IMF warns of global "Great Recession"

The International Monetary Fund warned on Tuesday that the world economy will likely contract this year in a "Great Recession." The IMF expects global growth to slow below zero this year, the worst performance since World War II.

This will be the backdrop when the Group of 20 leaders meet in London on April 2

Ever Closer To a World Wide Depression

I was just passing through a room that had CNN on, and the report out of Japan was not good.

Sony is sacking its President CEO, and is turning to their head of British operations. Japanese Car companies are reporting that sails are down 40%, and while unemployment remains the same, they are reporting this is due to people giving up on looking for jobs, rather than any stabilization.

This financial crisis is not ending any time soon, and the problem is worse than most understand.

IMF's top economist warns of another Great Depression

John Aravosis over at Americablog has a really interesting post about a warning made by the IMF's top economist.

AFP

The IMF's top economist, Olivier Blanchard, maintained that governments around the world should boost domestic demand in order to avoid another Great Depression similar to the global downturn that shook the world in the 1930s."Consumer and business confidence indexes have never fallen so far since they began. The coming months will be very bad," Blanchard said in an interview with the French newspaper Le Monde."

It is imperative to stifle this loss of confidence, to restart household consumption, if we want to prevent this recession developing into a Great Depression," he added.

John Aravosis writes about this news, and there were some interesting points he makes about the original Le Monde article.

Actually, I found the article in Le Monde, and I think the economist was even more vehement than the AFP translation. I'm also not convinced that AFP totally explained what the economist was suggesting - he wasn't just saying that we need to restart consumer demand, he was saying that governments have to consider boosting their own spending to REPLACE consumer demand, if necessary, even if it leads to larger deficits.

Here is what Le Monde says:
Dominique Strauss-Kahn, le directeur général du FMI, pousse les gouvernements à multiplier les dépenses budgétaires pour soutenir la croissance. Or, le Fonds était un grand ennemi des déficits.

Pourquoi ce revirement?

Nous sommes en présence d'une crise d'une amplitude exceptionnelle, dont la principale composante est un effondrement de la demande. Les indices de confiance des consommateurs et des entreprises n'ont jamais autant chuté depuis qu'ils existent. Du jamais-vu !...Les mois qui viennent vont être très mauvais. Il est impératif de juguler cette perte de confiance, de relancer et, si nécessaire, de remplacer la demande privée, si l'on veut éviter que la récession ne se transforme en Grande Dépression. Bien sûr, en temps normal, nous aurions recommandé à l'Europe de diminuer ces déficits. Mais nous ne sommes pas en temps normal.

What the economist appears to be saying is that governments need to consider REPLACING the loss of consumer spending with GOVERNMENT spending, if necessary, regardless of whether it leads to deficits.

Dominique Strauss-Kahn, the head of the IMF, is pushing governments to increase their own spending in order to support growth. The IMF has always been a big enemy of deficits. Why the reversal?We are facing a crisis of an exceptional breadth, the basis of which is a collapse of demand. The consumer and business confidence numbers have never fallen this much since they've first been recorded. We've NEVER seen this!...

It is imperative to curb the this loss of confidence, to relaunch it and, if necessary, replace private demand, if we want to avoid a recession that turns into a Great Depression. Of course, in normal times, we would recommend that Europe reduce its budget deficits. But these are not normal times.

What is the Possibility of Stagflation

It has been an interesting year for the world economy. Over the last three months central banks around the world have undertaken a number of measures to forestall deflation and lift the global economy out of economic slump and credit crisis. Aside from traditional monetary policy tools such as official interest rate cuts and relaxations in reserve requirements, central banks have resorted to alternative unconventional tools. There has been measurable easing of the credit crisis, U.S. and Europe, who may be joined by other central banks as they too head towards zero interest rates in leaps and bounds

With monetary policy transmission broken by the unwillingness of the private sector to lend or borrow, central banks have had to scurry for alternatives to rate cutting in order to restore markets. They set up an alphabet soup of liquidity facilities that lend funds or purchase assets, offered guarantees on deposits and loans, and established currency swap lines, in addition to a host of fiscal stimulus packages announced by governments.

So are the pieces now in place to prevent global stag-deflation?

It is too soon to tell. So far, money market and commercial paper markets have shown tentative signs of easing. But elsewhere in the private sector credit market, tensions remain as asset prices move shambolically and de-leveraging drags on among households, banks and businesses. Though money supply has grown, the velocity of money has slowed despite the flood of liquidity from central banks and official interest rates effectively at or near zero. In other words, we have fallen into a liquidity trap. Such a blow to consumer demand makes deflation in 2009 a real possibility.

Despite liquidity raining down on the financial system from the Fed and ECB, the financial fires have yet to be extinguished.

Yes, money market rates are off their peaks and the commercial paper market contraction has bottomed. But a lack of confidence among lenders in potential borrowers (and a lack of confidence among potential borrowers given the profit or income outlook) and falling asset valuations has stymied significant easing in market interest rates, such as for mortgages and car loans. Rate cuts and quantitative easing notwithstanding, it seems the threat of a liquidity trap is looming on the U.S.

