Part 13 (1/2)
Even more radical reforms must be i to fail roup But many other, less visible firress should resurrect the Glass-Steagall banking legislation that it repealed a decade ago but also go further, updating it to reflect the far greater challenges posed not only by banks but by the shadow banking system
These reforulations can go awry Financial fir their operations froovernulation in the United States has exacerbated this probleulator has, until very recently, been considered a dead-end, poorly paid job
Most of these probleulations can be carefully crafted with an eye toward the future, closing loopholes before they open That ulations only to a select class of fir-to-fail institutions, for exa them across the board, in order to prevent financial interulated firulation can and should be consolidated in the hands of fewer, ulators can be co the key role they play in safeguarding our financial security
Central banks arguably have the most power-and the most responsibility-to protect the financial system In recent years, they have perforulations, and worse, they have done nothing to prevent speculative , they have fed those bubbles, and then, as if to co in their power to save the victims of the inevitable crash That's inexcusable In the future, central banks must proactively use monetary policy and credit policy to rein in and tame speculative bubbles
Central banks alone can't handle the challenges facing the global econolobal current account i-term econo dollar; addressing both probleovernance The IMF s of a new international reserve currency And how the IMF governs itself , a handful of sing econohtful place at the table, apower and influence of the G-20 group
All of these reforms will help reduce the incidence of crises, but they will not drive them to extinction As the economist Hyman Minsky once observed, ”There is no possibility that we can ever set things right once and for all; instability, put to rest by one set of reforuise” Crises cannot be abolished; like hurricanes, they can only betruth should give us hope In the depths of the Great Depression, politicians and policy makers embraced reforms of the financial systehty years of stability and security It inevitably unraveled, but eighty years is a long time-a lifetime
As we contemplate the future of finance from the mire of our own recent Great Recession, ould do well to try to e lasts forever, and crises will always return But they need not looe; they need not overshadow our econothen the levees that surround our financial systeh the waters may rise, ill remain dry But if we fail to prepare for the inevitable hurricanes-if we delude ourselves, thinking that our antiquated defenses will never be breached again-we face the prospect of lobal financial crisis of 2007-8, the world looked into the abyss In the fourth quarter of 2008 and first quarter of 2009, global economic activity plummeted at rates last seen at the onset of the Great Depression
Only swift, radical policy h not always coordinated or careful, this collective response successfully prevented another depression, and econoers of deflation faded, and the world started to recover E economies turned around first, and by the third quarter of 2009too
But while the global economy has started to rebound, its risks and vulnerabilitiesyears One possible outco fiscal deficits may prompt some countries to default on their debt, or to resort to the printing press to h inflation last seen in the 1970s
Other troubles e as well Extre-co reliance on the carry trade in the dollar-er bubble than the one that just burst Should it deflate suddenly, the value of risky assets and global wealth would fall sharply, with the danger of a double-dip global recession
Other equally frightening events ht occur The European Monetary Union could break up Or japanarisks: its invest a rise in nonperfor crisis All of these scenarios could lead to a backlash against globalization
Much rides on how the global economy recovers-or falters-in the next few years Here, then, is a gli us (For a far more detailed analysis, please visit Roubini Global Economics at roubinicom)
V, U, or W?
