The European Commission has just released gloomy, updated macroeconomic forecasts, with Euro area GDP now projected to decline by 1.9% in 2009. In eleven out of 16 Member states, GDP is expected to fall in 2009, with an especially sharp decline in Ireland (-5%). Due to automatic stabilizers and fiscal stimulation plans, half of the countries are expected to run fiscal deficits exceeding the 3%-of-GDP red line. The European Commission forecasts very large deficits in Ireland (11% of GDP) and in Spain (6.2%). Strikingly, these two countries used to be part of the most virtuous members of the Euro area until 2007. Indeed, from 1999 to 2007, none of these two reached or even approached the 3% bound. General government budget was close to balance on average in Spain while Ireland ran a 1.6% surplus on average. All other Euro Members except Belgium, Finland and Luxembourg crossed the red line at least once, and five of them (France, Germany, Greece, Italy, Portugal) did it several times.
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The Washington meeting of the Heads of State to take place shortly reflects recognition of the need for international cooperation in the regulation of financial institutions and markets. There has been international cooperation in recent months, mainly among the major central banks, notably the coordinated interest-rate cuts that took place recently, and the provision of dollar financing by the Federal Reserve to the European Central Bank, which needed dollars to relend to European banks that could not obtain them commercially.
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We are entering in different phase in stock market weakness, one that gives me some cause for optimism. I believe that in recent weeks what we have witnessed is a transition from “liquidity fear” to “recession fear” or for the more technical, from liquidity risk to credit risk. It may be hard to notice the difference. Both forces are bad for stock markets in general. But they have a different impact on individual stocks and therein lies the opportunity for opportunistic investors who don’t mind a bare-knuckle ride in search of superior returns.
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Everyday, as a matter of urgency, central banks and governments are fighting against the fire. An amazing blow to confidence has burst within the most sophisticated financial system which has ever been experienced. Before smoke and dust fall down, it is wise to investigate the ways out on which governments should drive the players of this drama in order to contain damages and speed up reconstruction.
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The 1980s have seen the 2nd wave of economic globalization of modern history. It should not end like the first during the 19th century. Economic crises and wars often keep pace. The first energy shock of 1973, the start of the economic reforms in China at the end of the 1970s then in India and finally the fall of the Berlin Wall in 1989, gradually led to a huge transformation of the world economy. The idea to gather a G7 or even the G8 under the current format is clearly unsuitable when we see clouds accumulating on emerging countries, China and India included.
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On September 28, Dominique Strauss-Kahn became the new Managing Director of the International Monetary Fund. He follows in the footsteps of his French predecessors, Pierre-Paul Schweitzer (1963-1973), Jacques de la Rosière (1979-1987) and Michel Camdessus (1987-2000). Indeed, French bureaucrats have led the IMF for almost half of its existence. Look beyond 19th Street, and you will find the mark of Frenchmen in many more of the world's most influential economic organizations, from Pascal Lamy, who has been Director General of the World Trade Organization since 2005, to Jean-Claude Trichet, who has headed the European Central Bank since 2003.
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Since the month of August, economists have been trying to understand why something that was supposed to be positive for global growth, namely the diversification of risk through securitization, had turned out to be the source of the recent crisis. The first reaction was to characterize this as a liquidity crisis - some banks were having undue difficulties in securing funds in the interbank market, and thus central banks reacted by providing liquidity through open market operations. Many central bankers and academics started smiling with an "I told you so, there was so much excess liquidity, this was bound to happen", and adopted a tough anti-moral hazard stance. More than a month, and many billions of dollars of extra liquidity injections, later the situation in money and credit markets has not improved. Central banks have added liquidity to a situation of already "excess liquidity" to tackle an apparent liquidity crunch, and yet nothing has got better. Perhaps it was not about liquidity, after all.
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