In the U.S., private demand continues to fall sharply as does the string of awful economic and financial news. Job losses continue to keep mounting, and U.S. GDP is expected to shrink 4% or more in Q4 2008 and the contraction is expected to continue throughout 2009. Orthodox and unorthodox monetary policy measures are certainly needed but they have to be accompanied by a significant stimulus on the fiscal side to support aggregate demand. The great retrenchment of the private sector balance is already under way and the new U.S. administration is getting ready to make the largest investment in infrastructure of the last 50 years. The details of the size and content of the stimulus package are not available yet. However, there seems to be a general consensus that a package of $700-$800 billion dollars is the expectation. This may be enough, but it will be tight as recession sweeps up the entire world.

Contraction is not out of the question in 2009

OPEC TO CUT AGAIN

The Organization of the Petroleum Exporting Countries is ready to cut production by a significant amount when it meets later this month.

Oil fell below $49 a barrel on Tuesday, after reversing early losses in response to a rally in U.S. and European shares.

It had earlier fallen to a new 3-1/2-year low below $48, weighed down by gloom over the ailing world economy and its impact on fuel demand.

U.S. light crude for January delivery was down 54 cents at $48.74 a barrel by 11:06 a.m. EST. It earlier touched a new 3-1/2 year low of $47.36, its lowest since May 2005.
Prices had dropped nearly 10 percent on Monday.

London Brent crude was down 69 cents at $47.28 a barrel after touching a low of $46.02, its lowest since February 2005.

OPEC has already cut supply by about 2 million barrels per day, but this has so far failed to bolster prices, which have fallen nearly $100 a barrel from a peak of more than $147 in July.

Top exporter Saudi Arabia has highlighted $75 a barrel as a "fair price" for oil.

Oil prices fall on economy fears

Oil prices fall on more bad economic news and after Opec hinted it would not cut oil production soon. US light, sweet crude fell more than $1 to $55.93 a barrel. Brent crude lost 52 cents to $53.72. Prices fell after Opec's president downplayed the chance of a November output cut, and demand for oil is expected to be hurt as more countries slide into recession, with Japan's economy the latest victim. Oil prices have dropped more than 60% since their record highs of nearly $150 a barrel in July.

Japanese Economy Now in Recession

Japan's economy falls into its first recession since 2001 after shrinking by 0.1% in the July to September quarter. The world's second-biggest economy had previous shrunk by 0.9% in the April to June quarter. Growth in Japan has been hit by the global economic slowdown which has curbed demand for Japanese exports.

The eurozone officially slipped into recession last week, and the US is expected to follow.

G20 Summit Pledge to 'Restore Growth'

Considering the state of the world economy, I have been shocked at how little play the G20 financial summit received in the media. The G20 group of countries consists of 19 leading industrialised and developing countries, as well as the European Union, it's a pretty powerful group, meeting during a pretty major crisis. Should this event not have received a little more headlines? Is it just because President-elect Barack Obama was not participating? Is it because most people have moved past George W. Bush, the host of the financial summit?

Maybe.

Well the financial summit did take place and the G20 world leaders came together in Washington DC and have pledged to work together to restore global growth. They said they were determined to work together to achieve "needed reforms" in the world's financial systems.

This financial summit brought together leading industrial powers, such as the US, Japan and Germany, and also emerging market countries such as China, India, Argentina, Brazil and others - representing 85% of the world economy. The significance of this G20 financial summit was clear to the emerging economies - they now have to be taken into consideration in the management of the global economy.

Key issues agreed by world leaders at the G20 financial summit included:

• Reform of international financial institutions such as the World Bank and the International Monetary Fund
• An agreement by the end of 2008, leading to a successful global free-trade deal
• Improvements to financial market transparency and ensuring complete and accurate disclosure by firms of theirfinancial conditions
• Making sure banks and financial institutions' incentives "prevent excessive risk taking"
• Asking finance ministers to draw-up a list of financial institutions whose collapse would endanger the global economic system
• Strengthening countries' financial regulatory regimes
• Taking a "fresh look" at rules that govern market manipulation and fraud

World leaders had lots of advice and suggestions. German Chancellor Angela Merkel called for the stalled Doha round of global trade talks should be pushed forward so that a basic agreement can be reached. France's President, Nicholas Sarkozy called for another summit in the spring of 2009. Russian President Dmitry Medvedev said the global financial structures created at the end of WWII were now inadequate, and said it will be necessary to rebuild the whole international financial architecture.

Eurozone officially in recession

The euro zone is in its first ever technical recession after the economy contracted for the second time in a row quarter-on-quarter in the July-September period, an official estimate showed on Friday.

The European Union's statistics office, Eurostat, estimated that the economy of the 15 countries using the euro shrank 0.2 percent in July-September against the previous quarter after contracting by the same amount in April-June.

Germany and Spain declined for the second straight quarter, while France was one bit of good news, it's economy expanded in the third quarter.

