March 2: Evaluating the Numbers

The Financial Times produced some shocking numbers this weekend. Japanese exports have collapsed by an astounding 45.7%, the largest such decline since 1957. Stock Markets have collapsed to new lows for this crisis--so low that markets are at their 1997 levels. The budget deficit in the US is expected to reach $1,750 bn, the highest it has been since the Second World War.

Japan's stunning 'free-fall' is indicative of a broader phenomenon, the rapid decline in global trade and demand for finished goods. Japan's banking system, having been relatively insulated from the toxic assets and exotic debt instruments that poisoned so many western banks, is still afloat. The crisis in the world's second largest economy is further proof of a crisis of the economy proper; i.e., not a crisis of finance. For those economists, journalists and politicians who believed this crisis to be essentially financial (there really are very few left) Japan's erosion should provide good reason to stop calling it the financial crisis and start calling it what it is: an economic crisis.

A few notes on the implications of the data on Japanese exports:

The Yen has been appreciating rapidly since the crisis began. Investors pulling money out of other markets poured their financial wealth into the seemingly safe Japanese currency (this was accompanied by a similar but less extreme process forcing appreciation of the dollar). Since the collapse of Lehman Brothers, the higher the level of fear in the markets¹, the higher the Yen. This relationship has broken down of late due to fears that the Yen is now grossly over-valued and fears associated with export and industrial output data. We can expect depreciation of the Yen. This will likely lighten the gloomy data on exports but the extent to which any relative recovery in exports takes place will be a good indicator on the strength and prospects of the global economy. Positive change in exports is unlikely although a reduction in the rate of decline should be expected. It is looking grim.

Accordingly, this gloomy economic outlook combined with the seemingly divided and insufficient global response to the crisis has sent stock markets to new lows. Commentators spoke of a possible rally given the low prices of stocks. Others opined about a theoretical floor for stock prices. The floor has fallen out from under the prices and waiting for a rally seems a fools errand. The corporate sector will be subjected to serious stress because of the mounting uncertainty in markets which has made it very difficult to attract investors. Markets are telling us that we should not hold our breath for a fast and painless recovery.

In other news, the world's savings is still pouring into the US market. Our public deficit will reach $1,750 bn this year. Leaving aside the debate about whether the stimulus/bailout will be enough to pull the US out of recession and prevent employment from plummeting, the budget defect will have an enormous effect on overall private investment in the US. Orthodox economics talks about a phenomenon called 'crowding out.' That is when an entity, in this case the state, is sucking up so much of the world's liquidity that there is very little left to lend to other actors. Lets clarify this phenomenon. US public debt (what the Gov borrows) is considered to be risk-free. Put simply, this is because investors assume that as long as the US exists, debts will be repaid. Because US national debt is risk-free it is also very cheep. Riskier borrowers must offer higher interest rates to lenders to attract liquidity. With the US asking for so much money from the private sector and from abroad, other more risky borrowers will find that there is less money floating around to be loaned to them and thus will be obligated to compete against other borrowers by raising interest rates. Some will get loans some won't. What's more is that a firm can only offer an interest rate as high the expected returns on their investments; i.e., profits must be sufficient to service (make payments on) that loan. That means firms will be forced out of the private debt market. Access to state financing will become very important. The final bit to mention about crowding out is that it is not only private sector firms that are crowded out of the market. Small states can be crowded out of the market as well. Look forward to more desperate demands for sovereign loans out of the developing world².

Deficits and the global imbalances:

In the Financial Times on Jan. 2, it was revealed that US Treasury Secretary Hank Paulson sees "global imbalances" as the root cause of the present crisis. That is to say, the blame for this crisis was neither dishonesty or poor regulation but rather the underlying instability resulting from international trade--the massive inequality in rates of accumulation between exporting nations (China, Germany, Japan, Gulf States etc...) and debtor nations (US, UK, Spain etc...). The mechanisms that helped to propel the growth of such enormous bubbles in commodities and housing lie in the huge savings of the surplus nations. Those savings needed a place to go so they were put into financial markets in search of high rates of return (relative to the perceived risk of said investments). Those savings found their way into the pockets and homes of Americans and other OECDers. Savings also flowed, in a speculative fashion into commodities driving prices up³.
The planned stimulus to the US economy will exacerbate the current global imbalances. Unless the result of the stimulus is to depreciate the dollar and boost exports (a short term boost in exports is unlikely given the state of the global economy...) there will be little long-term economic benefits. To the extent that a large part of the stimulus could go to public goods (unemployment benefits, health care, infrastructure and education) the stimulus should be welcomed on basic human grounds but lets not be too optimistic about some sort of 'jump-start' to the economy as that is highly unlikely.
We should look out for international outcry about American spending and borrowing. In the long run we might expect the American policy to be a measured devaluation of the dollar. This might be the only way out of the crisis but it would spell one of the most monumental shifts in the post-war world and would thus be accompanied by major institutional and structural changes in the political-economic landscape⁴.

Footnotes:

1. Corresponding to VIX. A common measure of market volatility.

2. There is a strong historical relationship between private sector investment, employment and growth in capitalist economies.

3. This is not the whole story of the crisis. It is simply one level of it. A deeper understanding of the crisis must examine structural changes in production and exchange that gave rise to the imbalances but that is beyond the scope of my morning/afternoon.

4. What might be the fate Sino-American relations after a devaluation given the mass of dollars they have willingly accumulated? Could the dollar maintain its place as the worlds reserve currency?