Sunday, July 18, 2010

Roubini Ponders the "L-Shaped Recession"

Nouriel Roubini appears to be sticking with his "U-Shaped Recession" call, at least for now. However, his stance seems much more cautious than before.

Please consider Double-Dip Days by Nouriel Roubini. http://www.social-europe.eu/2010/07/double-dip-days/

The global slowdown – already evident in second-quarter data for 2010 – will accelerate in the second half of the year. Fiscal stimulus will disappear as austerity programs take hold in most countries. Inventory adjustments, which boosted growth for a few quarters, will run their course. The effects of tax policies that stole demand from the future – such as incentives for buyers of cars and homes – will diminish as programs expire. Labor-market conditions remain weak, with little job creation and a spreading sense of malaise among consumers.

The likely scenario for advanced economies is a mediocre U-shaped recovery, even if we avoid a W-shaped double dip. In the US, annual growth was already below trend in the first half of 2010 (2.7% in the first quarter and estimated at a mediocre 2.2% in April-June). Growth is set to slow further, to 1.5% in the second half of this year and into 2011.

Whatever letter of the alphabet US economic performance ultimately resembles, what is coming will feel like a recession. Mediocre job creation and a further rise in unemployment, larger cyclical budget deficits, a fresh fall in home prices, larger losses by banks on mortgages, consumer credit, and other loans, and the risk that Congress will adopt protectionist measures against China will see to that.

In the eurozone, the outlook is worse. Growth may be close to zero by the end of this year, as fiscal austerity kicks in and stock markets fall. Sharp rises in sovereign, corporate, and interbank liquidity spreads will increase the cost of capital, and increases in risk aversion, volatility, and sovereign risk will undermine business, investor, and consumer confidence further. The weakening of the euro will help Europe’s external balance, but the benefits will be more than offset by the damage to export and growth prospects in the US, China, and emerging Asia.

And one cannot exclude the possibility of an Israeli military strike on Iran in the next 12 months. If that happens, oil prices could rapidly spike and, as in the summer of 2008, trigger a global recession.

Finally, policymakers are running out of tools. Additional monetary quantitative easing will make little difference, there is little room for further fiscal stimulus in most advanced economies, and the ability to bail out financial institutions that are too big to fail – but also too big to be saved – will be sharply constrained.

So, as the optimists’ delusional hopes for a rapid V-shaped recovery evaporate, the advanced world will be at best in a long U-shaped recovery, which in some cases – the eurozone and Japan – may be long enough to stretch into an L-shaped near-depression. Avoiding double dip recession will be difficult.

In such a world, recovery in the stronger emerging markets – the great hope for the global economy – will suffer, because no country is an island economically. Indeed, growth in many emerging-market economies – starting with China – is highly dependent on retrenching advanced economies.

Fasten your seat belts for a very bumpy ride.

Shape of Things to Come

There is much more in the article, including a discussion on China, Japan, and more analysis of Europe. Inquiring minds will give the article a closer look.

The only puzzling thing to me is Roubini's statement "The likely scenario for advanced economies is a mediocre U-shaped recovery, even if we avoid a W-shaped double dip."

Remove the word "even" and the sentence makes perfect sense.

Indeed, Roubini goes on to say "So, as the optimists’ delusional hopes for a rapid V-shaped recovery evaporate, the advanced world will be at best in a long U-shaped recovery, which in some cases – the eurozone and Japan – may be long enough to stretch into an L-shaped near-depression. Avoiding double dip recession will be difficult."

Case for an "L" Shaped Recession

Thus, Roubini now appears to be leaning towards (or at least considering) my point of view as expressed on Tuesday, April 08, 2008 in Case for an "L" Shaped Recession http://globaleconomicanalysis.blogspot. ... ssion.html

Now that it's clear we are in a recession, the question has arisen as to what shape it will take: "V", "U", "L", or "W".

Nouriel Roubini proposed the question in The US Recession: V or U or W or L-Shaped? and came up with "U". http://www.rgemonitor.com/blog/roubini/252460/

[Roubini] : My view is closer to a U-shaped recession as I expect that the economic contraction will last at least 12 months and possibly as long as 18 months through the middle of 2009. This view is based on the fact that the last two recessions – in 1990-91 and 2001 – lasted 8 months each and today the macro and financial conditions are worse – relative to those two previous recessions - in at least three dimensions: ....

[Mish] : More likely to me is something like an "L" or a "WW" kind of scenario with the U.S. slipping in and out of recession for a prolonged period of time, perhaps 3-4 years or more.

Roubini nailed three reasons for a severe recession but dismisses "L" because the U.S. acted faster than Japan. I do not buy that argument for these reasons.

U.S consumers are in much worse debt shape than Japan.

There is global wage arbitrage now that did not exist to a huge degree in the mid to late 1990's. Even white collar jobs are increasingly at risk.

The savings rate in the US is in far more need of repair than what Japan faced. This will be a huge drag on future spending and slow any recovery attempts.

Japan faced a huge asset bubble (valuation) problem. The US faces both a valuation problem (what debt on the books is worth) and a rampant overcapacity issue as well.

Japan had an internet boom to help smooth things out. There is no tech revolution on the horizon that will provide a huge source of jobs.

If the Fed and Congress drag this out, which at this point seems likely, we will see a severe "L" or "WW" shaped recession playing out over several (or more) years.

Please bear in mind that flashback is not a criticism of predictions anyone made in 2008.

Moreover, the fat lady still has not sung. Perhaps by some miracle we have a weak U-shaped recession that looks and feels much worse.

Finally, I believe Roubini laid out a recession case as to how this would play out nearly as good as anyone.

Where to from Here?

As always, the key question I keep asking and more importantly addressing is: "Where to from here?"

I wholeheartedly endorse this statement from Roubini.

"as the optimists’ delusional hopes for a rapid V-shaped recovery evaporate, the advanced world will be at best in a long U-shaped recovery..."

Indeed, I have made similar, if not even more dire sounding statements many times, some of them recently. For example:

Wednesday, July 14, 2010: Expect Second-Half Housing and Durable Goods Crash http://globaleconomicanalysis.blogspot. ... rable.html

Tuesday, July 13, 2010: Are we "Trending Towards Deflation" or in It? http://globaleconomicanalysis.blogspot. ... or-in.html

Tax and Stimulate is No Solution

My sole criticism of Roubini does not concern his statements regarding the recession or the severity of it, but rather his Keynesian tax-and-spend solutions for curing it.

With that backdrop, please consider Roubini Says Obama Should Address Nation as Adults http://www.businessweek.com/news/2010-0 ... keene.html

“We have to recognize that Americans are adults,