Wall Street Steady Today

After two days that saw the Dow drop over 900 points to below 9000 again, and in spite of poor job data, Wall Street is holding steady today. Stocks seem set to recover some of the heavy losses sustained during the biggest two-day slump since 1987.

European stocks were higher ahead of the open on Wall Street. The FTSE Eurofirst 300 rose 1.2 per cent to 909.21. Asian equity markets were volatile, falling sharply before recovering most losses.

A thaw in the credit markets has helped the market today. The rate at which banks lend to each other, measured by three month dollar Libor, fell to a four year low following a fresh round of global interest rate cuts, fixed at 2.29 per cent.

Preventing a global slump must be the priority

Financial Times columnist Martin Wolf wrote an interesting article about the world economic meltdown, and what needs to be done to right the ship.

Preventing a global slump must be the priority

by Martin Wolf

Give credit where credit is due: Nouriel Roubini of New York University’s Stern School of Business was right. On February 20 2008, I wrote a column entitled “America’s economy risks the mother of all meltdowns”, based on his analysis of the 12 steps to disaster. Alas, not only has the US taken those steps, but it has also – with help from others, including the UK – dragged the world behind it.

In a more recent note, Professor Roubini predicts a combination of stagnation and deflation*. In doing so he points, with some glee, to the most recent analysis of the global outlook from JPMorgan Chase, once among the most bullish of analysts. Now, under the rubric “A bad week in hell”, JPMorgan states that: “Once again, we have taken an axe to near-term growth forecasts for the developed world and will likely follow up with additional downward revisions for emerging economies in the coming weeks. Already, our forecasts suggest that global gross domestic product will contract at a near 1 per cent annual rate” in the fourth quarter of 2008 and the first quarter of 2009.

JPMorgan expects shrinkage this quarter at an annualised rate of 4 per cent in the US, 3 per cent in the UK and 2 per cent in the eurozone. It is forecasting 0.4 per cent global growth in 2009, with advanced countries shrinking 0.5 per cent and emerging ones growing 4.2 per cent.

Given the near-disintegration of the western world’s banking system, the flight to safe assets, the tightening of credit to the real economy, collapsing equity prices, turmoil on currency markets, continued steep declines in house prices, rapid withdrawal of funds from hedge funds and ongoing collapse of the so-called “shadow banking system”, these forecasts even look quite optimistic. The outcome next year could be far worse.

If western governments had not intervened to guarantee and recapitalise banking systems, it would surely have been worse. Yet, as the charts show, even this has not halted the turmoil. Consider just two statistics: the capitalisation of world stock markets has halved; and, according to the Bank of England’s latest Financial Stability Report, mark-to-market losses on vulnerable debt instruments now amount to a massive $2,800bn (€2,240bn, £1,790bn)**.

So what should be done? Some would argue: nothing at all. The view is widely held, particularly in the US, that the world needs a big purge of past excesses. Recessions, on this line of argument, are good. People who hold this view also argue that governments caused all the mistakes. The market would, they insist, be incapable of the errors we have seen. To them, Alan Greenspan’s confession last week that “I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders” was about as welcome as Brutus’s knife was to Caesar.

Intriguingly, the Bank’s Financial Stability Report provides some support for this view: back in 1900, US banks had four times as much capital, relative to assets, as they do today. Similarly, the liquidity of the assets held by UK banks has collapsed over the past half-century. Implicit and explicit guarantees from governments have indeed made the financial system more dangerous than before. The combination of such guarantees with deregulation has proved lethal. Moral hazard is far from meaningless.

Yet the idea that a quick recession would purge the world of past excesses is ludicrous. The danger is, instead, of a slump, as a mountain of private debt – in the US, equal to three times GDP – topples over into mass bankruptcy. The downward spiral would begin with further decay of financial systems and proceed via pervasive mistrust, the vanishing of credit, closure of vast numbers of businesses, soaring unemployment, tumbling commodity prices, cascading declines in asset prices and soaring repossessions. Globalisation would spread the catastrophe everywhere.
Many of the victims would be innocent of past excesses, while many of the most guilty would retain their ill-gotten gains. This would be a recipe not for a revival of 19th-century laisser faire, but for xenophobia, nationalism and revolution. As it is, such outcomes are conceivable. Choosing to risk such an outcome would be like deciding to let a city burn in order to punish someone who smoked in bed. Risking huge damage now in the hope of lowering moral hazard later is mad.

Everything possible must be done to prevent the inescapable recession from turning into something worse. Many of the needed actions were laid out in an article on the FT’s Comment page this week by Columbia University’s Jeffrey Sachs. I would stress five points.

First, as Oxford university’s John Muellbauer argues, deflation is a real danger***. Yet deflation is lethal for indebted economies. Today, short-term interest rates look far too high in the eurozone and the UK. Central banks need to look at their economies afresh and cut rates by at least 1, and ideally 2, percentage points.

Second, the only way to let the private sector deleverage, without mass bankruptcy and huge falls in spending, is by substituting the asset everybody wants: government debt. Contrary to Professor Sachs, I think tax cuts are indeed part of the solution.

