The Future of the Global Recession

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As the world grapples with the worst economic crisis in more than seven decades, policy-makers are wringing their hands to find solutions that will shield their countries’ and the world from further storms, while reigniting the global growth engine that has spurred unprecedented prosperity in the second half of the twentieth century and beyond.

The global landscape looks bleak. The World Bank estimates that global economic growth will contract by 1.7% in 2009, compared to 1.9% growth in 2008. This will mark the first decline in the global economy since World War II.  The World Bank also estimates a 6 percent drop in the volume of world trade in goods and services, which would amount to the largest decline in 80 years. The International Labor Organization estimates that global unemployment could top 30 million in 2009, the highest ever.

We have already witnessed the falls of some of the world’s most venerable financial institutions, from Lehman Brothers to Bear Stearns, and have watched as countries have faced bankruptcy and last minute IMF bail-outs, from Iceland to Pakistan to Latvia and Hungary. In the Middle East, we have seen the shine rub off rising global city-states like Dubai, while populous countries like Egypt, Iran, and Morocco have seen their unemployment problems worsen. Many economists predict that more dominoes will fall in Central and Eastern Europe.

Developing countries, which have seen strong growth numbers in the past few years, will face sharply slower growth rates, and some outright declines.  The great unraveling of the global growth engine could hit developing countries the hardest. As World Bank President Robert Zoellick noted in a London speech on the eve of the G-20 summit, “Just as the global economy once helped to lift hundreds of millions out of poverty, today there is a risk of development in reverse, as our interconnected world transmits negative shocks with greater power and velocity. “

Meanwhile, the world waits with anticipation to see if America is turning a corner. While U.S President Barack Obama said at the recent G-20 summit in London that the world has for far too long relied on the spending of the American consumer to fuel its growth, his call of warning has not turned eyes away from America. A recovery in America would provide an enormous psychological boost to the global economy, potentially clearing away some of the blocked arteries of slowing world trade.

While stock markets in the United States, Asia, and the Gulf region have demonstrated signs of resilience and recovery in the last month, the question remains: is this a bear market rally, preceding the latest spiral downward, or are we witnessing the first signs of restored confidence that could boost recovery?

What is a policy-maker to do? It just might be one of the greatest policy challenges in a century. To understand the forces at play in today’s global economy, it’s important to know where to look. Suggested below are five key trends to watch – for both the policy-maker and the independent investor.

1) The Chinese Consumer

The world’s third largest economy has recently been seen as an engine of global growth. Its export industries feed goods to the world and its ravenous appetite for raw materials spawned booms in resource-rich developing countries. Its thirty year run of continuous growth averaging 9% is unprecedented. Still, the Chinese consumer has yet to play its part in the global economic turn-around. Simply put, the world needs Chinese consumers to spend more.

A key fact: China’s GDP amounts to one-third of its domestic consumption. A stronger internal consumer market in China will support the growth of industries and trade across Asia and beyond.

2) The U.S. Stock Market

Economists have long warned against making long-term forecasts based on the vicissisitudes of stock markets. But the U.S market is the biggest, most liquid, most globalized market in world history, and is thus seen as a bellweather of the global economy. When US markets drop dramatically, world markets take notice, and often follow suit.

While basic economic theory underlying the mistrust of stock markets as a predictor of future growth is valid, global market psychology does not always correspond well to theory. As a result, continued recovery in the U.S stock market – as we have witnessed in March – will affect markets positively worldwide. A settling of the U.S stock market will also restore confidence in the battered American consumer. Though Obama said the world should no longer rely on the American consumer, the reality is that American consumers helped fuel global prosperity, and they will do the same with global recovery.

3) The Foreign Worker

A visit to any major Gulf city will reveal an army of foreign labor and service professionals helping to power local economies. What is less well understood is the vital economic impact those workers have on their home countries, in the form of remittances. These remittances – money sent home by foreign workers, mostly from developing countries – amounts to some $300 billion a year, far outweighing official development aid and private capital flows. Indeed, in countries like the Phillipinnes, remittances are the most important source of income. Thus, foreign workers play a vital role in global growth as they feed growth back home.

World Bank officials estimate that remittances are likely to fall below $300 billion in 2009. If this trend continues, remittance-driven development pockets in developing countries will suffer, exacerbating already existing tight conditions.

4) Oil Investment       

While high oil prices are often blamed for recessionary spirals, it should be noted that oil remains one of the more under-priced commodities and has been the fuel that has lubricated global growth for the past six decades. While it has become fashionable to tout “the end of the oil era” in favor of green technologies, fossil fuels will remain a vital piece of our global growth engine. Moreover, low oil prices may offer short-term relief, but could prove to be disastrous in the longer-term.

Saudi Arabia’s Oil Minister Ali Al-Naimi, highly regarded in oil industry circles as a price moderate, has been ringing the alarm bell on low prices. He makes a convincing case, arguing that low oil prices create disincentive to invest in future supply, creating a coming oil crunch as demand inevitably rises. In a speech in Vienna in March, he said: "In years to come, if traditional energy supplies should prove inadequate because capital expenditure was curtailed due to unsustainable prices, unreliable indication of future demand or hopes for a substitute that oil cannot deliver, such a supply crunch would be catastrophic. The painful result would be felt sooner rather than later. It would effectively take the wheels off an already derailed economy."

Al-Naimi pointed to a price of $60 to $75 a barrel as a reasonable one that would offer incentives to increase production. “We frankly court disaster if these supplemental resources on which such high hopes for energy security and sustainability are pinned do not fulfil their high expectations," he said.

Thus, ironically, low oil prices could be viewed as a harbinger for future economic crises, and another bust and boom cycle to come.

5) Trade Finance

Trade remains one of the oldest and most tested means of creating prosperity and fueling growth. World trade numbers are on the decline, with the WTO forecasting a 9% fall in 2009. Trade transactions are fueled by banks and credit, and as banks struggle and falter, and credit dries up, so does trade. It is estimated that trade finance covers about $10 trillion of the total $15 trillion in world trade.

Thus, to reignite world trade, leaders of the G-20 states have stepped in with ambitious trade finance programs. They agreed a package to fund $250 billion in trade over two years.

As Reuters reported, “most trade finance instruments, such as letters of credit, are simple forms of lending, some dating back hundreds of years. They are also among the safest for the banks involved, because they are short-term, the banks know the exporters and importers, and the goods covered can be used as collateral for the deal.”

“Currently, as cash flow problems at exporters and importers become more severe, and they are less able to access cheap short-term finance to cover immediate needs, banks may be less willing to extend trade credit and reluctant to agree alternative forms of finance.”

Thus, watching trends in trade finance and support for measures that allow people and companies and businesses to engage in the oldest international economic activity of all – trade – will offer revealing clues about the future of the recession.

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