away from Treasuries.”