IMF: "Risks to financial stability have intensified"

For those hoping that credit conditions might gradually be returning to normal, today's IMF Global Financial Stability Report market update contained a stark warning:

Risks to financial stability have intensified since October 2008. Macroeconomic risks have risen as global growth has fallen precipitously alongside a sharp slowdown of global trade. Credit risks have also risen as a deterioration of economic and financial conditions have resulted in rising loan losses. At the same time, the flight from risky assets and illiquid market conditions has increased funding costs, even as risk-free rates have declined with monetary easing.

That is despite the massive bailouts, spending plans and other government interventions we have seen since the last report:

...With the help of extensive government support, market functioning toward the end of 2008 improved in a number of asset classes. However, the negative interaction between the economy and the financial sector has intensified as the credit crunch bites harder and extends globally, with confidence among financial counterparties remaining strained. Indeed, the recent shock to bank earnings and other bad economic news has put further downward pressure on bank equity prices, and the width of credit default swap spreads points to still-elevated systemic risks.

And if you think that prognosis was depressing, the sentence that follows is even worse:

Notwithstanding public injections of capital, many banks around the world may have an insufficient capital cushion to weather a deep global economic downturn.

Translation: many banks are insolvent and probably won't survive the global recession.

The credit crunch ain't over; not by a long shot.

Comments

[Razib Ahmed]

I agree with IMF’s analysis here. In the last 2-3 days, the export data of some Asian countries came and there has been significant decrease in exports earnings of China, South Korea and India. Until now, economic recession was mostly limited to Europe and America. Now, it is spreading to Asia. I will not be surprised to see media headlines about a deepening economic crisis in Asia in the next few weeks.

[Arthur Eckart]

Plunder: to rob of goods or valuables by open force, as in war; despoil, or fleece; to take wrongfully, as by pillage, robbery, or fraud; loot.

BEIJING (Reuters) - The United States has plundered global wealth by exploiting the dollar's dominance, and the world urgently needs other currencies to take its place, a leading Chinese state newspaper said.

"The grim reality has led people, amidst the panic, to realize that the United States has used the U.S. dollar's hegemony to plunder the world's wealth," said the commentator, Shi Jianxun, a professor at Shanghai's Tongji University.

Shi, who has before been strident in his criticism of the U.S., said other countries had lost vast amounts of wealth because of the financial crisis, while Washington's sole concern had been protecting its own interests.

Shi suggested that all trade between Europe and Asia should be settled in euros, pounds, yen and yuan, though he did not explain how the Chinese currency could play such a role since it is not convertible on the capital account.

My comment:

The U.S. is the only economy that can expand with huge negative net exports. Even the E.U., which is a group of countries, would fall into recession attempting to be the main engine of global growth, trying to pull Asian economies, e.g. Japan, China, the "Asian Tigers," etc. In Europe, there are no Microsofts, Ciscos, Intels, Apples, Googles, Genentechs, etc., while their emerging industries generally continue to lag the U.S. badly, and their older industries are much less efficient. So, it'll continue to be a U.S.-centric world, until a country or group of countries can compete with the U.S.

Also, export-led economies will need to exchange their goods for more U.S. goods (consumer and capital goods) rather than exchange their goods for U.S. assets (e.g. Treasury bonds). That means export-led economies will need to produce less and consume more, while the U.S. produces more and consumes less.

The U.S. dollar remains the ultimate hard currency, and the only universally accepted currency (when Saddam was captured, he wasn't carrying Euros, Iraqi Dinars, Yen, Swiss Francs, or gold. He had U.S. dollars).

The root cause of the financial crisis is global imbalances. For example, China sold its goods too cheaply, which induced U.S. demand. China then lent its dollars too cheaply, which also induced U.S. demand. So, there was a virtuous U.S. cycle, of consumption and investment. The U.S. captured increasingly larger gains of trade, while China captured increasingly smaller gains of trade (e.g. through diminished U.S. marginal utility, and China earning greater negative returns, through low interest rates, inflation, e.g. not exchanging its goods for enough U.S. goods, currency exchange rates, etc.). The cycle became a boom that was unsustainable. Here's what an Oxford economist stated:

Through the quarter-century in which China has been opening to world trade, Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States. This is the real meaning of the vast trade surplus—$1.4 trillion and counting, going up by about $1 billion per day—that the Chinese government has mostly parked in U.S. Treasury notes. In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China.

Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.

