IMF faces sluggish growth but no genuine recovery
October 7, 2012 3:12 pm
by Gavyn Davies

The Annual Meetings of the IMF and the World Bank take place in Tokyo this week, and as always they provide a good opportunity to take stock of the condition of the global economy, and of economic policy.

There is much less of a crisis atmosphere surrounding this week’s meetings than there was a year ago, largely because the actions of the ECB have succeeded in calming the eurozone storm for the time being.

However, there have been significant downgrades to growth prospects in China and India in the past year, and growth in the major developed economies has been extremely unsatisfactory.

The IMF’s economic projections, which show global real GDP growth running at around 4.5 per cent per annum over the medium term, are looking increasingly difficult to reach. Certainly, the latest projections, released in July, appear likely to be downgraded. For example, the IMF forecast for GDP growth in 2013, which was as high as 3.9 per cent in the July projection, is around a full percentage point higher than the latest average forecast from the major investment banks.

On a brighter note, however, the risk that the global economy is actually sliding towards a renewed recession seems to have diminished in recent weeks, and the data published for September indicate that growth has probably passed the low point for the latest mini cycle. Sluggish growth, but no recession, is likely to be the IMF’s message from Tokyo this week.

When examining the impact of global GDP growth on financial markets, it is useful to separate the big picture, measured in years, from the mini cycle, measured in months or quarters. At present, the big picture looks very unsatisfactory, but the mini cycle has touched bottom. It is the latter which has been underpinning risk assets since last June.

The worrying state of the big picture for global growth is captured by the following graph, which shows the behaviour of the output gaps in the major developed economies in recent years (estimated using OECD methodology):

The developed economies have become caught in a low growth trap where the margin of spare capacity is either remaining broadly unchanged (as in the US case), or is actually increasing (as in the eurozone and the UK). Only in Japan is the output gap narrowing, and that is mainly because the trend growth in real GDP has fallen to such low levels: it is a low hurdle to clear.

I am sure that many people will say the output gap is an artificial construct which is impossible to measure accurately in real time. That is true, but the basic point is clear. Of all the major developed economies, only Germany and Canada have managed to get their real GDP levels above the pre-recession levels of 2007. No economy has returned to anywhere near the pre-2007 trendline for real GDP, extrapolated to the present.

A couple of years ago, many forecasters assumed that much of the shortfall in real GDP, relative to previous trends, would be eliminated over a few years, as growth rates rebounded in the manner which normally happens following a recession. In fact, some said that the rebound might prove to be more rapid than normal, simply because the decline during the recession had been so large. None of that now seems tenable.

Instead, the bleak arithmetic made famous by Reinhart and Rogoff, which showed that the growth rate following a major financial crash would remain very subdued for a long time, seems to have taken hold. The central banks have taken extraordinary steps to ensure that “this time is different”, but their efforts have been mostly cancelled out by a combination of fiscal tightening from 2010 onwards, and an unknown amount of supply side shrinkage in economic capacity. Christine Lagarde, the IMF Managing Director, has repeatedly asked for government action to match that of the central banks, and she will doubtless do so again this week. It is unlikely to be forthcoming.

Why then, have the markets been in reasonably good shape while all this has become clear this year?


I would suggest two reasons. The first is that consensus opinion no longer expects a sharp recovery in growth rates in the developed economies in the years ahead. The accompanying graph shows how consensus forecasts for growth have changed in the US, and this chartpack shows similar graphs for all the major economies. The key point is that the large downgrades to growth projections occurred in the second half of 2011, since when growth in the G7 has come in as bad as expected but no worse. Outside the developed economies, the most important downgrades have come in China, where the stockmarket has of course underperformed.

The second reason is that the mini cycle in global growth rates, which was clearly headed downwards in the first half of 2012, has stabilised in the third quarter, and has headed into recovery territory in September. The final chart shows the performance of some key activity indicators which capture inflexion points in the mini cycle:


It is clear that low point was reached in May or June. This is confirmed by economists at J.P. Morgan, who have recently started to produce a weeklynowcast” of global GDP growth, calculated by extracting the common growth factor from all of the major pieces of economic information published each month around the world. This is extremely useful for tracking likely changes in global GDP growth in real time. This week, Bruce Kasman, Joseph Lupton and David Hensley report that the implied global GDP growth rate has risen from 1.2 per cent in June to 1.9 per cent in September.

This is no real cause for celebration, except that it does clearly reduce the “left tailrisk of a renewed global recession. The mini cycle now looks likely to head upwards for a while, as it did at a similar time of year in 2010 and 2011.

