The Global Recession: What Stimulus Is Needed for Recovery?
By Elliott Morss
We start by adding up what the credit freeze and global recession have cost us to date. We then estimate the effects of these losses on global demand and what will be needed to neutralize these losses.
The following table indicates that global stock market losses have been almost $29 trillion.
Global Stock Market Losses
|Percent Loss||Dollar Loss (in tril.)|
|Region||Index||From 3-Yr High||From 3-Yr High|
|United States||S&P 500||-52.03%||($10.35)|
|Asia||S&P Asia 200||-50.38%||($6.85)|
|Latin America||S&P Lat Am 40||-61.56%||($0.85)|
Using the Standard and Poor’s Case Shiller real estate index along with Federal Reserve flow of funds data, I estimate that US housing values have fallen approximately 27% from their highs or by $7 trillion. Let us assume real estate values in the rest of the world have fallen and the same amount.
These assumptions mean that together, real estate and stock market losses total $43 trillion, a sobering number inasmuch as annual global GDP is only $55 trillion.
Let’s take this one step further by estimating the losses in GDP we can expect in 2009. The Economist’s Intelligence Unit provides estimates of GDP changes in 2009. If that data is put together with actual GDP data, we can estimate what GDP losses can be expected. This exercise suggests a GDP loss of $700 billion. This sounds low
The Economist also provides data on changes in industrial production from the prior year, and these numbers are scary. Data on a selection of countries are provided in the following table.
To recapitulate, we have capital losses of $43 trillion, GDP losses of $700 billion, and very scary industrial production declines which are clearly a leading indicator for further job losses.
With global income off almost $44 trillion, how much is global consumption likely to fall? Certainly, anything other than the most basic consumption items will take a hit: durables such as automobiles, TV sets, etc. will fall as well as other consumption items that can be postponed. Global consumption is 70% of global GDP, or approximately $38 trillion. With a global income and asset loss of $44 trillion, it is reasonable to expect consumption will fall by 20% or by $8 trillion. On top of this, global investment, which was approximately $16 trillion in 2007, is likely to fall by the same percentage or by $3 trillion.
Together, these admittedly back-of-the-envelope calculations suggest that without a stimulus, global GDP will fall by $11 trillion in 2009. The next question is what sort of a stimulus will be needed to neutralize this loss.
Economists generally agree that the right sort of government expenditure – like infrastructure expenditures, will have a 1.5 multiplier effect: that is, a $1 expenditure will generate a stimulus of $1.5 (for more on multipliers, see Dunn & Henwood “Holiday Blues” in the Liscio Report – http://tlrii.typepad.com/. That means we would need a stimulus of $7.3 trillion to neutralize the $11 trillion loss in GDP.
That is not going to happen. Why not? Even if governments of the world agreed this was needed, if governments printed that amount of money, all credibility in their currencies would be lost.
Consider how much the United States could do. This year, it is running a $400 billion deficit projected to go to $1.75 trillion next year. And keep in mind that total US government revenues are only $2.7 trillion annually. How do we come up with $1.75 trillion? Do we borrow it? No, because we want the government expenditures it is financing to have the maximum stimulatory impact. So we print it. As Paul McCulley points out in “Saving Capitalist Banking from Itself” at www.pimco.com, “Section 13(3) of the Federal Reserve Act of 1932, [permits] the Fed, upon declaration of “unusual and exigent circumstances” to lend to anybody against collateral it deems adequate, and total freedom to expand its balance sheet, essentially creating liabilities against itself that trade at par – also called printing money – so long as the Fed is willing to surrender control over the Fed funds rate, letting it trade at zero, or thereabouts.”
Nevertheless, there is a limit on how much pump-priming, printing of money any one country can do. Money, like Treasury Bills and Bonds, is a US Government debt. How much US government debt will the world take on? Right now, quite a lot because the dollar is a “safe haven”. But there are limits. I doubt Roubini was talking about the US Treasury when he suggested: ” At some point, a sovereign [bank] might crack, in which case the ability of governments to credibly commit to act as a backstop for the financial system – including deposit guarantees – could come unglued.” http://www.rgemonitor.com/blog/roubini/
Let us return to the $6 trillion global government stimulus that is needed. What have governments done so far? Dani Rodrik has several useful pieces on his blog – http://rodrik.typepad.com/. In one, Kevin P. Gallagher, a guest blogger estimates global stimulus efforts at $3 trillion. This is followed by a posting by Sameer Khatiwada, another guest blogger who works at the ILO. He says Gallagher’s numbers mix fiscal stimulus efforts with steps taken to unfreeze the credit markets. If the numbers are limited to only fiscal stimulus, the global number is only $1.7 trillion – not enough, not nearly enough. This is not an original thought – see, for example, Paul Krugman http://krugman.blogs.nytimes.com/.
But the United States has done more than any other nation, and it is informative to examine in detail what it has done. First of all, consider the stimulus package. Of the $787 billion total, approximately $215 billion will go to state and local governments. Most of this money will be used so these governments don’t have to lay off large numbers of workers. In other words, this money will not be used to help the economy recover. Instead, it is intended to keep things from getting worse. That leaves only $572 billion as stimulus.
Consider the other steps the government is taking which fall mostly under the heading of trying to end the credit freeze. These include the $700 billion TARP, FDIC’s loan guarantees (more than $1 trillion), and $300 billion in FHA loan guarantees. These outlays and guarantees are not directly stimulatory. Indeed, they are intended to shore up credit markets and banking institutions. They are not intended to allow banks to make further imprudent loans.
I don’t see nearly enough stimulus. As a consequence, this recession will be long and severe.
Sources: For stock market capitalizations, www.world-exchanges.org.