Looking on the Bright Side

The recession is going global, the markets are tanking again, the central banks are slashing interest rates in ways that smack of desperation and the latest U.S. unemployment figures show that the economy has now lost over a million jobs this year already.

Are we down-hearted? No.

First, the financial crisis is starting to ease.

A) The LIBOR rate, which is the interest rate at which banks offer to lend unsecured funds to other banks in the wholesale money market, is back down below the panic level it reached as Lehman Brothers went into bankruptcy.

B) Even better, credit default swaps look much less worrying. Lehman Brothers had some $400 billion in CDS trades out when it folded, and there were very real fears that as much as 10-20% of them could go sour. All Lehman's CDS trades have now been settled at a total cost of $6 billion, and much of this had already been collateralized. This means the world-at-large can breathe a lot easier.

The total sum at stake in the CDS market is over $55 trillion, about the size of global GDP. It now seems, even if the worst happens, that the net cost of resolving these trades will be about 1.5% of the total — less than a trillion dollars. This is a lot of money — close to what the U.S. economy produces each month. But it is not fatal.

C) The central banks and governments all get it. We have never seen such levels of international coordination in cutting interest rates and in mutual guarantees. The U.S. Federal Reserve is making $120 billion available in cash to Brazil, Mexico, South Korea and Singapore in exchange for their local currencies to ease dollar shortages.

This is unprecedented and very smart. And it comes on top of the unlimited supply of greenbacks the United States has provided to the major economies.

D) China has taken a strategic decision to become a "responsible stakeholder," just as World Bank President Robert Zoellick has been urging it to do. The nadir of the crisis was in the week of October 6-10, when Iceland collapsed, the Dow sank to 8,000 and the IMF announced a global recession.

On the weekend of October 11-12, at the IMF-World Bank meetings in Washington, the G-7 central bankers met and agreed that they would not let another major financial institution go under (as Lehman had just done) and announced joint interest rate cuts.

Unprecedentedly, China then joined in, announcing its own cuts, just two weeks after it had made its own unilateral cuts. And now the Beijing leadership has announced a two-year, $586 billion state investment program which looks like classic Keynesian policy.

And it is huge: about 16% of China’s economic output last year, and roughly equal to the total of all central and local government spending in 2006. It will certainly increase domestic demand, ease the slump in commodity prices and should also suck in more imports and erode China's current account surplus. It is a policy that will significantly help the global economy.

As a result, there is now a Chinese joke that goes like this:
1949 — only socialism can save China
1969 — only China can save socialism
1989 — only capitalism can save China
2009 — only China can save capitalism.

Second, we now have a reasonable sense of how grim and how long the recession is going to be. The good news is that while there is still a long way to go, the most frightening moment of the financial and banking crisis appears to be over. Thanks to coordinated international action, there will not be a global banking meltdown, of the kind that followed the 1931 crash of Austria's Creditanstalt.

We are now in a deep but fairly conventional global recession that started in the third quarter of this year, will last for at least 18-24 months and see a decline in GDP among the G-7 countries of 2-3%.

The BRIC countries, Brazil, Russia, India and China, will slow markedly, to a growth rate as low as 3% next year for Russia and perhaps 6% for China. That would mean halving China's growth rate last year, which will feel like a hard landing. China's new state investment measures should help ease the damage.

In 2006, the collective growth rates of the BRICs added more than $600 billion to global GDP. In 2009, they will be hard-pressed to add $350 billion. But they will still be growing.

Analysts seldom pay much attention to the group of middle-income countries whose GDPs are in the range of $400 to $900 billion: Mexico, Australia, Turkey, Taiwan, Indonesia, Saudi Arabia and South Korea. The collective GDP of those seven countries is equivalent to that of Japan, and their potential and dynamism will be crucial.

Each of them is slowing, either because of dependence on shrinking export markets or the fall in commodity prices. In 2006, their collective growth rates added nearly $300 billion to global GDP. Next year, they will probably add less than $100 billion. But they will still be growing.