Nevertheless, as the world’s key policy makers gather in Tokyo this weekend, the much bigger task, of turning this bounce into a sustained recovery, looks as far away as ever.


October 7, 2012, 6:47 p.m. ET

Biting the Bank That Saved You
The feds sue J.P. Morgan for doing the favor of rescuing Bear Stearns.


The U.S. Department of Justice and New York Attorney General Eric Schneiderman teamed up last week to sue J.P. Morgan in a headline-grabbing case alleging the fraudulent sale of mortgage-backed securities.

One notable detail: J.P. Morgan didn't sell the securities. The seller was Bear Stearns—yes, the same Bear Stearns that the government persuaded Morgan to buy in 2008. And, yes, the same government that is now participating in the lawsuit against Morgan to answer for stuff Bear did before the government got Morgan to buy it.

The case is even stranger because it rests on highly dubious claims and is being prosecuted in a highly convenient venue. The suit is the product of a joint federal-state task force that President Obama announced to great fanfare in his 2012 State of the Union message to investigate "the abusive lending and packaging of risky mortgages that led to the housing crisis." Mr. Obama's gumshoes still haven't uncovered the mortgage crime of the century, so apparently this lawsuit will have to do a month before Election Day.

Mr. Schneiderman filed the suit in New York court under the state's Martin Act. This means he doesn't have to prove intent, which is convenient because it would not be easy proving that Bear intentionally foisted bad paper on investors when Bear was buying so much bad paper for itself.

There's an old joke that a prosecutor can indict a ham sandwich, but in this case the government isn't even saying which sandwich. Or how much it cost. Instead, it offers a range of dates plus examples of securities that are likely part of the case.

The headline number is $22.5 billion, and that number does appear in the complaint, but only as a general figure for all losses on a broad range of mortgage-backed securities created by Bear. The suit doesn't ask for a specific amount in damages because the government hasn't decided how much of the losses were tied to wrongdoing.

The government makes two general claims: that Bear Stearns promised it would be more careful than it was in selecting mortgages to be included in bundles of loans sold to mainly institutional investors, and that Bear didn't adequately compensate investors for mortgages that should never have been included.

Regarding the first charge, the suit describes a sloppy process of selecting loans, internal discussions about whether and how it could be improved, plus salty emails knocking the quality of some Bear deals. It's far from clear that this proves that Bear's offering documents were fraudulent.

The suit also claims that "a number of studies" show that high default rates "are evidence of faulty underwriting." Well, high default rates are certainly evidence that a housing bubble burst, but to win in court doesn't a prosecutor need to show particular people committing particular acts?

As for the second claim, it hangs on the fact that Bear often got refunds from mortgage originators and did not immediately pass them on to the institutional investors. But while that may strike prosecutors as mean, we're told that the refund commitments for bad mortgages that Bear received from sellers of loans were not always identical to the terms Bear offered when it turned around and sold those loans to investors. So if Bear got a refund and didn't immediately pass it on to investors, it may have been because it wasn't required to do so.

Perhaps in the rush to prepare for Tuesday's press conference, prosecutors didn't have time to compile a complete list of the transactions at issue. Or maybe they have no earthly idea and don't care, because the real goal is to get J.P. Morgan to write a big settlement check.

Mr. Schneiderman nonetheless said last week that the Morgan complaint would be a "template" for more suits in the future. It would be nice to know which deals Mr. Schneiderman is talking about, because some institutional investors have already filed their own suits. This has saved the New York AG lots of work because he was able to cut and paste from those suits to create his.

The work was no doubt even easier after he hired Karla Sanchez, who filed such suits as a partner at the Patterson Belknap law firm and is now New York's Executive Deputy AG for "economic justice." She was working on this case until Morgan raised the issue and she was recused. How can anyone now believe this has been a disinterested investigation?


As for the federal government's role, it's helpful to recall some recent history: In the mid-2000s, Bear Stearns became—outside of Fannie Mae and Freddie Mac—perhaps the most reckless financial firm in the housing market. Bear was the smallest of the major Wall Street investment banks. But instead of allowing market punishment for Bear and its creditors when it was headed to bankruptcy, the feds decided the country could not survive a Bear failure. So they orchestrated a sale to J.P. Morgan and provided $29 billion in taxpayer financing to make it happen.

The principal author of the Bear deal was Timothy Geithner, who was then the president of the Federal Reserve Bank of New York and is now the Secretary of the Treasury. Until this week, we didn't think the Bear intervention could look any worse. But now Mr. Geithner's colleagues are telling taxpayers that they were forced to bail out not only financiers but fraudsters as well?