Neither government likes to draw attention to this arrangement, because it has been so convenient on both sides. For China, it has helped the regime guide development in the way it would like—and keep the domestic economy’s growth rate from crossing the thin line that separates “unbelievably fast” from “uncontrollably inflationary.” For America, it has meant cheaper iPods, lower interest rates, reduced mortgage payments, a lighter tax burden. The average cash income for workers in a big factory is about $160 per month. On the farm, it’s a small fraction of that. Most people in China feel they are moving up, but from a very low starting point.

This is the bargain China has made—rather, the one its leaders have imposed on its people. They’ll keep creating new factory jobs, and thus reduce China’s own social tensions and create opportunities for its rural poor. The Chinese will live better year by year, though not as well as they could. And they’ll be protected from the risk of potentially catastrophic hyperinflation, which might undo what the nation’s decades of growth have built. In exchange, the government will hold much of the nation’s wealth in paper assets in the United States, thereby preventing a run on the dollar, shoring up relations between China and America, and sluicing enough cash back into Americans’ hands to let the spending go on.

Chart of U.S. Real Disposible Income over the past four years:

http://2.bp.blogspot.com/_otfwl2zc6Qc/SYcBvfeDlkI/AAAAAAAAJJg/VIfwx5qxiqg/s1600-h/dpi.bmp

From Article:

Buried in today's BEA report on Personal Income is some good news in "Table 10." Real Disposable Personal Income and Real Personal Consumption Expenditures: Percent Change From Month One Year Ago," see chart above. Real disposable personal income increased in each month of the last quarter, ending in December 2008 with 1.3% growth compared to December 2007. Maybe 1.3% growth in real disposable personal income is not great, but at least it's positive and at least the trend is going in the right direction: up.

Chart of U.S. Personal Saving Rate (over past four years):

http://4.bp.blogspot.com/_otfwl2zc6Qc/SYcDmIWqmwI/AAAAAAAAJJo/CKagXnna5Ww/s1600-h/saving.bmp

From Article:

The personal saving rate has increased in each of the last four months and reached 3.6% in December (see chart above), as consumers were able to save $378.6 billion in December (on an annual basis), an amount approximately equal to the annual savings for consumers from falling gas prices.

It's likely (unless Obama messes it up) a huge rally will begin at some point in 2009, given the increases in household income and saving (see charts above), along with the $9 trillion in cash on the sidelines:

Cash at 18-Year High Makes Stocks a Buy

Dec. 29, 2008 (Bloomberg) -- There’s more cash available to buy shares than at any time in almost two decades, a sign to some of the most successful investors that equities will rebound after the worst year for U.S. stocks since the Great Depression.

The $8.85 trillion held in cash, bank deposits and money- market funds is equal to 74 percent of the market value of U.S. companies, the highest ratio since 1990, according to Federal Reserve data compiled by Leuthold Group and Bloomberg.

“There is a store of cash out there that is able to take the market higher,” said Eric Bjorgen, who helps oversee $3.4 billion at Leuthold in Minneapolis. “The same dollar you had last year buys you twice as much S&P 500 as it did a year ago.”

Leuthold Group, whose Grizzly Short Fund returned 83 percent in 2008 thanks to bets against equities, said in its December bulletin to investors that stocks offer “one of the great buying opportunities of your lifetime.”

The ratio of cash on hand to U.S. market capitalization jumped 86 percent in the first 11 months of the year, the biggest increase since the Fed began keeping records in 1959.

Cash holdings peaked one month before equities began to recover during the two longest recessions since World War II. In July 1982, money of zero maturity as a percentage of the U.S. stock market’s value rose to 95 percent before a 20-month bear market ended and the S&P 500 began a six-month, 36 percent advance, data compiled by Bloomberg show.

Cash on hand reached $604.5 billion in September 1974, representing a record 1.21 times U.S. stock capitalization. That preceded a 31 percent gain in equities between October 1974 and March 1975, Bloomberg data show.

“If history tends to repeat itself, we’re in the exact same scenario,” said Neil Hennessy, who oversees $650 million as president of Hennessy Advisors in Novato, California. “Once the money starts to come back into the market, buying is going to beget more buying. People don’t want to be left behind.”

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a4JGucN3jZxM

The NBER stated the recession began in December 2007. However, that was a close call, since the U.S. was on a path to a soft-landing, until September 2008. I believe, the recession began in September 2008 and will end in the middle of 2009.

[Beal]

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