Friday, May 28, 2010

Drachma drama or Dragon's dance?

While concerns remain, recent roilings in Greece and Europe are no threat to global economic recovery.

I had written in April 2009 that the US and global economies would begin their recovery from the recession in July 2009. This opinion was based on five factors, all publicly known. The opinion was however at considerable odds with prevailing expert opinion at the time: Uber-gurus Paul Krugman (winner of the 2008 Nobel Prize for Economics) and Robert Reich (a key member of President Clinton's cabinet and recently ranked by the Wall Street Journal among America's Top Ten Business Thinkers) were predicting another Great Depression; the IMF was in March 2009 foreseeing a recovery for the world economy only in 2010 and the OECD was forecasting a recovery in early 2010.

Subsequent developments suggest the July 2009 date for the beginning of the recovery was remarkably accurate – expert opinion has increasingly been veering round to such a view.
The IMF rapidly revised it's view and declared on July 8th 2009 that the world economy had "begun to pull out of recession". The OECD followed suit in September 2009, stating that "the global recession is coming to an end faster than thought a few months ago and may already be over". Dr. Alan Greenspan said August 3rd 2009 that the economy had begun to grow “from the middle of July”. This guest column I've written in CEO World magazine in February 2010 summarizes this and draws some inferences.

However, there remains on the street even today (nearly a year later) some skepticism regarding the strength of the recovery. The reason is primarily that the job market hasn't revived strongly.

In hindsight if I can be accused of anything, it's for being overoptimistic in using the word "strong" in April 2009 to characterize the impending recovery. However, the US GDP growth figures for the 3 quarters beginning July 2009 have read 2.2%, 5.4% and 3% - figures that can hardly be characterized as weak (and in fact the best growth figures in about 6 years ) ! The tenacious will doubtless argue here that GDP is an inadequate measure of human well-being, but that's a diferent debate altogether. Even the apparently moribund US job market has begun a significant uptick.

Do all the events in Europe that have roiled world markets in recent weeks disprove the recovery thesis? I've been keeping a log of events, economic data, news reports etc. over the past year, and more closely since the European "crisis" hit. The objective data is quite unequivocally in favor of continuing recovery. Significantly, the OECD upped global GDP growth projections a couple of days ago. The US growth estimate was raised to 3.2 percent this year and 3.2 percent next year. That was higher than a forecast made last November of 2.5 percent this year and 2.8 percent in 2011. Euro-area growth was estimated at 1.2 percent this year and 1.8 percent next year - an improvement from the November figure of 0.9 percent this year and 1.7 percent next year. The IMF in April 2010 raised it's global growth forecast for 2010 to 4.2%. Prof. Eswar Prasad of Cornell University and the Brookings Institution writes in May 2010 that the global economy has been in recovery since mid-2009; the Financial Times is tracking the recovery using his TIGER index.

And of course the five factors remain valid as ever. Markets are understandably spooked but much of the talk of double-dip, breakup of the EU, long-drawn out economic malaise etc. is based on unjustified extrapolation, unconvincing hunches and / or grandstanding by a few people. In fact this thinking is a product of the same lack of clearsightedness alluded to in the CEO World guest column - when things are rollicking along people will brook no bad news, but when things are looking bad even the slightest bad news spawns Armageddon-like foreboding. Given the general gloom that recessions engender, few brave souls would risk standing out like a sore thumb, making light-hearted proclamations of sunny recovery.

We also need to get used to the idea that in the post-crisis era the world has become far more inter-connected than ever before. Our existing worldview fashioned in the fragmented, fractious and adversarial Cold War era is hopelessly inadequate to understand the full effects of this new
inter-dependence. So the new hyperconnected world will be a rocky place for sometime to come, punctuated by periodic ripples, minor panics etc. However these should not detract from the fact that the underlying economic firmament (that was apparently ripped by the financial crisis) is on firm ground.

A somewhat larger and more credible threat to the world economy is from potential rumblings in the Chinese economy, with China's currency peg* being of particular concern. These rumblings are muted as of now, and there isn't much reason to doubt the ability of the Chinese leadership to handle them; however this is a region that will bear watching. Overall at this point there is, in my assessment, a probability of less than 10% for a relapse into recession for the US, 15-20% for Europe and below 5% for Asia.


Update Jun 9th 2010: Should the admittedly dismal US jobs report for May, released June 4th, cause us to abandon belief in the recovery? While it does give pause for thought, it is but a single data point and hardly constitutes sufficient evidence to declare a slide back into recession. A more reliable jobs indicator would be the 3-month moving average of jobs created - this figure for the last 3 months is way above the 150,000 threshold u
sually used to indicate recovery.
US Fed Chairman Dr. Ben Bernanke also said on June 7th that the US recovery probably began sometime late last summer, and that consumer spending and business investments appear to be taking over from the fading government stimulus in lifting the economy. In today's testimony to the House Budget Committee he said the US economy will grow at around 3.5% this year, and that he expected significant private sector job creation going forward. He also said he didn't expect a major impact from Europe's debt crisis on the US economy - the exact word he used was "modest". US Treasury secretary Tim Geithner is convinced there's a "modest but solid recovery in place". So the poor May US jobs report (and the Eurozone troubles), though disquieting, are likely the inevitable ripples as the post-crisis world structurally readjusts to a changed reality, are no reason to question our faith in the five factors, and don't detract from a recovery that remains firmly on track.

Update June 21st 2010: China's contentious currency peg (which I've referred to above as of particular concern to the global economy's health) has officially begun to be loosened from today. The timing appears somewhat dubious, and suggests this may just be posturing for the benefit of the G20 meeting this weekend. However if China is indeed serious about this move (and there are many reasons to believe it is), it signals Chinese confidence in the global economy, as Goldman economist Jim O'Neill among others thinks.
More importantly, if China does deliver on the implicitly promised upward valuation of the Yuan, then a major distortion of market forces in the global economy will be reduced over the coming months. That scenario diminishes a major threat to the world economy, and virtually banishes the fears of a relapse of Eurosclerosis. And in that case, the probabilities of an early relapse into recession then fall to below 5% for the US, between 5 and 10% for the Eurozone and well below 5% for Asia. (If you'd like to see a more detailed computation of these probabilities, drop me a mail).
* a levee.