Recoveries coor or sustainability A V-shaped recovery is swift and vigorous; a U-shaped recovery is slow and underwhel; and a W-shaped recovery is a double dip, in which the econoain The most likely scenario at present is a U-shaped recovery in advanced econorowth for a number of years Here's why
First, labor market conditions remain weak In 2010 the US unemployment rate reached 10 percent (A more comprehensive measure that accounts for partially eed workers topped 17 percent) Many jobs in real estate, construction, and the financial sector have disappeared forever Likewise,and service-sector jobs that have been outsourced offshore will not return
Even workers who have kept their jobs have seen their inco the pain,” asked their ee cuts The fall in hours worked was equivalent to the loss of another 3 million full-time jobs, on top of the 84 million jobs formally lost by the end of 2009 Those losses ests that up to one-quarter of all US jobs could be eventually outsourced Therefore the unemployment rate may continue to rise for a while, and when it finally falls, it will do so very slowly
Moreover, the current recession is different from previous ones This recent crisis was born of excessive debt and leverage in the household sector, the financial system, and even the corporate sector The recession wasn't driven by ; it was a ”balance sheet” recession driven by a staggering accumulation of debt Recent research by Carests that a ”balance sheet” recession can lead to a weak recovery, as every sector of the econoes” and cuts down its debt
This will take a while Households in the United States and the United Kingdos rates rose above 4 percent by the end of 2009, studies done by the IMF and other scholars suggest that this rate needs to rise to 8 percent or higher in the next few years That will rowth rates of consumption But since consuh in other countries that have also seen declining savings rates), reduced consurowth
Other indicators point toward a U-shaped recovery In a typical V-shaped recovery, the corporate sector plows money into capital expenditures-better known as ”capex”-contributing to a rapid rebound Unfortunately, in this recovery, capex spending will be anemic because much of the economy's capacity (factories, machines, computers, and other fixed assets) sits unused Indeed, capacity bottomed out at a much lower number (67 percent) than in previous recessions (75 to 80 percent) Even by the end of 2009, 30 percent of capacity remained idle in the United States and Europe Why, in this cli?
In addition, for all the government support that the financial systeed As of this writing, in the United States alone the FDIC shut down more than 130 banks and placed 500 or more on a watch list More i systeed; much of it has become a ward of the state Despite public subsidies, securitization is a shadow of its forle with the consequences of having taken on tootied financial system's ability to finance future residential invest, and consuoods will be seriously constrained We will not return to the kind of gro during the go-go years of 2003-7, financed by an unsustainable credit bubble Other factors suggest the likelihood of a U-shaped recovery The policies that helped the economy recover-especially the fiscal stiroill follow If it's not withdrawn-if policy er deficits to pay for tax cuts and spending increases-then we'll sier fiscal train wreck Continued sti will also lead to fears that countries will default on their debt or inflate it away, pushi+ng long-ter out the econolobal current account irowth in the next few years During the last decade the United States-as well as countries like the United Kingdom, Ireland, Iceland, Spain, Dubai, Australia, New Zealand, the Baltic states, and other central European economies-functioned as the world's consucurrent account deficits Conversely, China, e Asia, most of Latin America, japan, Germany, and a few other Eurozone economies served as the producers of first and last resort, spending less than their incoroup of countries is retrenching by saving roup is not co lobal delut of industrial capacity, the recovery of global aggregate demand will be weak at best
All of these factors point toward a slow U-shaped recovery in the United States and in other spendthrift advanced economies The recovery rowth for the fourth quarter of 2009 was 59 percent, the strongest in six years But ure can be explained by the direct and indirect effects of the fiscal stimulus as well as by the fact that in the final months of 2009 companies replenished inventories
These forces her in the first half of 2010 So too rams and tax credits for first-time home buyers The US Census will hire alrowth for a brief period But groill stall in the second half of 2010 as the effects of these teroill slu and the deleveraging of the private and public sectors have occurred
Europe on the Edge
As bad as things look in the United States, the medium-term prospects of the Eurozone and of japan ions the recovery will be U-shaped for rowth rate of the Eurozone and japan (around 2 percent) is lower than that of the United States Second, these countries will have a harder ti fiscal policy to counter the effects of the crisis: even before 2007 they ran large fiscal deficits and had large stocks of public debt relative to their GDP (in many cases close to or above 100 percent) Third, these countries face serious challenges over both the short ter populations None of these probleroup of Eurozone countries known as the PIGS-Portugal, Italy, Greece, and Spain-are in grave trouble In recent years their debts have soared and their competitiveness has declined The reasons are complicated The adoption of the euro enabled them to borrow more and consu credit booes This made their exports less competitive At the same time, excessive bureaucracy and other structural ih-skill sectors, even though wages in these countries trailed behind the average for the European Union
