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Story of the assumed Great Depression

By Surjit S Bhalla
May 03, 2008 13:37 IST
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In for a penny, in for a pound. And several Big Time pounds may be in for being not just wrong, but massively wrong. Over the last several months, there has been a constant drumbeat announcing the impending doom. It all started out quite innocently. The US current account was under stress, the dollar too high.

Then came the sub-prime crisis. From an also ran to the housing crisis, it became the main event. Estimates of banking losses of around $400 billion are now widely accepted.

This event started the forecasts of the great US depression. Everybody chimed in and wanted to be the first to claim credit for the forecast, heck reality, of the housing sub-prime inspired US depression. Forecast a no-brainer recession, indeed Depression. The perfect buy, rather sell!

The institutions and individuals who chimed in with their few billions worth would convince anybody. George Soros, Mark Mobius, Jim Faber, the IMF, Goldman Sachs, JP Morgan, Morgan Stanley, Alan Greenspan, all said that a recession was a near reality and a Depression a distinct possibility.

If not a Depression, then a prolonged recession; if not a prolonged recession, then sub-par low levels (around 1%) of GDP growth as far as the forecast could be made. These names are legendary and I apologise for missing other BIG names, but the fact is that the names of super distinguished market players forecasting a radical change in US growth patterns would fill this entire page, let alone my column. Merrill Lynch went so far as to write, just a few weeks ago, that damn the data we are already in a recession.

A consistent and near lonely exception to this doom today, doomer tomorrow assessments was Macroeconomic Advisers, a firm led by Dr Laurence Meyer, formerly of the US Fed. This firm has consistently maintained that not only will the US avoid a recession, but that the recovery will also be sharp. There are a few other lonely outfits (Oxus!) but really the cupboard is near empty.

Associated with calls for a US depression was the conclusion that those who had argued about globalisation and global decoupling were wild-eyed optimists or ones at some distance from reality. The world really had not changed, and if the US went into a deep slump, everybody was threatened Big Time. But what happened, or has happened to date? The US has grown for two successive quarters at the snail pace (formerly Japanese and European pace) of 0.6 per cent per annum.

Japanese industrial production growth has accelerated; this according to the new 2004 base. European growth has continued on its 2% plus pace, though the ECB's obstinate adherence to an outdated monetarist model may force Europe to face a cost of lower than potential growth, and with no offsetting gain on the inflation front. 

China's GDP growth has declined marginally from above 11 per cent to "only" 10.5 per cent. Korean growth continued, as has growth in several parts of Latin America and Africa. Indian growth has been hurt much more by a highly contractionary exchange rate and interest rate policy than by the US slowdown. The current 8.3 per cent growth is well below last year's 9 + per cent growth, and considerably below its realisable potential of 10 per cent GDP growth.

If more than a marginal slowdown has not occurred in non-US world growth, then the important question is "Why Not?" And that question will be reinforced if the US avoids a recession, as seems likely. There are two independent explanations for the possibility that the experts have got the future of the US economy horribly wrong.

The first explanation is that the US-centric gloomsayers have not appreciated how much the world has changed -- just as their Indian counterparts who believe in karma so how can the world change? Today, India and China alone account for as much world growth as the US economy itself.

This simple statistic explains the "stabilisation" possibilities in the modern world, and why the world economy is likely to prevent the US economy from entering into a recession. Just look at US export growth. The Great Depression Redux -- forget it.

There have been other pointers towards a no-US recession. None of the traditional leading indicators are "working" according to history; retail sales, payroll employment, unemployment, industrial production, purchasing managers indices are well above levels associated with entry into a recession.

The forecasters may have concentrated on just one variable, housing, which has been the worst since the Depression. Extrapolation from this one, albeit important, statistic may turn out to be fatal (for the forecast).

But why is the world economy so resilient now and different than earlier points in history? This will likely be a popular research subject. But there are pointers, explanations.

A strong contender would be the large presence of the newly emerged middle class in the developing world, and especially because of their size, the middle class populations of India and China.

The middle class is many virtuous cycles rolled into one middle -- high and increasing consumption of infrastructure and durables, high productivity growth, high incomes and even higher savings and investments. It is the actions of the middle class that provide stabilisation in the world economy, and its growth.

The middle class is a long-run factor. The world financial markets were close to breakdown just a month or so ago. While the rest of the world's central banks missed the big picture, not so the US Fed led by Prof. Ben Bernanke. His timely interventions, and a worldview of what works and what does not, has most likely helped avert a global financial meltdown; if such a meltdown had occurred, it would have affected all of us quite severely.

If Bernanke is successful in his policies (and my bet is yes) then a historical place for him next to the world's best ever central banker, Paul Volcker, is assured.

The author is Chairman, Oxus Investments, a New Delhi based asset management company. The views expressed are personal.

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Surjit S Bhalla
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