Third, it is crucial that lending be sustained both inside and among economies. Having gone to such trouble to recapitalise banks, governments should insist that their money be used to sustain credit lines to those likely to remain solvent. If banks are unwilling to do this, central banks will have to replace them, as the Federal Reserve is now doing.

Fourth, it is in the vital self-interest of the affected high-income countries to keep hard-hit emerging economies afloat through the crisis.

Finally, it is equally evident that the world will not return to equilibrium if countries in strong financial positions do not expand domestic demand. The day of the housing bubbles and huge current account deficits in high-spending high-income countries is gone. Those who rely on current account surpluses to sustain demand must think again.

Decisions made over the next few months may well shape the world for a generation. At stake could be the legitimacy of the open market economy itself. Those who view liquidation of past excesses as the solution fail to understand the risks. The same is true of those dreaming of new global orders. Let us first get through the crisis. The danger remains huge and time is short.

LibertyAir Blog

World Share Prices Set for Worst Month Ever

Reuters is reporting that October was the worst month ever in financial history. Dating back to 1920, there are only 4 comparable months in terms of market volitility, and loss of wealth that I could find. The first was September 1931 where the market was down 29.94%, second was October 1987 where the market was down 21.76%, third was May of 1940 where the markets were down 23.95% and last was March of 1938 where the market was down 25.04% which would mean that right now, October 2008 is the single worst month in financial market history.

Shares in Asia and Europe fell on Friday, heading for their worst month ever, while the low-yielding yen shot up as Japan's interest rate cut failed to quell concerns about the deteriorating global economic outlook.

The Bank of Japan joined a global easing cycle by trimming interest rates by 20 basis points to 0.3 percent, but disappointed many who had expected a bigger quarter point cut.

The move followed the Federal Reserve's decision to cut interest rates to 1 percent this week -- its lowest level since June 2004 -- to stave off a prolonged recession.
The euro zone, Australia and Britain are expected to follow suit next week.

However, investors feared a round of rate cuts was not enough to stem the flow of worsening corporate earnings and bolster consumer consumption in major economies which might be already in recession.

In response, oil and commodities fell sharply. U.S. crude oil fell 3.6 percent to $63.58 a barrel, down some 55 percent from its record high around $147 set in July. Gold fell to $724.10 an ounce and was set for its largest monthly fall in more than 30 years.

Worst Is Yet to Come.

Economist Nouriel Roubini warns that the worst in markets and economies is yet to come. On October 23rd, Nouriel predicted the potential shutdown of financial markets. A day later U.S. stock futures suspended trading after declines of more than 6% at opening tripped the circuit breakers. Nonetheless, Nouriel does not expect another Great Depression, but states that policymakers must act quickly and wisely.

Here are the main elements of Nouriel’s outlook: Tsunami of corporate defaults; 2-year U-shaped U.S. recession that threatens to turn into an L-shaped one if policymakers do not regain control of the financial system; global re-coupling to the U.S. will advance from non-U.S. markets to non-U.S. real economies – not even the strongest emerging markets such as Brazil and China will escape global re-coupling; vicious cycle of deflation in goods markets, labor markets, commodity markets, financial markets, corporate and household earnings, and aggregate demand; de-leveraging to reduce excess debt in municipalities, households and some firms; U.S. stock markets declining another 20-30%, bottoming fall 2009 at the earliest, then moving sideways for years post-recession if growth remains anemic as it did in Japan after its 1990s real estate and equities bust; U.S. unemployment rise to reach 8-9%; the demise of the shadow banking system.

According to Nouriel, USD assets, commodities, U.S. and international equities, housing, and the USD are quite risky right now. Seek safety in cash or cash-like instruments such as T-bills and bonds of safe, large governments. Though he believes the U.S. dollar will retain its reserve currency status for decades, its status will gradually erode.

Given the size of the expected contraction in private aggregate demand (likely to be about $450 billion in 2009 relative to 2008), Nouriel argues that a fiscal stimulus to the order of $300 billion minimum (and possibly as large as $400 billion) will be necessary to partially compensate for the sharp fall in private aggregate demand. Here is Nouriel’s testimony before the Joint Economic Committee.

Financial Crisis Is a World Crisis

It is pretty easy to focus on what is happening in this country with the economic meltdown, but this really is a world economic emergency. This financial crisis has revealed and even exacerbated many existing vulnerabilities in the globa economy such as current account deficits that were ignored when times were good – i.e., when capital was plentiful.




Iceland -

Iceland has been at the forefront of the global credit crisis. What was essentially a banking crisis has turned into a national crisis as Iceland’s banks are too big for their government to rescue.

Iceland’s banks were highly leveraged, and were heavily reliant on wholesale funding to finance their aggressive expansion abroad. With the rapid depreciation of the local currency and the seize-up of credit markets, Iceland’s banks had trouble refinancing their debt and appeared headed for collapse when the government stepped in and nationalized the three biggest lenders.

