Too soon to declare an economic turnaround

PUBLISHED : Tuesday, 04 August, 2009, 12:00am
UPDATED : Tuesday, 04 August, 2009, 12:00am

Her Britannic Majesty Queen Elizabeth II clearly is a woman of more power and influence than most people in the world. The latest proof is that she got a letter last month from some British professors apologising for the failure of economists to predict or head off the financial crisis that is still devastating the world.

The apology was a belated response to the Queen's question in November when visiting the London School of Economics. She asked why no one had predicted the financial crisis and recession.

The learned professors' letter of apology was more craven than informative, asserting that 'financial wizards' were guilty of 'wishful thinking combined with hubris'. Of course, it is not true that all economists failed to predict what was coming, but almost all those in government and supervision did, and were mesmerised by the financial wizards.

Meanwhile, what is happening in the real world here and now continues to baffle economists. I am reminded of the old saying that if you laid all the world's economists end to end across the face of the earth they would fail to reach a conclusion.

Has the US actually left recession behind? That was the burning question being asked on Friday when the new US numbers showed second-quarter gross domestic product down by only 1 per cent, against the consensus forecast of minus 1.5 per cent. This led some economists to proclaim that from mid-2009 the recovery and positive growth had resumed and that the third quarter would clearly show positive growth.

Many media, in their rush for the headlines, missed the fact that the data for the first quarter and for last year had been revised downwards. The first quarter of this year was revised to minus 6.4 per cent from the original estimate of minus 5.5 per cent. No it has not been as bad as the Great Depression of the 1930s, but it at least deserves to be called the Great Recession.

For technical reasons, the US is likely to see positive growth in the third or fourth quarter as inventory reduction slows. But the key question is what happens after that. New York University professor Nouriel Roubini, nicknamed 'Dr Doom' because he did forecast the recession, now predicts global recovery in late 2009, but expects another dip into recession by late 2010 or 2011 on higher oil prices, high government debts and a failure to create jobs.

World stock markets have been excitedly wallowing in the good news and ignoring the bad, with the Dow Jones Industrial Average staying above 9,150 points on Friday.

More thoughtful economists point to two worrying concerns about how long or sustainable the recovery will be: one is the lack of consumer demand; the other is the continuing rise of unemployment. Put them together and you have a damaging recipe for the global economy.

Dave Rosenberg, chief economist and strategist with Canadian wealth management firm Gluskin Sheff and Associates, wrote in his Breakfast with Dave column: 'It is amazing that anyone would go long an equity market with a reported price-earnings multiple of 700x but that is indeed what we have on our hands.'

He also noted an 80 per cent similarity between the performance of the S&P 500 Index from March 9 to today and what happened in late 1929 and early 1930. After a whippy rally in 1930 - just as today - the S&P fell in a series of sharp movements right through to the middle of 1932.

Doubts about US economic health also spill over into arguments about the strength of China's recovery and particularly whether it can maintain the magic 8 per cent growth target. Nouriel Roubini believes that Beijing will meet the target this year.

However, the original 'Dr Doom', also known as Marc Faber, who is the Hong Kong and Thailand-based publisher of the Gloom, Boom and Doom Report, challenges the optimism and declared last week that the true rate of China's growth is a mere 2 per cent, not the 7.8 per cent claimed by the government.

'The Chinese government is one of the few governments in the world that knows its GDP numbers three years in advance,' he told CNBC. 'I'd be careful about China.' Even so, he predicted that the Chinese markets could continue to rise since, 'If you throw money at the system, lots of things go up in value - but maybe they go up for the wrong reasons. What disturbs me today ... is that the lows in March and late last year, sentiment was incredibly bearish about everything.'

But now, 'there's this incredibly bullish sentiment when insiders are actually selling and the technical picture of the market doesn't look that great'.

Mr Faber was another who correctly predicted the global recession, but his predictions are sometimes eccentric. He told me during an interview in the early 1990s that the up and coming place for a bright young financial man was North Korea.

Michael Pettis, professor of Peking University, offers a more thoughtful and carefully reasoned analysis of why China will struggle to achieve more than 5 to 7 per cent growth over the next few years. He argues that China's great growth rates were achieved because US consumers bought the excess over its domestic consumption.

But the hard economic facts of life mean that the US has to pull in its belt, with inconvenient consequences for China's export and overall growth. If the US recovery turns out to be jobless, as some are predicting, the situation will be worse for China and the world, and could spark trade restrictions in the name of protecting domestic jobs everywhere.

The lesson is that although the stock markets are riding the crest of a wave, and some green shoots may be appearing, there is still a long way to go before a global economic spring can be safely declared.