Many newspaper reports give us false hope that the global economic crisis has started to abate. They argue that the US financial system is recovering. There was a stock market rally during May because US banks posted better-than-expected profits.
Other indications used to support arguments that the world has moved into recovery mode are that countries such as India and China are not doing as poorly as expected. I do not believe that the global economic crisis has bottomed out.
I expect increasingly bad news about the global financial system, particularly in the US, over the next year. I also think that the recoveries in countries such as India and China will be slow and may not have the positive impact on global recovery that many economists hope for. In fact, the bad news about growing unemployment and business failures around the globe leads me to think that we may be looking at even further financial problems. As unemployment increases and more businesses fail, the pool of defaulters grows, bank asset write-downs increase and conditions in global credit markets deteriorate further.
Global finance will have to write down a huge amount of assets in the future. This financial sector had not made adequate provision for bad debt, even though it made increasingly risky loans over the past decade or more. For example, renowned financial commentator Satyajit Das says that 30% of US debt was rated noninvestment grade (junk) in the 1980s; by the 1990s, this figure had grown to 50% and, by 2008, more than 70%t of debt was rated junk.
Watching the US markets rally in May increased my scepticism about that country’s financial institutions. The Obama administration’s stress tests of the banks gave an optimistic view of the US financial system.
This optimism came less than a month after the International Monetary Fund had revised its estimates of losses to be faced by financial institutions to $4,1-trillion, from $2,2- trillion in January this year and $1,4- trillion in October last year.
Nouriel Roubini, chairperson of RGE Monitor, argues that the macroeconomic scenarios used for the stress tests significantly underestimate the extent to which conditions in the macroeconomic environment may deteriorate. Further, it seems that US financial institutions are still misleading investors about their actual profitability and health. Many of the US banks’ recent profit announcements were positive because of one-off factors. Many large banks received one-off payments from AIG, which was paid with bail-out money from the US government. Goldman Sachs changed its reporting dates and was able to report a profit. The markets rallied because of wishful thinking, not because of real improvements.
The hope that countries such as China and India may lead the way out of the economic crisis is also misleading. Countries such as China and India have become too dependent on the US economy to sustain the relatively recent large expansions in their manu- facturing and services sectors. These countries have, generally, neglected to build their domestic mass markets.
China’s economic recovery package has been focused on improving infrastructure and housing, not on increasing local demand for cheap consumer goods. It will take a much bigger stimulus package to offset the economic decline and job losses owing to the decline in demand for exports. India has not paid sufficient attention to implementing an economic recovery package. Overall, their recovery still seems dependent on recovery in US demand.
I expect that there will be more negative news in global financial markets. This bad news will cause further declines in global aggregate demand, more job losses, and declining global economic growth.