The resulting noxious et deficits left the PIGS countries heavily indebted to banks elsewhere in Europe All are highly leveraged, ion Worse, the dramatic appreciation of the euro in 2008-9 has increased the loss of co the to burden the wealthier, healthier members of the European Union
This wasn't supposed to happen The European Monetary Union was designed to bring stability and unity to Europe When member states joined, they ceded control over monetary policy to the European Central Bank; they also joined the Stability and Growth Pact, which imposed restrictions on the size of their fiscal deficits In theory their membershi+p would force these countries to undertake structural refor all member states Instead, the opposite happened Ger their fiscal i their co But the opposite occurred in Italy, Spain, Greece, and Portugal, where fiscal ih and labor costs rose above productivity growth As a consequence,have two Europes instead of one
Other factors have aggravated the divergence Labor e and culture haration So a rise in unemployment on the periphery of the union will not lead workers to ions as ht As a consequence, labor markets in the European Union are much less flexible than those in the United States Equally troubling, the individual nations of the EU do not share the fiscal burden of government, as states do in the United States The fact that fiscal policy is left in the hands of the individual countries liree to which one nation can help another
If these econoences persist and widen, the European Monetary Union could break up For exa and fiscal fudges to deal with its problems If it continues to do so, Greece could lose access to debt o hat in hand, begging for direct loans from other member states, the European Central Bank, the European Coht bail out Greece for the sake of the survival of the Monetary Union But if sial, or other ness and ability of the European Central Bank, much less the French and German taxpayers, to bail out other member states would reach a limit Greece would then have to exit the Monetary Union and adopt a new, devalued currency like the drachma to replace the euro
This twin scenario-default and devaluation-could have terrible consequences By adopting a new, depreciated drachma, Greece would necessarily default on public-and most likely private-debts denoentina in 2001 Its exit froered a massive default on public and private debts denominated in US dollars It also led to the forced conversion of dollar-denominated domestic debt into peso liabilities with a much lower value, a process known as ”pesification” Likewise, a devaluation and default by Greece or Italy would lead to a ”drachmatization” or ”liralization” of dothese claims, mostly other European banks
No currency union has ever survived without a fiscal and political union as well Should such defaults and devaluations take place, the contrast between the Eurozone and the United States would become ever starker California and et crises, but a strong tradition of fiscal federalism-as well as provisions in the bankruptcy code-makes it possible to solve some of these local proble mechanisms
A breakup of the Monetary Union could even lead to the partial destruction of the European Union itself Any member nation that exits the Monetary Union and defaults on debts held by other member nations may ultimately be expelled froo, has become a very real possibility for authorities in Athens, Roence and an erosion of economic competitiveness in these countries have made such an outcome far more likely than ever before
Whither japan?
japan is in asof its real estate and equity bubble in the early 1990s led to a Lost Decade of econonation-punctuated by four recessions-as well as serious deflation In the wake of the bubble, japanand fiscal stimulus too late, then abandoned the, recapitalizing only late in the decade A double-dip recession in 2000 only exacerbated the twin problenation japan returned to a potential growth of 2 percent only after 2004
During the recent crisis the contraction was more severe in japan than in the United States, despite the fact that most of japan's financial institutions had little exposure to toxic es or structured financial products Instead, japan proved vulnerable on account of its heavy dependence on foreign trade, which was itself dependent on a weak yen When global growth and trade collapsed in 2008-9, exports collapsed The yen-based carry trade unraveled, driving the yen to appreciate Its recovery since then has been ane-ter population, corants, has put its econorowth An inefficient, somewhat ossified service sector with low productivity has proven resistant to change, as have rigid economic and social conventions like lifeti no will to undertake the structural reforms necessary to break free of these restraints japan's position as the world's second-largest econoer secure: China is likely to supplant it in the coh public deficits, weak growth, and persistent deflation point to a possible fiscal crisis So far that fate has been avoided, thanks in part to high private savings rates In addition, japan's large current account surpluses have led both the private sector and the central bank to accus that could be eventually used to service the growing doovernh it now shoulders a gross public debt equivalent to almost 200 percent of GDP