Could Stiglitz be right over poor prospects for 2010?

Joseph Stiglitz, Nobel laureate in Economics, made headlines again this week with remarks at a conference in Singapore.

He suggested that the first quarter of 2010 and even the whole of 2010 may turn out to be considerably weaker than most people forecast, both for the US and globally, and called for a new round of significant stimulus measures.

If Stiglitz is right, the economy globally will weaken, oil prices which 2 months ago hit $80 after a $35 bottom in February and now trade around $75 could soften considerably; perhaps to $50. Global GDP growth after around -3 to -4 per cent in 2009 could remain anemic to slightly negative. And what the Gulf states have seen with Dubai World, could develop into something even more serious. Could Stiglitz be right?

Credentials

The short answer, of course, is that we don’t know but Stiglitz certainly has the credentials to be taken seriously. He remains, and has been for some time, the top ranked academic economist globally in terms of publications and citations. He was one of the few voices in 2003 and 2004 warning of financial excesses building both globally and the US.

These views were influenced by his time as Chief Economist at the World Bank during the Asian Financial Crisis of 1997 and 1998 which saw sharp implosions in Indonesia, Thailand, and Korea. Stiglitz was and remains critical of the IMF handling of the crisis. Stiglitz views stand in contrast to the more rosy predictions from central Bankers and international institutions.

Ben Bernanke has effectively declared the recession to be over. And current data seem to also point in that direction. Unemployment rates in North America and European beginning to fall a little after plateauing and retail sales edging up. In China, auto sales are up sharply on last year and now exceed those in the US.

But having said this, the central bankers that now declare an end to the downturn are the same ones who failed to identify it in 2007 and early 2008. Stiglitz’s seeming caution for given his track record and research credentials would seem to merit careful consideration.

Comparing today and the 1930s

A place to begin is with comparisons between the current episode and the Great Depression of the 1930’s. In the 1930’s there were rallies in the stock market while the trend was to fall. The sharpest market falls in the US were in 1931 and 1932, and in November/ December of 1929 there was a sharp rally.

But in the 1930’s unemployment grew rapidly month after month peaking at 25 per cent in the US and in Europe. The output compression approached 50 per cent, and stock market falls were in the 80 per cent range from the peak. Were we to match this we have some way to go?

Delayed 1930’s?

One scenario is that today’s events differ from the 1930’s in that the policy response to the financial and price shocks (housing, oil) has been vigorous and much quicker. Here the story is that only after New Deal policies kicked in 1933/1934 did the US economy recover, although some modern economists now argue that New Deal polices slowed the recovery which was market lead.

Since the fateful mid October events and the G8 Finance Ministers meeting which had governments commit to honour all liabilities of national banks, there have been large stimulus packages and extremely lax monetary policy with large budget deficits and injections of liquidity into banking systems. The result has been than while we may have tracked the 1930’s globally in trade and output compression early on until Feb/March 2009, since then the story has been different as we have plateaued and then mini bounced.

The scenario of a delayed 1930’s is that with no room for more monetary stimulus with near zero interest rates and ballooning deficits constraining more stimulus, all ammunition is now spent and the decent we saw in the 1930’s will resume but with a year or so’s delay.

Global Japan?

A second scenario builds on Japanese experience after 1989. Japan had three decades of nearly 8 per cent growth and became one of the wealthiest and best performing economies on the planet. When the bubble eventually burst in 1989, house prices in Tokyo were to fall by 70 per cent, and the Japanese banks remained largely insolvent for 10 years or more.

A decade and a half of zero to near negative growth followed, and Japanese revival was just budding as the financial crisis hit. And it hit hard in Japan. The global Japan scenario is one of similar performance. The massive global bubble in housing prices which by some estimates wiped out $30 trillion of assets worldwide, and with oil prices going for $145 to $35 barrel, and a more than halving of copper prices suggest it could take a similar time for the global economy to recover.

Strengthening Green shoots?

A third scenario is the central Bankers more roseview. We have survived a potential global meltdown in the financial system. The joint government pledge to honour bank liabilities has held. The stimulus packages and lax monetary policy have begun to work.

The data show small rebounds in retails sales, international trade is edging higher, unemployment rates have edged down a little, and as these changes filter through they increase incomes and boot confidence for a growing if slow, economic revival.

I will leave it for readers to form their own views of the most likely scenario. If history teaches us anything it is that surprises, on the upside as well as the downside, lie in store. But Stiglitz could be right, and he has performed a welcome service in not letting us become too complacent about 2010.

* The writer can be reached at j.whalley@alrroya.com