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

King Ludd is Still Dead

Kenneth Rogoff

01 October 2012


CAMBRIDGESince the dawn of the industrial age, a recurrent fear has been that technological change will spawn mass unemployment. Neoclassical economists predicted that this would not happen, because people would find other jobs, albeit possibly after a long period of painful adjustment. By and large, that prediction has proven to be correct.
Two hundred years of breathtaking innovation since the dawn of the industrial age have produced rising living standards for ordinary people in much of the world, with no sharply rising trend for unemployment. Yes, there have been many problems, notably bouts of staggering inequality and increasingly horrific wars. On balance, however, throughout much of the world, people live longer, work much fewer hours, and lead generally healthier lives.
But there is no denying that technological change nowadays has accelerated, potentially leading to deeper and more profound dislocations. In a much-cited 1983 article, the great economist Wassily Leontief worried that the pace of modern technological change is so rapid that many workers, unable to adjust, will simply become obsolete, like horses after the rise of the automobile. Are millions of workers headed for the glue factory?
As Asian wages rise, factory managers are already looking for opportunities to replace employees with robots, even in China. As the advent of cheap smartphones fuels a boom in Internet access, online purchases will eliminate a vast number of retail jobs. Back-of-the-envelope calculations suggest that, worldwide, technological change could easily lead to the loss of 5-10 million jobs each year. Fortunately, until now, market economies have proved stunningly flexible in absorbing the impact of these changes.
A peculiar but perhaps instructive example comes from the world of professional chess. Back in the 1970’s and 1980’s, many feared that players would become obsolete if and when computers could play chess better than humans. Finally, in 1997, the IBM computer Deep Blue defeated world chess champion Gary Kasparov in a short match. Soon, potential chess sponsors began to balk at paying millions of dollars to host championship matches between humans. Isn’t the computer world champion, they asked?
Today, the top few players still earn a very good living, but less than at the peak. Meanwhile, in real (inflation-adjusted) terms, second-tier players earn much less money from tournaments and exhibitions than they did in the 1970’s.
Nevertheless, a curious thing has happened: far more people make a living as professional chess players today than ever before. Thanks partly to the availability of computer programs and online matches, there has been a mini-boom in chess interest among young people in many countries.
Many parents see chess as an attractive alternative to mindless video games. A few countries, such as Armenia and Moldova, have actually legislated the teaching of chess in schools. As a result, thousands of players nowadays earn surprisingly good incomes teaching chess to children, whereas in the days before Deep Blue, only a few hundred players could truly make a living as professionals.

In many US cities, for example, good chess teachers earn upwards of $100-$150 per hour.
Yesterday’s unemployed chess bum can bring in a six-figure income if he or she is willing to take on enough work. In fact, this is one example where technology might actually have contributed to equalizing incomes. Second-tier chess players who are good teachers often earn as much as top tournament players – or more.
Of course, the factors governing the market for chess incomes are complex, and I have vastly over-simplified the situation. But the basic point is that the market has a way of transforming jobs and opportunities in ways that no one can predict.
Technological change is not all upside, and transitions can be painful. An unemployed autoworker in Detroit may be fully capable of retraining to become a hospital technician. Yet, after years of taking pride in his work, he could be very reluctant to make the switch.
I know a chess grandmaster who, 20 years ago, prided himself on his success at winning money in tournaments. He vowed that he would never end up teaching childrenhow horsey moves” (the reference is to the knight, also called the horse). But now he does exactly that, earning more from teachinghow horsey moves” than he ever did as a competitive chess player. Still, it beats being sent to the knacker.
Of course, this time technological change could be different, and one should be careful in extrapolating the experience of the last two centuries to the next two. For one thing, mankind will be confronted with more complex economic and moral questions as technology accelerates. Still, even as technological change accelerates, nothing suggests a massive upward shift in unemployment over the next few decades.

Of course, some increase in unemployment as a result of more rapid technological change is certainly likely, especially in places like Europe, where a plethora of rigidities inhibit smooth adjustment. For now, however, the high unemployment of the past several years should be mainly attributed to the financial crisis, and should ultimately retreat toward historical benchmark levels. Humans are not horsies.


Updated October 8, 2012, 1:51 a.m. ET

World Bank Cuts Asia Growth Forecast



SINGAPORE The World Bank on Monday cut its forecasts for economic expansion in developing East Asia, and warned of the potential for the exit of more than one country from the euro zone to wipe more than two percentage points off growth next year.

