A common theme is that, notwithstanding the ongoing banking crisis, the world’s governments have finally got a grip on the task in hand. Although a deep and protracted recession looks all but unavoidable, a depression seems averted – even Roubini says so. The same policy blunders made in the 1930s have not been repeated. The Fed’s expansionist policies have already succeeded in dramatically shifting the yield curve. Governments are in control.
Martin Wolf’s column in yesterday’s FT gave us pause for thought. Wolf took issue with the US stimulus package on offer.
Last week, President-elect Barack Obama duly unveiled his American recovery and reinvestment plan. Its title was aptly chosen, for Mr Obama spoke, astonishingly, as if the policies of the rest of the world had no bearing on the fate of the US. He spoke, too, as if a large fiscal stimulus would be enough to restore prosperity. If that is what he believes, Mr Obama is in for a shock. The difficulties he confronts are much deeper and more global than that.
Yves Smith over at Naked Capitalism takes up Wolf’s argument and calculates…
So if I have this right, “needed” stimulus is the 10% (full employment” deficit + 7%, or 17% in each of the next two years. What Obama is delivering is 5% over two years, or 2.5% a year, plus a baseline of 8.3%, for a total of 10.7%.
So to get where we need to get (if you buy the logic of this sort of exercise) is an additional 6.3% PER ANNUM deficit as a % of GDP. Remember, Obama’s plan is roughly 2.5% per year. 6.3/2.5= 2.5 times.
Read that again, If you believe the math, Obama’s program would need to be 2.5 times bigger to live up to its billing. And that is before you get into details like “tax cuts are likely to be less effective than other measures”.
But that isn’t the half of it. A larger stimulus – though certainly dramatic – is still assumed at this point to be a possibility. Something achievable.
The below graph is from Albert Edwards at Societe Generale. It’s frightening (click to enlarge):
The OECD’s leading indicators are pointing to a total and swift collapse in Chinese GDP growth. Edwards produces two more graphs, using another indicator not included in the OECD’s calculations – electric power output.
And the relationship between electric power output and GDP:
If the Chinese economy collapses, or even slows dramatically, then the raison d’etre for the country’s huge FX reserves – as a sterilisation measure to dampen domestic inflation – will evaporate. With that, so will China’s US Treasury holdings. Or alternatively the Chinese could devalue the yuan.
Either way, the US will be in trouble. Treasury prices could collapse (although given the current renewed banking collapse fears, not before a significant rally has occured) and if that happens, the Fed’s yield-lowering credit easing policies will be left in tatters. As will any plans for economic stimulus packages. Hypothetically that would leave just the nuclear option: devaluing the dollar.
Why would the Chinese let that happen?
…surely the authorities have learnt the lessons of the 1930s and we can rely on them to do the right thing? It depends what the alternative is. A Yuan devaluation would undoubtedly be likely if the alternative was the overthrow of the Communist Party. As The Economist pointed out recently, economists and bankers begged President Hoover not to sign the 1930 Smoot- Hawley Tariff Act