Global economic downturn is picking up speed

Editor: Sharon Li
22 Dec 2008 07:01:16 GMT

By William L. Watts & Greg Robb

WASHINGTON (MarketWatch) -- The global economic downturn is gathering speed in Europe, Asia and the United States and while there is talk of a recovery in the second half of the year, it is far from a certainty, economists say.

The pace of the slowdown in China has come as a surprise to economists. The downturn in the European Union is now expected to hit all countries, not just the smaller countries like Spain, Italy and Greece.

And the United States seems set for the longest recession in the post-war era.

Most models see some pickup beginning after June. But the environment is not easy to forecast.

"The central fact is I don't think anyone knows how this will play out," said Martin Bailey, a former economic adviser to President Bill Clinton and now an analyst at the Brookings Institution.

Most annual forecasts are "notoriously wrong," said Steve Ricchiuto, chief economist at Mizuho Securities in New York.

Ricchiuto and other economists say that it will not be until May that it is clear whether there will be a rebound in calendar year 2009.

Simon Johnson, former chief economist at the International Monetary Fund and now a professor at MIT, is one economist with major doubts about a quick turnaround.

Instead of a V-shaped recovery, Johnson predicts it will look more like a "bathtub," with slippery sides that will be impossible for the global economy to climb.

There is a global pullback by investors underway, where the public wants to save more.

Governments around the world are stepping into the breach with stimulus plans, but because they didn't save during the summer days of the expansion, they don't have enough fiscal power to provide the necessary stimulus, Johnson said.

President Obama's economic stimulus plan is likely to top $775 billion, according to the latest media reports.

The British and French are proposing to spend between 0.5% and 1.5% of GDP, which is "inadequate," Johnson said.

And Germany is dragging its feet, which could damage the synchronized attempts to increase savings.

"It is a dangerous new world," Johnson said.


Recent business confidence surveys and activity gauges, including closely-watched purchasing mangers indexes for the manufacturing and services sectors, point to a deepening recession in the fourth quarter of this year across Europe. After contracting 0.2% in the second and third quarters, euro-zone GDP could fall by 0.6% or more in the final three months of the year, economists said. See full story.

"The basic theme there is that the short-term business surveys are dire," said Brian Hilliard, head of economic research at Societe Generale. "Output is really collapsing and fourth-quarter (euro-zone) GDP could fall 1% and the perspective is little better for the first quarter of next year.

"I think that's going to make itself evident in business investment in the euro zone as well, so that's going to do a lot of damage through the rest of next year," he said.

The downturn hasn't only hammered countries, such as Ireland and Spain that have echoed U.S. housing woes. It's also hit more robust economies, even sending European powerhouse Germany into a recession of its own, noted Jonathan Loynes, chief European economist at Capital Economics in London. The firm predicts euro-zone GDP will contract by 1% in 2009.

Deutsche Bank predicts that a steep near-term fall will make for a 2.5% contraction in GDP in 2009, marking the 15-nation region's worst recession since World War II. Growth will rebound in 2010, but the recovery will be more tepid than in normal recoveries, said economist Mark Wall, in part due to a lack of a coordinated policy response across the region.

Despite qualms, the European Central Bank will likely have little choice but to drop its key interest rate below 2% for the first time in its decade-long history, economists predict. The central bank has slashed its key rate from 4.25% to 2.5% in a series of rate cuts that began in October.

Meanwhile, German Chancellor Angela Merkel earlier this week said Germany would decide on a second fiscal-stimulus plan in January. Merkel has resisted calls by other European leaders to significantly boost public spending in the euro-zone's largest economy. Germany's current plan would boost spending by 31 billion euros over the next two years.

As for Great Britain, ideas the Bank of England will have little choice but to join the Fed in exploring the zero bound on interest rates have sent the pound tumbling to all-time lows versus the euro.

An aggressive round of rate cuts by the Monetary Policy Committee since October has dropped the BOE's key lending rate from 5% to 2% -- matching the all-time low since the bank's founding in 1694. Another big cut is expected next month.

"With the risks of a deep and protracted recession rising, we expect the MPC to cut rates to 1% next year. Unorthodox policy measures similar to those already in train in the U.S. will probably follow," wrote economists at Royal Bank of Scotland.

Forecasters see Britain, saddled with a burst housing bubble and outsized exposure to the troubled banking sector, bearing the worst of the global downturn. The British government was the first to effectively part-nationalize its troubled banking system and has implemented a controversial 20 billion pound fiscal stimulus package.

GDP is now likely to contract by at least 1% in the fourth quarter, Loynes said, setting the stage for a contraction of around 2.5% in 2009.

Societe Generale's Hilliard sees a 1.5% 2009 contraction.

The economy will likely begin to show some signs of life in the second half of next year as lending conditions finally begin to stabilize, Hilliard said.


Although the U.S. has been in a recession in last December, it feels like it has gained strength in recent weeks, economists said.

Fourth quarter growth in expected to be below negative 6% rate in the final three months of the year, and the first three months of 2009 look almost as bad.

The rough consensus sees flat growth in the third quarter and some form of growth in the final quarter.

Bailey, the former top economist for Clinton, sees a 20% chance of an upside surprise in growth in the second half of the year if things start to bottom.

Nothing Obama will do will stop the two negative quarters. But he may instill some confidence to lead to a turnaround.

However, there is a 30% to 40% chance that the economy stays in recession through the entire year, with the unemployment rate rising above 10%, Bailey said.

But some economists are optimistic about a rebound.

Joel Naroff, president of Naroff Economic Advisors, said that U.S. businesses are reacting quickly to the downturn and will be in better shape for a rebound after the first quarter.

"Businesses are reacting so quickly they are not going to need to keep cutting back, which is what typically keeps recessions going longer," Naroff said.

For Ricchiuto of Mizuho Securities, the biggest test will come quickly next year when the market will expect the Fed to follow up on its promise to keep printing money.

"Are they (the Fed) ready to walk the walk after they've talked the talk," he asked.

Spreads on many debt classes have come down dramatically in the wake of the Fed decision earlier this week.

"The Fed now has to validate or markets could get nasty," he said.

Overall, Ricchiuto is skeptical of any outlook.

The recent market declines have been so severe that there has been a permanent shift.

"People in their 40s now think they are going to have to work until they're 80," he said.

"Twenty years of savings have been wiped out. We can't assume the world is going back to normal.


Experts painted a grim picture for the Asian region in 2009.

"Asia is not doing well at all," said Son Won Sohn, an economist at the Martin Smith School of Business at California State University, Channel Islands.

"Decoupling, which looked for a while like it was going to work -- turned out to be a myth."

Japan is mired in a recession, South Korea will be lucky to reach 2% growth this year and Chinese growth could fall below 6%.

The downturn in global trade has just begun to have a negative impact on China's economy, but it is pressure that will last for most of 2009, according to Brad Setser, an expert on China at the Council of Foreign Relations in New York.

"The latest data for November was off-the-charts bad," Setser said.

In addition, China's own domestic cycle looks to have turned, he said.

"The pace of the downturn has been a little bit of a surprise," he said.

Global threats

Economists remain very worried about protectionism.

Despite pledges by the G-20 last month to cooperate and avoid protectionism, trade analysts see signs that the opposite may be occurring.

If China moves to protect its export sector, it will likely set off a hostile reaction in the U.S. Congress.