The economic forecast for 2010
As we usually do on this site (WorldCrisis.ru -- CF), we begin by analyzing the previous forecast, the one for the year 2009. It began by stating that 2009 would be the year of write-downs of the losses, incurred, first of all, by the financial institutions and other companies. In particular it was noted that the scale of securitization chains, that is of credits issued by, first of all, financial companies, having derivatives as a collateral, would be reduced considerably.
This forecast came true almost completely. First of all, it was publicly admitted that the financial standing of a major fraction of companies and their securities is at odds with reality. The distortions were so significant that investors and even US functionaries began suing the rating agencies, who kept inflating the credit ratings in the interests of the financial elite.
Second, it has become clear that the system of derivatives in general does not suit the conditions of the financial crisis, those of the dropping GDP, asset depreciation and of the financial risk insurance system falling apart. As a result, to avoid liquidity crisis, the monetary authorities of the US had to replace mutual credits of banks, secured by derivative paper, by direct credits from the FRS. The volume of such programs reached, only officially, a couple trillion dollars, and various rumors raise the estimate to 9 trillions.
Third, the degree of mutual mistrust became so high that the credit portfolio of the US banks began to shrink rapidly, having reached the levels not seen in decades. Shrinking of such a scale had not taken place for at least 40 years -- the volume of credits kept growing all the time. The unique and scary tempo of the decrease in the credit portfolio volume is the main proof that the crisis is continuing.
A special mention was made of the continuing "parade of devaluations", the aim of which, according to the forecast, was to save those enterprises that were about to collapse under the weight of the credit burden, being no longer able to refinance their debts. This phenomenon manifested itself, first of all, in the support of the national banking systems, on which the UK spent over 50% of its GDP, Netherlands -- over 40%, USA -- over 30% (taking the off-the-balance-sheet FRS funds), Germany -- over 20%. A significant fraction of these funds is emissionary in origin (exceptions are Russia and China who used moneys accumulated in the reserves), while the currency devaluation, barely seen in their relative movements, is seen clearly in the growth of gold price. Meanwhile the US authorities are actively pressuring the banking system to increase crediting of the real sector.
For the above-mentioned reason no large bankruptcies took place (even though the destiny of GM is, most likely, still awaiting many American enterprises) but in the US for example, the bankruptcy rate of small enterprises grew up sharply. As it usually happens during the acute phase of the crises, numerous cases of financial fraud were revealed, of which the Madoff case was the most conspicuous. As in other similar cases, it soon became clear that the regulating bodies had all the possibilities and all the information needed to nip this fraud in the bud. The fact that this had not been done undermined faith in the entire system of financial regulation, which, under conditions of the crisis, clearly won't increase stability of the global financial system.
In the forecast, the sovereign defaults were assumed to begin in 2009. The large amount of cash emission prevented these events, even though the problems of Ukraine, Spain, Greece, Dubai were heard about.
In the forecast, a lot of space was dedicated to the choices of government policies, American above all, pursuing economic recovery. In particular, it was stated that since the American economists are not inclined to study interactions between the sectors of the economy, they would not be able to understand exactly how the declining demand and changes in its structure would influence revenues in various sectors, and consequently, they would not be able to formulate a well articulated and adequate recovery policy for the real sector.
That's exactly what has happened -- the US authorities, having no adequate information, limit themselves with supporting the credit system at large (which in fact amounts to the efforts, and not the most successful ones, to prolong the credits) and with targeted support of the largest businesses. In this respect, the forecast came true with such an accuracy that I am going to quote it here: "If Obama indeed wanted a change, under the slogan of which he was elected, then yes. But the entire composition of his administration, which consists almost exclusively of Clinton's era corrupt officials, indicates that they will prolong the current situation to the end. Prolong, extending the pleasure of distributing budget funds and keeping the global financial system in check. Besides that, such a scenario allows them to maintain the living standards in the US and prevent social protests (even though according to some data, the nation's authorities are getting ready for them). Naturally, all this is possible only up to a certain moment, but let me assume that this moment will come after 2009, although some experts expect sharp events to begin this Fall".
As was forecast, the US was busy with propaganda of optimistic expectations, demonstrated the "recovery" (up to and including statistical re-calculations aimed at transferring the growth rates from the past years to the two past quarters of the year 2009), and obstructed public discussion of the real causes of the crisis internationally. Besides, the US manipulated oil prices actively to maintain the optimal shape of its balance sheet.