Now reports suggest that Iceland’s government is poised to announce a reported $6 billion rescue package from the IMF. While such a package would be a positive step in providing liquidity, there is no question that a severe economic contraction is coming. Some analysts predict Icelandic GDP could shrink by 5-10% after almost 5.0% growth in 2007.

Hungary -

Another country that has been hit hard by the global credit crisis is Hungary. While Hungary has not suffered the banking crisis that Iceland has. Hungary's banking sector is mostly foreign-owned, rather than made up of highly leveraged, internationalized domestic banks like in Iceland. Yet Hungary is facing a similar crisis as Iceland in that the global credit crisis has exposed long-simmering vulnerabilities. High levels of foreign currency lending, slow growth (1.3% in 2007), twin deficits (both current account and budget), and heavy reliance on non-deposit foreign funding all contributed to making Hungarian assets sell-off targets.

The ECB came to Hungary’s rescue last week, saying it would lend as much as EUR5 billion ($6.7 billion) to Hungary’s central bank to help revive the local credit market. But the verdict is still out on whether the ECB credit line and government measures are enough to prevent Hungary from becoming an ongoing hotspot.

Eastern Europe -

Given Hungary’s woes, many an analyst is focusing on the rest of Eastern Europe for signs of trouble. The slowdown in the region’s key export market, the Eurozone, is expected to dent growth across the region. Meanwhile, high current-account deficits and widespread foreign currency lending are particular risk factors. Poland and the Czech Republic are considered among the least vulnerable, but they are far from immune. Meanwhile the Baltics, Bulgaria, and Romania have long been on analysts’ radar as particularly weak links.

Baltics -

All three Baltics (Estonia, Latvia, and Lithuania) boomed over the last seven years and posted double-digit growth rates at their peak, helped by cheap credit from Scandinavian parent banks and EU membership in 2004. Now these economies are in the midst of a sharp slowdown, with Latvia and Estonia officially in recession. There is no question that the Baltics are in for hard times. In the context of the global credit crisis, the risk is that foreign capital inflows could dry up and lead to an even sharper slowdown that could infect the financial sector. But there are some factors that suggest the sharp slowdown might not evolve into a full-fledged, Iceland-level crisis. One, external deficits in the Baltics are funded to a large extent by inflows from Swedish parent banks, and sharply cutting off credit would hurt these banks. Two, substantial foreign ownership of banking assets limits the governments’ contingent liabilities, as Swedish parent banks would be expected to provide support to their Baltic subsidiaries if they get into trouble. Three, the Baltics’ sharp slowdowns have led to speculation that devaluations (they have exchange rates pegs to the euro) could be in the offing. While devaluation cannot be completely ruled out, such fears may be overblown as these countries tend to have shallow financial markets, relative little hot capital, and successfully defended against speculative attacks earlier this year.

Bulgaria and Romania -

Bulgaria and Romania – the so-called ‘gravity defiers’ – are also on the short-list of CEE economies most at risk of being the next hotspots in the global credit crisis. Despite massive current-account deficits (projected to hit 23% of GDP in Bulgaria and 16% of GDP in Romania this year), booming credit growth, and high inflation, these economies have not hit slowdown mode yet – hence the term ‘gravity defiers’.

In the case of both countries, the financing of their current-account deficits has deteriorated, with foreign direct investment (seen as less subject to reversal than other forms of financing) only plugging about a third of Romania’s current account gap and over half of Bulgaria’s. As a result, these economies are highly susceptible to capital outflows, which would trigger a harsh real adjustment.

Another risk is these countries’ high degree of foreign currency lending, particularly notable in Romania which has a flexible exchange rate, meaning unhedged borrowers are highly exposed to currency swings. Romanian households’ high levels of foreign currency lending are similar to those in Hungary (55% in Romania vs. 60% in Hungary of total household loans). And like Hungary, Romania has a budget deficit of over 2% of GDP. Meanwhile, Bulgaria has a budget surplus, which potentially gives its government more room to maneuver if outflows trigger a sharp slowdown. Bulgaria and Romania will be key countries to watch as the global credit crisis unfolds.

Balkans -

The negative effects from the credit crunch on the Balkan region have been limited so far. Growth has remained strong, ranging between 4.3% for Croatia and 8.2% for Serbia in Q1 08. Nonetheless, the significant widening of the current account deficit experienced by most of the countries is a source of concern as both external credit and FDI inflows are likely to slow. Croatia may feel severe pressures since it has the highest foreign debt in the region, at 90% of GDP, and the share of foreign currency mortgages and personal loans is near the level seen in Hungary.

Turkey -

A number of analysts have cited Turkey as particularly vulnerable to global market turmoil given its large current account deficit. At 5.8% of GDP in 2007, Turkey’s deficit – while substantial – is lower than many of its emerging Europe peers though. The financing quality, however, has deteriorated of late and it will be important to watch how this trend evolves. Compared to other CEE countries, however, Turkey is less likely to face a bank-related credit squeeze, since the banking sector is relatively liquid with a loan-to-deposit ratio well below 100% and since wholesale borrowing is a smaller fraction of banking sector liabilities. So while Turkey is not immune to the global credit crisis and will experience slower growth, it is much better placed than earlier in this decade to weather the storm.

