Monday, February 9, 2009

TechTicker:'s Martin Wolf "We'll Be Lucky if Downturn Only as Bad as Japan's"

These continue to be amazing times because the eventual outcomes are so bipolar. The viewpoints, the end games, the eventual destinations are hotly debated. Anyone professing to "know" where we are going is making an educated guess, but I'll continue to hang out in the camp of "worse recession" since 1930s.

The Financial Times Chief Economics Commentator, Martin Wold is quite pessimistic. (this gentlemen shows up a lot in websites I frequent) - he made an appearance today on Yahoo's Tech Ticker.

Part 1 (5 minute video)

The stimulus bill and latest bank bailout plan expected to be announced this week are obviously key to turning around the U.S. economy. But they're of even greater importance given the world economy is at such a critical juncture, says Martin Wolf, chief economics commentator for The Financial Times.

"There's no precise definition of a depression" but the global economy "looks incredibly bad - far beyond a normal recession," says Wolf, author of Fixing Global Finance. We "could have a very severe and prolonged recession."

Wolf, who is also a professor of economics at University of Nottingham, believes "it will be lucky" if the current downturn is only as bad as Japan's so-called lost decade. Unlike the U.S. today, Japan was able to count on a strong global economy to mitigate the affects of its burst bubble and struggling financial system. "There is no world economy to rescue the U.S.," he says. "Chances are [it will prove] much worse than Japan." (editor's note: wait, I thought China was going to save the U.S.?)

We discuss Wolf's recipe for avoiding this outcome in subsequent segments but he offers three major recommendations here:

  • Use government spending to boost short-term demand.
  • Aggressively restructure and recapitalize banks - and have central banks lend directly into the economy if need be.
  • Rebalance demand so countries with big surpluses (like China) increase consumption to help the global economy move away from its reliance on "massive" deficits in the U.S. and U.K.
Part 2 (8 Minutes)

Martin Wolf, chief economics commentator for The Financial Times, is a believer in the power of government spending to revive the economy, especially now when the private sector is in major retreat.

But believing in fiscal stimulus is much different than supporting the bill currently being discussed in Congress, which Wolf believes is "too small, too wasteful and too ill-focused."

Similarly, Wolf is discouraged by the expected path of the next bank bailout plan; that's critical because "there's no sustainable recovery without a sound financial system" whether the stimulus package or well designed or not, he says.

As detailed in part one of our interview, the commentator, author and economics professor has a fairly dire view of the state of the global economy. Given that, he says the risk of going forward with such bad polices are profound, including:

  • A continuation of a deep recession (if not worse)
  • More debt defaults by corporations and sovereign nations worldwide.
  • "Horrendous" unemployment in the U.S.
  • Ultimate loss of confidence in policymakers, leading to "panic" in financial markets.

Still, Wolf did write a book entitled Fixing Global Finance and he offers "six principles" for stemming the current downturn in which he notes the one silver lining to the economic mess we find ourselves in, as detailed toward the end of the accompanying video.

EDIT 4:30 PM - part 3 is now available (5 Minutes)

The next phase of the bank bailout plan presented by Treasury Secretary Tim Geithner (now slated for Tuesday) is expected to be multi-faceted but missing one key element: An admission by policymakers that major U.S. banks are insolvent.

There are two explanations why the Obama administration (like its predecessor) refuses to even acknowledge this possibility in public, says Martin Wolf, chief economics commentator for The Financial Times:

  • One, policymakers have better information than private economists and really believe the big banks aren't insolvent, i.e. they continue to view the crisis as a "liquidity problem," and believe so-called toxic assets will return from their currently "artificially low" levels once confidence is restored.
  • Two, policymakers "are not prepared to admit the truth" because it means existing shareholders and bank managements will be wiped out. It also means "admitting total failure" of efforts to date to stem the crisis, says the author of Fixing Global Finance.

Arguing today's toxic assets are "fundamentally worthless" - and there's lots more losses coming - Wolf says the lack of political will (or outright cowardice) to admit to reality means "we're really in trouble." Why? Because confidence in policymakers will continue to deteriorate as their ill-conceived solutions continue to fail.

Once policymakers (ultimately) agree insolvency is really the underlying problem, there are two options for dealing with the banks:

  • Nationalize them, and then inject government capital as the U.K. government has started to do with RBS and Lloyds. (a.k.a. The Swedish Solution)
  • Put them into FDIC receivership or force them into bankruptcy, whereby common stock and preferred debt shareholders get wiped out and "senior" debt holders end up owning the banks.

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