Towards a new global balance
We are at a point in the crisis where the financial markets, and economic commentators, do not know whether to panic about deflation or inflation, about a sudden collapse in the dollar, or a sudden collapse in the euro.
These scenarios may be contradictory at the first, but they are much more consistent over time. The policies a central bank enacts to fight deflation could lead to inflation later on. The period of the crisis which marked risk aversion among investors was accompanied by a strong dollar (as US investors repatriated funds), but as inflation looms on the distant horizon, the dollar weakens. This scenario would have deep implication for the role of the dollar as a global reserve currency.
So in order to get some clarity into these wildly different scenarios, let me propose what I consider to be a probable evolution of the crisis. The first two of these points are history, the rest is my forecast.
1. Between November 2008 and February 2009, global trade and global industrial production contracted at a faster rate compared to the early phases of the Great Depression. The sudden drop in global demand led to a fall in headline and core inflation rates. There was a justifiable fear that a sustained period of weak demand could lead to deflation.
2. In March 2009, the sudden decline in global exports and industrial production halted, and partially reversed. Confidence indicators improved. Retail sales improved. There was talk about Green Shoots, about a V-shaped recovery. Some economists even claimed that we may be in a recovery already.
3. In April 2009 and May 2009, exports and industrial weakened again – more than reversing the small gains in March. Taking the March to May period together, it is fair to say that the steep decline in exports and industrial production came to a halt – but without any signs of recovery. The V-shaped recovery scenario seems to be out. The question is whether it is going to be a U, an L, a declining sinus wave, or potentially a douple-dipper, a short-lived recovery followed by another slump.
4. My own guess is a mild double-dipper, followed either by a long period of subdued growth, and more financial instability. I think the present recovery hopes are premature. There is so much stress in the financial sector that we will not see a recovery beyond a robust inventory correction at this point. This can still be substantial in statistical terms, and we might see vastly improved GDP data for Q2 and Q3, but underlying demand will remain weak: US consumers are still repairing their balance sheets, credit flows will not improve for at least another year, and possibly longer. The number of bankruptcies is rising everywhere, and the capacity and willingness by governments to bail out companies like Opel is falling.
5. Central banks will maintain a zero-interest rate policy for the entire duration of the crisis. The monetary stimulus will eventually succeed in raising demand, and the result will be a strong bounce-back, perhaps in mid-to-end 2010;
6. General price pressures increase. Central banks at that point need to consider whether to reverse policy.
7. As we are heading into the next US presidential elections in November 2012, the Federal Reserve will be under political pressure not to increase interest rates too much, as this would undoubtedly kill off the nascent recovery. We will see a return to moderately high inflation rates in the US, a lower dollar, and possibly more distress on the US bond markets, as investors switch to the euro markets.
8. US central bank will eventually fight inflation, but probably not before November 2012, at which point inflation may well in the high single digits. Inflation in the euro area will be lower, but so will economic growth, as the euro will be massively overvalued.
9. Global central banks will start to diversify away from dollars into euros.
Copyright © 2009 WFE
About Wolfgang Munchau
Wolfgang Munchau, 48, is associate editor and European economic columnist of the Financial Times. Together with his wife, the economist Susanne Mundschenk, he runs eurointelligence.com, an internet service that provides daily comment and analysis of the euro area, targeted at investors, academics and policy makers.
Wolfgang was one of the founding members of Financial Times Deutschland, the German language business daily, where he served as deputy editor from 1999 until 2001, and as editor-in-chief from 2001 until 2003. FT Deutschland is now a firmly established player in the German media market with a daily circulation of more than 100,000 copies sold.
Previous appointments included correspondent posts for the Financial Times and the Times of London in Washington, Brussels and Frankfurt. He was awarded the Wincott Young Financial Journalist of the Year award in 1989.
He holds the degrees of Dipl-Betriebswirt (Reutlingen), Dipl-Mathematiker (Hagen), and MA in International Journalism (City University, London).
Wolfgang has published three German-language books. His book Vorbeben, on the financial crisis, has received the prestigious GetAbstract business book award in 2008, and is now published by McGraw Hill in the US.
Wolfgang and Susanne live in Brussels with their sons Joshua and Elias.