Ukraine -

Ukraine’s high reliance on external finance makes it particularly vulnerable in this global economic downturn and credit crunch, leading it to seek financial assistance from the IMF. Worsening macroeconomic fundamentals including persistent inflation and a widening trade deficit and domestic and regional political uncertainty have contributed to deposit outflow, tighter domestic money market rates and exchange rate volatility, increasing near term risks for Ukraine's banking sector. The value of the Ukrainian currency, the hryvnya, sank by 20% so far in October forcing the National Bank of Ukraine to intervene and sell dollars at an artificially low rate. Moreover, the equity markets fell over 70% this year.

Russia -

Russian consumers have remained insulated from the loss of wealth in the equity market and troubles that Russian banks face in rolling over their debt, but growth is likely to slow to 5-6% next year from 7% plus in 2007. Meanwhile financing costs are on the rise, eating into corporate profits and the falling oil price may limit a planned investment spree, particularly as a large amount of Russia’s savings are tied up in the domestic banking sector and attempts to avoid a bust in the Moscow property sector.

South Africa -

Despite a growth rebound to 4.9% in Q2 2008, South Africa cut its growth forecast to 3% for 2009 on worries that a global recession would depress export demand (especially of metals) and investment inflows needed to finance its current account deficit. The fall in commodity prices has pressured the Rand, which fell to its lowest level since 2003, and domestic equity markets. The South African Reserve Bank left its benchmark interest rate unchanged at 12% for a second consecutive time, even after inflation reached a record 13.6% in August. Meanwhile, President Thabo Mbeki's resignation ushered in a period of political and economic uncertainty.

UAE -

The UAE is one of several oil exporters starting to feel the pinch from the reversal of speculative capital that flowed in early this year to bet on currency revaluation. Long-term project finance costs already tightened throughout the GCC earlier this year and the freezing of global credit markets exposed UAE banks which financed rapid credit growth with foreign not local borrowing. As a result, local interbank rates more than doubled to over 4.6% despite liquidity injections and a central bank liquidity provision for UAE banks. However, although Dubai’s liabilities might be much greater than its assets, most participants and ratings agencies still assume that the federal government (read Abu Dhabi, home of the largest sovereign wealth fund) will step in if they get into serious trouble. Yet, with the oil price and capital inflows falling the UAE’s surpluses and will be smaller next year even if its budget still balances and worries about Dubai’s property market are looming.

Kazakhstan -

Despite its oil wealth, a reliance on short-term borrowing by its banks abroad has left Kazakhstan, one of the few oil exporters to run a current account deficit, exposed. However, unlike some of its neighbors, it will use domestic funding including the $27 billion National Oil Fund to cushion its economy. But with the oil price dropping and new output delayed, Kazakhstan is set for much slower growth next year, particularly as its previously bubbly property market is cooling quickly

India -

India is taking a severe hit from the global financial crisis with the stock market down over 50% year to date, FII outflows crossing $10bn and the currency plunging over 20% year to date. While the central bank is injecting liquidity, easing bank credit and capital inflows, cutting policy rate to contain risks to the financial sector and downtrend in asset markets, correction in the near-term seems inevitable. Double-digit inflation, high interest rates and global liquidity crunch will significantly impact domestic demand and industrial activity in 2008-09 pulling down the recent boom. Moreover, twin deficits, both approaching 10% of GDP, pose a challenge as forex reserves decline.

Pakistan -

Pakistan, recently hit by a political crisis, is also on the verge of a balance of payments crisis as large capital outflows and decline in forex reserves – below-adequacy levels – pose risk to finance the oil-led ballooning fiscal and current account deficits, and external debt payments. To prevent debt default, the government is seeking $10-15bn in loans from IMF, ADB and World Bank and might approach strategic donors like Saudi Arabia and China. The stock market and currency slump have also led to liquidity injections by central bank along with restrictions on stock trading, short selling, and the establishment of a stabilization fund.

Indonesia -

A single day double-digit plunge in stock indices in early-October pulled down Indonesia’s stock
down market helped push the index down over 40% year to date leading authorities to suspend trading and ban short-selling. Capital outflows, rupiah decline and credit tightening have invited central bank intervention in money and currency markets. But the rundown of forex reserves poses significant risk to the subsidy-laden fiscal deficit and commodity correction-hit current account. Balance of payments risks are only exacerbated by the high foreign-currency denominated debt causing the government to seek loans from World Bank and other multilateral institutions.

China -

The third quarter marked the fifth consecutive slowing of Chinese real GDP growth. Slowing industrial production and real fixed investment are suggesting more weakness ahead particularly if the worst consumer sentiment since 2003 persists. Slowing growth implies fewer commodity imports – even if government sponsored infrastructure projects pick up some slack – clouding the outlook for countries like Brazil, Chile and Australia, among others. The Chinese government fiscal and monetary responses, which have already begun, could cushion its fall and aid in its rebalancing. Yet falling asset prices are taking their toll on local and national fiscal coffers and corporate profits and consumption could be the next shoe to drop as robust retail sales may not stand up to slowing income growth.