For Europe, as it was assumed in the forecast, the debates went along the lines of divisions between the individual states and EU at large as well as along the internal division lines within the Euro zone. As we assumed, the North-European countries (Germany and France) who play the main role in determining the ECB policies, are quite happy with the "strong" Euro, while the southern countries, Spain and Greece in particular, suffered great deal from that policy. This is related to the details of the economic model of these countries, under which the main incomes for significant parts of population come from tourism. Under conditions of crises when tourism shrinks, these countries used to increase their social programs, which allowed them to support the population and to devalue their currencies, thus stimulating tourism. The latter became impossible when Euro was introduced, while the former caused the budgets to go out of limits set by the Stability Pact, which by the way everybody just stopped paying attention to. But in any case, the elites of the southern European countries began considering leaving the Euro zone quite seriously.
A weakness of the 2009 forecast was its lack of discussion of China and South-Eastern Asia in general, of the Latin America, and of the selected large markets, such as the oil market. The forecast concluded with macro-economic indicators. The US GDP was forecast to drop 8-12%. Official data do not support such a drop, but there is no particular reason to trust them. The statistical authorities in the US (as elsewhere) are famous for the games they play with numbers, while the very notion of GDP appears to be fairly controversial. But specific numbers which are a lot harder to tamper with, show that the drop of the mentioned scale indeed took place. This is seen from the chart of the bank credits above and from the yearly data on retail sales and aggregate demand, not to mention the real estate market.
For these reasons it's impossible to tell for sure whether the forecast materialized in this part, or not. As for the statement that the dollar had to fall a bit with respect to other currencies in the middle of the year, it turned out to be quite true, but the expected coming of a new wave of crisis by the end of the year did not happen, while the US dollar did begin its rise with respect to the Euro. A few words about that will be said below, and now let me start with the 2010 forecast proper.
The key to describing the economic evolution of the world in the coming year is to make a choice between the deflationary and (hyper)inflationary scenarios. The choice will depend on the interaction of two major parameters of the US economy: the monetary emission and the decline in the aggregate demand. The latter should be of the order of 8-12% a year, unless a way of increasing the consumer crediting is found. This is analogous to the events of 1930-32 in the US. Emission can, if only in part, compensate for this decline, but it causes inflation, which also reduces the demand expressed in real prices. For this reason, the emission rate has to grow continuously in order to compensate for the falling demand. Let's note that pure scenarios materialize rarely (a refusal of a government to support the economy the way it happened in the '30s was unique, and most likely a repetition of such a scenario is impossible -- except for perhaps in Russia), and that means that the scenarios will alternate. But right now we are interested in the events of 2010 and not in the general scenario of the crisis.
If one fails to compensate for the decline in demand, then all companies, producers and middle-men alike, including banks and other financial institutions, get in trouble. Sooner or later they lower the price of their services, cut expenses... And then a chain of bankruptcies begins, in which the very first bankruptcy triggers a chain of other ones, because the reserves are already exhausted, and under the conditions of falling demand, attracting credits is tough. A new deflationary wave begins, the way it happened in Fall 2008, in the beginning of the '30s in the US, or to some extent, in Japan of '90s (but only to some extent because in Japan, the picture is washed out due the monstrous volume of export).
A major difference between these scenarios is that the deflationary one increases the cost of money while the inflationary one, on the contrary, lowers it. Accordingly, those institutions who have priority access to funds (such as the founding banks of the FRS which, at least for now, carries out the dollar emission) are interested in the deflationary scenario, and those who need money (budgets of various levels) -- in the inflationary one. Those with positive balance sheets (banks) need the cost of money to go up, although there are details. The thing is, the fractional reserve banking system, practiced nearly everywhere in the world, leaves the banks unprotected against the runs on the bank (which busted many of them in the '30s in the US), therefore those who can not obtain refinancing in a higher level bank can be afraid of deflation. But in any event, those are not the ones that determine the stance of the financial elite on the issue. And those with negative balance sheets (households, state budgets, corporations) are more interested in an inflationary scenario, which allows their debts to depreciate. And their nominal incomes grow in that case, which makes them feel better.
There is one more circumstance. For the last 30 years, any growth in any sector was linked, one way or another, to inflating financial bubbles. And the US authorities, for whom it is a matter of life or death to crank up the economic engine again, will try (and indeed are trying!) to inflate these bubbles here and there, expecting to create "secondary" demand and restart the entire economic mechanism.
Thus we can note that the balance of interests in the American society (which, up to minor details, is understood to determine the situation in the entire world, since the US is the world's largest consumer) is more or less clear, but the timing of making the decision will be determined by the politics and is therefore outside the scope of purely economic analysis.