The institution tipped the region to grow 7.2% in 2012, down from a projection of 7.6% in May, with that rate picking up to 7.6% in 2013, still lower than an original forecast of 8.0%.

A significant driver behind that was a downgrade of the body's view on China, which it now sees expanding 7.7% in 2012 and 8.1% in 2013, as limited policy easing, property market correction and subdued external demand weigh on the world's second-largest economy.

Most developing East Asian nations are well placed to withstand a crisis in Europe or more subdued global demand, with some scope for policy easing and enough space for fiscal stimulus in the case of a major external slowdown, the World Bank said. It also noted their ample international reserves and low reliance on European banks and wholesale funding.

But in a press briefing Monday, World Bank Chief Economist for East Asia and Pacific Bert Hofman highlighted the importance of beefing up social safety nets, and readying steps to support growth that might be needed down the road.

"Fiscal stimulus doesn't drop from the sky—you actually need to have programs and projects ready to be able to effectuate a stimulus if and when needed," Mr. Hofman said. "So continuing to prepare, making sure that you have the types of program that could help in case of a crisis is very important."

While economic uncertainty, lower interest rate spreads, and apparent declines in the effectiveness of developed economies' monetary stimulus should reduce the potential for the latter to spur capital flows into the region, Mr. Hofman stressed the need to monitor flows and ensure credit growth doesn't get out of hand.

Countries that are dependent on commodities exports could be particularly vulnerable to any renewed global slowdown, the World Bank said. Indonesia and Malaysia will be cushioned to some degree because falling oil prices will shrink their subsidy burden, but they would still be exposed to the lower cost of other commodities.

It also noted that the potential for severe fiscal tightening in the U.S., if lawmakers fail to agree on alternatives to measures that will otherwise automatically come into effect around the turn of the year—the so-called fiscal cliff—posed risks.

The World Bank defines developing East Asia as: Cambodia, China, East Timor, Indonesia, Laos, Malaysia, Mongolia, Papua New Guinea, the Philippines, Thailand, Vietnam and the Pacific island economies.

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

October 7, 2012 6:34 pm
Economic recovery ‘on the ropes’
The US is the brightest spot in the world economy, as another global recession threatens, according to the latest Brookings Institution-Financial Times tracking index.

Tiger (Tracking Indices for the Global Economic Recovery) shows the world’s recovery to beon the ropes”, despite the best efforts of the world’s central banks to boost demand.
Economic data and confidence indicators have deteriorated since earlier in the year across the Group of 20 leading developed and emerging economies, apart from the US, which is on the brink of the presidential election.

The financial markets, however, have remained relatively strong, with the financial component of the index recording its strongest position since June 2011.

The Tiger findings cast a shadow over this week’s annual meetings of the International Monetary Fund and World Bank in Tokyo, as the world’s finance ministers and central bankers struggle to find ways to generate self-sustaining growth.

The deterioration in hard data and sentiment has forced economic forecasters to lower their estimates of growth this year and next. A leak of the detailed IMF forecasts, to be published on Tuesday, showed the fund revising down its 2012 global growth forecast to 3.3 per cent from 3.4 per cent in July, and shaving another 0.3 percentage points off its July forecast of 3.9 per cent for 2013.

Professor Eswar Prasad, of the Brookings Institution, said: “The global economic recovery is on the ropes, battered by political conflicts within and across countries, lack of decisive policy actions, and governments’ inability to tackle deep-seated problems such as unsustainable public finances that are stifling growth.”

The Tiger index shows momentum in the global economy dissipating despite action by the Federal Reserve, European Central Bank, Bank of Japan and Bank of England to boost the recovery. Only in the US has economic momentum remained reasonably robust, while it has slackened off in the formerly strong economies such as the Brics (Brazil, Russia, India and China).

The Tiger index combines measures of real economic activity, financial variables and indicators of confidence, according to the degree to which they are all moving up or down at the same time. Using sophisticated statistical methods it can capture the co-movements of data which are measured on a very different basis and across many countries.

In this release of the index, the Brookings Institution produced a separate indicator for the troubled peripheral European economies of Portugal, Italy, Ireland, Greece and Spain. Only Ireland, among these five countries, has avoided a sharp descent towards the levels last seen during the financial and economic crisis of 2008-09.

Prof Prasad said that fiscal policy and structural reforms were hamstrung in most economies, leaving the burden on central banks to revive the flagging recovery. “In the absence of a broader range of decisive policy measures – including fiscal, financial system and structural reforms needed in many countries – the world economy may soon be down for the count,” he said.

Copyright The Financial Times Limited 2012.