South Korea -

South Korea is the most vulnerable of Asian countries to a sudden stop of financial flows. Korea looks set for another financial crisis given its vulnerabilities that include: the highest loan-to-deposit ratio in the region, rapid growth of short-term foreign debt, a current account deficit, a slowing property market, high food/fuel prices squeezing small- and medium-sized enterprises in the construction industry as well as consumers and large corporations facing an export slowdown. Its currency is down roughly 30% year-to-date despite the announcement of a bank support package as foreign investors have pulled out of Korean assets in a flight-to-safety and de-leveraging that marks the global credit crisis. Many fear Korea's credit crisis will shape up to a repeat of 1997 but others believe that, due to its large war chest of forex reserves and its status as net creditor to the world, Korea's interbank dollar funding squeeze is unlikely to become a 1997 redux. The most worrisome sources of a potential Korean credit crisis are not the foreign currency bank debt built up from hedging exporters' USD shorts and the interest rate arbitrage that resulted as a by-product. Such foreign debt can surely exacerbate the de-leveraging that Korea’s bank sector faces, however the real fire starter for a Korean crisis is domestic debt. Korea needs to restructure after having over-invested in construction/real estate companies and over-lent to households. With a slowing economy endangering asset quality, Korean banks will need to get pickier about who they loan to.

Argentina -

The global financial meltdown has put Argentine's private pension assets in jeopardy. Argentina's government could move to take over the management of $28.7 billion in private pension funds that sharply declined in value this year due to global turmoil. The government is attempting to increase the pool of money it can borrow from in order to meet debt obligations next year. As of now, retirement and pension fund administrators manage private pension accounts for 9.5 million depositors, of which some 40% are active contributors. Essentially, most mandatory funds flow into the private pension system would now become part of the government's pay-as-you-go public pension scheme. Besides that, the government would have access to some USD 1.2bn per year in new flows currently deposited in the system. The idea of using social security funds to avoid a default (or to pay the debt) next year should cause a sharp drop in confidence in the country and in its government.

Brazil -

The financial crisis has triggered downwards revisions in economic growth in Brazil for 2009. While the country is set to post 5.1% this year, the forecast for 2009 is 2.8%. The financial crisis and decline in commodity prices which tent to reduce the amount of exports contribute to lower growth.

Venezuela -

In Venezuela, the key problem is the fact that its sovereign wealth fund, known as Fonden, holds about $300 million in debt instruments that Lehman had agreed to cash. With Lehman’s bankruptcy, Venezuela will have a hard time selling the debt. Moreover, the Venezuelan's sovereign wealth fund has a significant amount ($2billion) allocated in structured notes that have lost part of their value amidst crumbling markets, and therefore they are hard to cash to cover expenses. Meanwhile the fall in the oil price may crimp Venezuela’s fiscal expansionism.

More News in the World Banking Industry

Beyond the stock markets there was other financial news concerning the world economy.

Sweden became the latest government to shore up its financial sector, presenting a plan worth 1.5 trillion kronor (152.2 billion euros, 206.1 billion dollars).

The French government said it would inject 10.5 billion euros (14 billion dollars) into the country's six biggest banks to boost their capital following moves by fellow European countries. Among the beneficiaries, the biggest bank Credit Agricole will get 3.0 billion euros, BNP Paribas will get 2.55 billion and Societe Generale 1.7 billion.

There was also more gloom in Britain, with the release of figures showing its public deficit worsened to 12.6 billion pounds (21.6 billion dollars, 16.2 billion dollars) last month. The September figure compared with a deficit of 8.7 billion pounds 12 months earlier, said the Office for National Statistics.

Dow Closes Up Over 9,000 Points

The market is back up over 9,000 again, at least for now, with the Dow closing up over 400 points yesterday.

European stock markets rose Tuesday ahead of Wall Street's open as interbank lending rates continued to decline. British shares was 1 percent higher, Germany's DAX was up 0.9 percent, and France's CAC-40 index of leading shares rose more strongly at 2.4 percent.

Asian stocks were mixed. Japan's benchmark Nikkei was up 3.3 percent, Australia, the main index gained 3.9 percent, India's stockmarket was the biggest winner up point 6.5, while Hong Kong's Hang Seng Index lost 1.84 percent, Shanghai's benchmark fell 0.8 percent and South Korea's index shed about 1 percent.

Stock markets overall continue to be buoyed by the fall in interbank lending rates as they may presage more stable conditions across all the financial markets. There has been a slow trickle of good news coming through, notably with lower Libor rates. Figures released this morning show that the lending rates between banks in the U.S. and Europe have dropped to the lowest levels in over a month as credit markets continue to improve.

However, futures have indicated the Dow may give up some of the gains made yesterday, when it opens today with profit-taking and unease about the health of some major U.S. corporations. Among the companies reporting today are Caterpillar Inc., Apple Inc., DuPont Co. and Pfizer Inc.