Indeed, to carry out the emission, one needs a conscientious decision of the FRS. But within the FRS itself, except for its leader Bernanke, who is not only appointed by the US president but is more of a scientist than a banker, practically nobody supports the inflationary scenario. The banking elite remember their golden 1930s, when the printing press access allowed them to easily buy on the cheap practically all valuable assets in the US and almost everywhere else in the world. The '30s were the time of the most significant redistribution of property in the favor of the financiers, the period which they don't mind repeating. Besides, the entire system of the economic mainstream, that is not only the theory, but its supporting institutions, including the IMF and the World Bank, created in the last 30 years, the period of financial dominance in the economy, is built upon the thesis that high inflation is unacceptable in any event.
However the FRS does not hang in the air and the Washington's pressure on it gets stronger and stronger, the above mentioned example with financial bubbles is an indicator of that. The House has tried already to carry out an independent audit of this body, and the FRS managed to repel the attack, but how much longer is that going to last? Bernanke is desperately fighting for independence of his structure, in particular, for the bankers' right to independently appoint the directors of the regional reserve banks, but it is clear that if the White House's attacks intensify, the FRS will not be able to hold ground. And the White House needs money badly: to increase the social payouts, to support strategically important sectors, for the military programs, and finally, for the recently adopted health care reform.
By the way, there are many people who don't understand why Obama fights for this program so desperately. The answer is obvious: today, tens of millions people in the US are unable to obtain health insurance in principle, while there is no free medicine in the country. As the living standards of the populace there will deteriorate further, about 100 million people (according to the optimistic estimates and 150 million -- half the nation -- according to the pessimistic ones) will become unable to get medical help. No state leader can afford that, which means the reform must be carried out at any cost, which requires money.
FRS has already committed a severe violation of the IMF Statute, having began a direct buy-out of the US Treasuries on the money created by direct emission. How much was bought out off the balance sheet is a secret so far. But in any event, the emission will have to be increased since the FRS can not afford to leave the White House without funding, that would be a catastrophe for the nation's central bank, and the one that will almost inevitably lead to the nationalization of the emissionary functions of this body.
On the other hand, the FRS has a way of decreasing the amount of money in the economy: by stopping the banking stimulus program. At the recent FOMC meeting a plan to begin collection of the funds previously issued to the banks was announced, which will strengthen the deflationary trend. In my opinion, the financiers will win the first round of the fight. That's because they are clearly quicker to react and because Obama's economic policy is to a large degree controlled by Wall Street whose representatives occupy practically all key economy positions in the White House, and because any major decisions in the US government have to go through long and painful discussion in the House. And because the efficiency of jump-starting the economy by inflating new bubbles turned out to be extremely low.
Here we ought to return to the 2009 forecast, or rather that section of it, which discussed the USD growth at the end of the year. In my opinion, a choice between a (hyper)inflationary scenario and a deflationary one -- in favor of the latter -- had to be made back then, which would create a turning point in the markets: up for the dollar, down for the stock markets and oil. However, a number of events, among which was the process of re-electing Bernanke the FRS chairman for the second term, delayed the process. Nevertheless, the second deflationary wave is likely to strike in the first half of the current year. It will carry the Dow down to the level of 6000-7000, oil -- to the level of $35-40 a barrel, and EUR/USD -- to the 1.35 mark or lower. After which for a number of reasons, including the pressure from the White House, the emission will continue, which will stop the decline at a new, lower level.
Let's note one important thing related to the role of China in the modern global economy. China began experiencing serious economic problems: the engine of its economy is export, which is shrinking. As a consequence, the Chinese authorities are beginning to stimulate internal consumption by non-economic means, which will inflate sizable bubbles in the Chinese economy quite quickly. And what to do? The leaders can not seriously count on the growth of internal demand: if the production is reoriented towards internal consumer, the revenues and wages will begin to drop. Otherwise, colossal multi-year programs are needed, for which there is no time. And to issue bad credits would mean to seriously undermine the financial system of the country.
And nevertheless, there is a solution. Let's imagine that today China enters the global financial markets with securities denominated in renminbi. Then only due to a change in the exchange rate (renminbi revaluation), China acquires a powerful source of income, which can offset the export revenue decline and can speed up the process of re-orienting the economy towards internal consumption dramatically. And the global financial market, suffocating in excess cash with no ability to invest it profitably, will rush into these new securities. Moreover, for China this will become a powerful instrument of influencing the global politics, since it will be quite easy to control to whom and in what volume these new papers will be sold.
