“The world is looking straight into the face of a great depression”.
New recession threatens the globe as debt crisis grows
by Ambrose Evans-Pritchard – Telegraph (UK) published 11/10/11
Europe’s escalating debt crisis has cast a black shadow over the world’s fragile recovery, threatening to tip large parts of the global economy into a deep downturn and even outright recession.
The OECD’s index of leading indicators for China, India, Brazil, Canada, Britain and the eurozone have all tipped below the warning line of 100, with the pace of the decline in Europe exceeding the onset of the Great Contraction in early 2008. Professor Simon Johnson, a former chief economist at the IMF, rattled nerves earlier this week by warning the world is “looking straight into the face of a great depression”.
The grim data is coming thick and fast. Japan’s machinery orders fell 8.2pc in September as the post-Fukushima rebound lost steam and the delayed effects of the super-strong yen began to bite. Export orders have been declining for eight months. “Outright contraction is possible in the quarters ahead,” said Mark Cliffe from ING.
Exports in the Philippines dropped 27pc in September, the sharpest fall in two years. Korea’s exports have showed sharply, caused by a 20pc slide in shipments to Europe. Manufacturing has been contracting for the past three months.
Christine Lagarde, the IMF’s chief, warned in Asia that “there are dark clouds gathering in the global economy. Countries need to prepare for any storm that might reach their shores”. She said “adverse feedback loops” are at work as financial stress and economic woes feed on each other.
China’s carefully managed soft landing has turned uncomfortably hard, with ripple effects through the commodity markets. Spot iron-ore prices have dropped 30pc since July to $126 a tonne. Copper prices have fallen 20pc since August. Barclays Capital said the risk of contagion to China has become serious. The bank is monitoring the country’s “key high frequency data” for early warning signs of the sort of sudden crash in metals demand seen during the Lehman crisis.
China had the firepower to respond to the 2008 crisis with blitz of credit that helped lift the whole world out of slump, a feat that cannot easily be repeated if there is a second shock. The IMF said loans have doubled to almost 200pc of GDP, including off-books lending. This is an unprecedented level of credit growth, twice the intensity of the Japanese bubble in the late 1980s.
The authorities are trying to deflate the excesses slowly with higher interest rates and reserve ratios. This is proving painful. Yao Wei from Societe Generale said prices of new residential property fell 14% in October. Railway investment collapsed by 40% as the insolvent railway ministry struggled to cope with $300 billion of debt. Highway construction dropped 2pc.
Europe is in a deeper, more intractable crisis. Industrial output buckled in September with falls of 4.8pc in Italy, 2.7pc in Germany, and 1.7pc in France from a month earlier as the effects of the debt crisis – as well as fiscal contraction and prior monetary tightening – finally hit with a vengeance.
EU commissioner Olli Rehn slashed growth forecasts from 1.6pc to 0.5pc next year, warning “that recovery has now come to a standstill and there’s the risk of a new recession unless determined action is taken”. This did not stop Brussels sending a letter to Italy calling for yet more fiscal cuts to meet it is balanced budget target by 2013.
“It is imposing pain for pain’s sake, and it is going to cause creditors to collect even less on their Club Med debts than if austerity were abandoned. Even in the early 1930s they weren’t as bad as this,” said Charles Dumas from Lombard Street Research.
Humayun Shahryar from the hedge fund Auvest said the eurozone faces a “major economic collapse”, perhaps with double-dgit falls in GDP. “European banks are massively over-leveraged and almost every one is worthless if you mark to market. This is going to be worse than 2008 because they have run out of bullets. The sovereign states are not strong enough to stand behind the banks,” he said.
Professor Johnson said the EU authorities had made a serious mistake by raising capital ratios for banks to 9pc rather than forcing them to raise fresh capital. “That will lead to a further contraction of credit.”
Banks have already taken drastic steps to cut their loan books rather than raise money in a hostile market, earmarking over €700bn for the next year. There will be knock-on effects for the rest of the world. European banks account €2.5 trillion cross-border loans to emerging markets.
In the US, the economy has held up better than feared so far but faces a fiscal shock early next year. Tax write-offs have pulled capital expenditure forward into late 2011, flattering the picture. Payroll taxes will rise automatically from 4.2pc to 6.2pc in January. Dumas said the combined fiscal squeeze could be as much as 2pc of GDP, heavily “front-loaded” in the early months. “Sharp recession is likely,” he said.
“The credit spigot has been turned off in the US,” said Chris Whalen from Institutional Risk Analytics. “Almost every bank is still running down its loan book, so we are facing a slow motion credit-crunch.”
Fiscal and monetary stimulus has disguised the underlying sickness in the debt-laden economies of the West over the past two years. This heavy make-up has at last faded away, exposing the awful visage beneath.
It is a delicate moment. The risk of a synchronised slump in Europe, the US and East Asia is bad enough. What is chilling is to face such a possibility with the monetary pedal already pushed to the floor in the US, UK and Japan.
Worse yet is to do so with Europe spiralling into institutional self-destruction, allowing its debt crisis to metastasize because EMU has no lender of last resort. That is an unforced error we could do without.