Baltic Dry Index Falls Nearly 20% in Two Days

One thing about this financial crisis is that people are learning about all these indexes that affect their lives. How many people before the financial crisis knew what the Libor Rate was and why it so affects their lives. Now today I have learned about the Baltic Dry Index and why the news is not good for the economy.

The Baltic Dry Index is an index covering dry bulk shipping rates and managed by the Baltic Exchange in London. According to Baltic Exchange, the index provides:

“…an assessment of the price of moving the major raw materials by sea. Taking in 26 shipping routes measured on a timecharter and voyage basis, the index covers Supramax, Panamax, and Capesize dry bulk carriers carrying a range of commodities including coal, iron ore and grain.”

—The Baltic Exchange, in BalticExchange.Com

Because dry bulk primarily consists of materials that function as raw material inputs to the production of intermediate or finished goods, such as concrete, electricity, steel, and food, the index is also seen as a good economic indicator of future economic growth and production, termed a leading economic indicator because it predicts future economic activity.

The Baltic Dry Index has been falling since late June, not long before the commodities bubble burst in July, and has been in retreat since then. What is particularly worrisome is its steep dive in the last two days, despite Herculean efforts to get the banking system operational.

This Guardian article suggests that the culprit may be a rapid deterioration in the Chinese economy, but I am also concerned that another factor may be at work that the financing of trade is seriously impaired. In this post "International Trade Seizing Up Due to Credit Crisis," from the Naked Capitalism blog there are reports cited that banks are refusing to honor letters of credit from other banks. If this persists, international trade will break down, because shipping companies rely on these letters to underwrite their vast cargos.

There is some hope today that the worst of the financial crisis may be over, thanks to the mass injections of capital into banks by governments in Europe and the US. But the damage to the world economy is already a fact of life and the Baltic Dry is pointing to a further slowdown in both output and inflation in many of the world's economies.

G7 Financial Rescue Plan

Over the weekend G7 governments agreed to address this global financial crisis in a coordinated manner, laying out a set of common objectives and principles so that each country could define its own special local financial program.

Here are the main policy actions that will be undertaken:

• Preventing systemically important banks and broker dealers from going bust by taking “decisive action and use all available tools to support systemically important financial institutions and prevent their failure” as in the G7 statement
• Recapitalization of banks and broker dealers via public injections of capital via preferred shares – i.e. partial nationalization of financial institutions. “Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses”
• Temporary guarantee of bank liabilities: all deposits, possibly interbank lines (along the lines of the British approach; see here for U.S. and for Eurozone approach), likely other new debts incurred by the banking system.
• “Ensure that our respective national deposit insurance and guarantee programs are robust and consistent so that our retail depositors will continue to have confidence in the safety of their deposits”
• Unlimited provision of liquidity to the banking system and to some parts of the shadow banking system to restore interbank lending and lending to the real economy.
• “Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses”
• Provision of credit to the corporate sector via purchases of commercial paper (certainly in the U.S., possibly in Europe)
• Purchase of toxic assets to restore liquidity in the mortgage backed securities market (U.S.). “Take action, where appropriate, to restart the secondary markets for mortgages and other securitized assets.
• Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary”
• Implicit triage between distressed banks that are solvent given liquidity support and capital injection and those that are non-systemically important and insolvent that will need to be closed down/merged/resolved
• Use of the IMF and other international financial institutions to provide lending to many emerging market economies – and some advanced ones such as Iceland – that are now at risk of a severe financial crisis.
• Use of any other tools that are available and necessary to avoid a systemic meltdown, including implicitly more monetary policy easing as well as possibly fiscal policy stimulus. “We will use macroeconomic policy tools as necessary and appropriate”
  

Former Fed Chief Says U.S. Now in Recession

When I first read this I thought duh? But it is news that former Federal Reserve Chairman Paul Volcker has said that the U.S. economy is in recession. He went on to say that the priority for U.S. authorities in the credit crisis needs to be stabilizing the financial system even though this would mean heavy government intrusion.

Volcker is credited for battling double-digit inflation that flared in the 1970s. He was a chairman of the U.S. central bank between 1979 and 1987, before handing the reins over to Alan Greenspan, and oversaw a sharp increase in interest rates to quell the price pressures.

Volcker is currently the chairman of the board of trustees of the Group of 30, an international body composed of central bank governors, leading economists and private financial sector experts.

U.K. to inject $63 billion into British banks

The British government is making a major cash infusion into three of the nation’s largest banks that will leave the British taxpayers as their largest shareholders. The British government is spending about 37 billion Pounds ($63 billion) in a bid to sshore up the ailing British banking system from collapse amid the global financial crisis.

The British government is requiring the banks being helped to lend more money to small- and medium-sized businesses and homeowners in addition to banning bonuses for board members. British Treasury chief Alistair Darling, speaking with Brown Monday, said it would be "nonsense” for board members to be taking their bonuses. The British government is also insisting that the bulk of future bonuses be paid in shares to ensure that bonuses encourage management to take a more long-term approach to profit making.