In order to implement such a program, China needs at least three things: presence of renminbi outside the country (and the programs to accomplish that are already in place and active); convertibility of renminbi (even limited one), and finally, a living global financial system. If the collapse of the SUD-based contemporary system happens before such a Chinese program is launched, the effectiveness of the latter is likely to be reduced considerably. It can't be ruled out that a realization of this fact is what makes the US demand renminbi revaluation from China (since within the export-import framework, such a revaluation will only redistribute the middle-man income from such operations in favor of China). But in any event, Chinese activity is likely to have a considerable stimulating effect on the US elite, causing them to make at least some decisions.
All this means that in 2010 China, amid deteriorating economic indicators and growing bubbles in the internal economy (in that sense the country will make an accelerated march along the US footsteps of the '00 decade) will begin an accelerating expansion into the global financial system and will speed up the formation of a China-centric regional financial cluster.
Thus in 2010 the global financial system will continue moving along the trajectory on which it took off in Summer 2007, and most likely, in the first half of the year, another deflationary episode will take place, which will give way to a new spiral of monetary emission in the Fall. Whether that will cause hyperinflation is an open question, but the most likely answer is no. In this case, serious problems are ahead for the oil exporting countries, therefore it can't be ruled out that the problems like those of Dubai in late 2009 will become familiar. Big troubles are ahead for Europe: even though Euro will head downward, which will make the exporters' life easier, the US demand will continue to decline, and therefore in general the economic position of the EU will weaken.
"Small" countries of Europe will encounter special problems. They won't be able to count on the US help, while the EU leaders too will be out of money. This will spell a sharp decline in the living standards in these countries, which will cause a significant growth of income difference among the EU countries. Besides, a significant fraction of the population of the poorer EU countries will have to migrate back home, since unemployment will grow everywhere and jobs will be reserved for own citizens. Almost certainly, crime will go up, including ethnic crime, which will require authorities of a number of EU countries to demand stronger regulations of cross-border migration. I am not sure whether the process of European integration will recede in 2010, but I am positive that its rate will go down considerably.
One has to take one more thing into account: the second deflationary wave will annihilate all the efforts of the global leaders to maintain optimism among the consumers and companies, which means a sharp rise in savings and a reduction in portfolio investments. Since under deflation, cost of money will grow, more and more potential investors will go into cash and stay that way. By the end of the year, when another inflationary wave strikes, they will be in a rush to invest.
Meanwhile, since falling demand will be the main mechanism for the crisis to continue, and the global demand is expressed mainly in USD, all countries of the world, including China, India and Latin America, will actively support the present model. Meanwhile, as the US share in the global aggregate demand will decline continuously, they will seek alternative sources of demand, and that includes developing national programs of its stimulation. This means that the global financial system, built on the dollar, will remain strong (even though its influence over the regional economic processes will weaken), while the positions of IMF, World Bank and other international financial organizations will weaken. Created within the Bretton-Woods framework and called upon to spread the basic provisions of the "Washington consensus" worldwide, these bodies will lose their positions to other organizations, possibly yet to be created, amid the crisis and incessant economic forecasting errors.
The decline rates of the main macroeconomic indicators in the US are not expected to change and will be around 8-12% a year. This means continuation of serious problems for the South-Eastern Asia and their growing re-alignment towards China and India, as potential sources of demand. China, as has been said, will promote its own currency in the regional markets actively and prepare grounds for their capture through emission of own securities. As far as India is concerned, it will continue its traditional, more conservative policies. Similar processes will unfold in Latin America, except that there, Brazil will be the center, and the formation of a regional currency will accelerate. The competition of the US and Latin America for influence over Mexico will be interesting to watch.
Economic problems and pessimistic sentiment will force the Western governments to search for non-economic factors to blame for the economic difficulties. I mentioned that in the 2009 forecast and the events in Afghanistan, Pakistan, Iran and early in this year even Yemen support such a view point. Most likely, the policy of creating (so far) controlled regional conflicts will continue.
To conclude the forecast, let me note that most likely, no serious collapse of the infrastructure, financial and industrial alike, will take place in 2010, which means that all the trends that began in 2009 will continue their smooth evolution. The key factors for specific businesses will be:
-- difficulties in attracting and deploying investments
-- beginning decay of the middle-class-based social system and respective problems in marketing policies for nearly all producing companies
-- major shifts in management policies
-- growth of bad debts and inaccessibility of credit
Practically any company wishing to continue its business successfully during the crisis, will face these problems, although perhaps the ordering may vary. And only those who solve these problems, will win.
This is the end of the 2010 forecast but I can't rule out having to come back to it later this Summer.
M. Khazin, Moscow, January 1-6, 2010.