Senate Committee Tackles Global Slowdown Implications
As the United States trudges forward through the uncertainty of the economic landscape, the outlook for the year ahead continues to deserve revisions. The International Monetary Fund (IMF), the Institute of International Finance, Inc. (IIF) and private think-tanks have each recanted projections that global growth will be around 2.2% in exchange for forecasts that are far gloomier. With the U.S. grappling with a financial crisis that has cascaded to the rest of the world’s markets, everyone is bracing for the worst market conditions seen in a quarter-century, and maybe even worse than the post-World War II slowdown. Estimates from the World Bank show the first global trade decline in decades, with global wealth losses approaching $50 trillion.
“I think all of us know we are in the worst economic downturn our country has seen since the Great Depression,” said Senate Budget Committee Chairman Kent Conrad (D-ND). “We have lost nearly two million jobs in just the last four months.” Conrad felt the predictions from the IMF that world gross domestic product (GDP) would fall from 2.2% to .5% were “overly optimistic.” He called for hearings into the implications of the global slowdown and possible policy steps the U.S. could take to confront the effects and risks of the crisis.
“I have no doubt—none at all—that a recovery package is necessary and a large recovery package is necessary,” stated Conrad, adding he didn’t believe the current proposed plan was properly designed to spark recovery. “I am also concerned that we’re going to find four months from now the administration coming back to us and asking for hundreds of billions of dollars more to deal with the financial institutions of the country.”
Conrad wasn’t alone in his trepidation. Ronald Kurtz, professor of Entrepreneurship, MIT Sloan School of Management, senior fellow, Peterson Institute for International Economics, forecasts a global contraction of minus 1% in 2009, with no recovery on the horizon and worldwide growth for 2010 remaining flat relative to this year.
“A rapid return to growth requires more expansionary monetary policy and in all likelihood this needs to be led by the United States,” testified Kurtz. “But the Federal Reserve is still some distance from fully recognizing deflation and by the time it takes that view and can implement appropriate actions, declining wages and prices will be built into expectations, thus making it much harder to stabilize the housing market and restart growth.”
Kurtz believes that the most likely outcome will not be a V-shaped recovery or a U-shaped recovery, two consensuses held by the official and private sectors respectively. Instead, he foresees an L-shaped one, where there is a steep fall followed by a struggle to rebound. He admits there could even be a “lost decade” in store for the world economy, and though there may be some episodes of incipient recovery, as seen during the financial woes of Japan during the 1990s, they will prove hard to sustain.
“While we agree that a rapid fall is underway and the speed of this is unusual, we do not yet see the mechanisms through which a turnaround occurs,” warned Kurtz. “In fact, in our baseline view, there is considerably more decline in global output already in the works and, once the situation stabilizes, it is hard to see how a recovery can easily be sustained.”
Tim Adams, former Treasury Under Secretary for International Affairs, now managing director, Lindsey Group, agreed with Kurtz’s view that the U.S. has to lead the world out of crisis and that the weakness of balance sheets remains the main hurdle to overcome domestically.
“Despite aggressive monetary and fiscal policy measures, the next year or two will still prove challenging,” said Adams. “The global financial deleveraging process will continue. Banks will continue to rebuild their balance sheets and remain reluctant to extend new credit. Private capital will likely avoid the banking sector, paralyzed by uncertainty over asset quality and expected sweeping changes to the U.S. and European regulatory regimes. The demand for credit will also remain weak.”
Adams foresees the banking sector will continue to wade through dire straits. He said that since the extent of toxic assets is probably at least $1 trillion, and could be as high as $3 trillion, Congress will likely be forced to release additional funds to banks. He suggested one policy path could be for the Fed to purchase assets by expanding its own balance sheet, then applying the Troubled Asset Relief Program (TARP) funds to just the expected present value of the calculated credit risk or loss, allowing the Central Bank to leverage the $250-$300 billion to as much as $2.5-$3 trillion in actual asset purchases.
Though positives are difficult to point to, the plummet in the price of oil will continue to help keep the U.S. trade deficit in check, with the January deficit possibly as low as $30 billion, meaning the need for U.S. net capital inflows are falling. Non-oil exports for the U.S. have also grown at a substantially quicker pace than non-oil imports.
“The obvious risk is that bad news compounds: the initial fall in [global] output gives rise to a further fall in investment, employment and consumption, dragging growth down further,” said Brad Sester, fellow, Geo-economics, Council on Foreign Relations. He then said the sustainability of improvement will be dependent on the price of oil, which also hinges on the U.S. and other nations taking steps to increase domestic demand growth, or whether reliance is simply placed on the reemergence of U.S. demand. “The only bright spot: the synchronized global slowdown leaves little doubt about the needed direction of the global policy response.”
Matthew Carr, NACM staff writer