Rod Oram: Four drivers now four horsemen

THIS IS a global recession like none before it. The causes are more systemic, the impacts more damaging and the recovery more uncertain. Thus, the changes to the world economy will be more profound.

Therefore, consumers, corporates and governments need to respond very differently in many respects than they have in the past. So far, by and large, they aren't.

Let's start with the four main causes. The first was innovation in the finance sector. Complex new products offered households and corporates abundant, cheap credit. Central banks abetted by keeping monetary policy too loose too long. These factors fuelled reckless consumption and corporate activity. Asset prices whether houses, shares or businesses soared to unrealistic and unsustainable levels.

The second cause was a sense of invincibility. The creators, sellers and buyers of these new instruments believed they had engineered risk out of the financial system. They took less care about whom they traded with and they neglected to charge more for higher risks.

The third was inter-dependence. World trade grew strongly for more than two decades. Developed countries had voracious appetites for cheap imports. Developing countries, particularly China, boomed from supplying them.

And the fourth was imbalances. While many developed countries racked up massive trade and current account deficits, many developing countries piled up huge trade and foreign exchange reserves. They loaned the money to their western customers to keep the merry game going.

But over the past 18 months, each of the four drivers of seemingly endless, risk-free global growth has failed. First, much of the financial innovation proved to be a costly scam. So far global banks have written off $US2.8 trillion of bad assets, the Bank of England estimated recently. That is equivalent to 85% of the tier one capital of the entire global banking sector.

Bankers are shell-shocked, credit markets traumatised and investors stunned. Governments are trying to revive the global financial system. But the $US1 trillion of new capital they have injected so far hasn't worked.

More help is needed. Re-establishing strong private sector ownership, good regulation and some semblance of normal working of the global financial sector will take some years. Even then, the amount of credit for business and consumers will remain far, far below the heady heights seen in the mid-2000s.

Thus global demand will take some years to recover to pre-crisis levels. Industries will have a tough time adjusting. For example, carmakers have a current global manufacturing capacity of 94 million cars a year, according to CSM Worldwide, an automotive industry consultant. But global demand is running at only 60 million cars a year.

Around the world, measures of consumer and business confidence are plumbing historic lows.

So inter-dependence is weakening fast. World trade volumes will shrink this year for the first time since 1982 (apart from the 9/11 blip in 2001), the World Trade Organisation forecasts.

Producing countries are suffering mightily. In December, compared with year earlier levels, Taiwan's industrial production fell 32%, Japan's exports were down 35% and China's fell 2.8% when normally they would have grown by 40% or so.

In addition to the export shock, many of these countries are also being hit by a loss of domestic activity, creating a double blow to them, HSBC said in a recent report.

As a result, Asian GDP figures are horrendous. In the last quarter of 2008, Japan's economy is estimated to have contracted by 10% at an annual rate, Singapore's 17% and South Korea's 21%. China barely grew on a seasonally adjusted basis in the quarter compared with 13% growth in calendar 2007.

At first glance, the consuming countries in the West are getting off more lightly. The IMF forecast recently that the US economy will shrink 1.6% this year, the euro area's by 2% and Japan's by 2.6% (by comparison, bank economists' forecasts here range from 0% growth to 1.5% contraction).

But leading indicators such as manufacturing orders suggest that those three huge economic areas could suffer contractions closer to 5% this year.

While these dramatic slumps are helping reduce the global imbalances in trade, current accounts and foreign exchange reserves, there are plenty of other excesses that will take much longer to work through and will be even more painful. These include very high household debt and low savings in many developed countries, particularly the US, the UK, Ireland, Australia and New Zealand.

So quite simply, the four great drivers of the past 15 years of global prosperity have collapsed. Rebuilding the economic systems and relationships will take years.

If this were a recession, it would have been triggered by high interest rates aimed at killing inflation. The negative growth would last eight months, based on past global averages. While companies, households and governments would have to respond astutely and the post-recession economy would be leaner and fitter, it wouldn't be very different from the one before.

But this global crisis was triggered by a collapse in asset prices and will last a lot longer. Those are two definitions of an economic depression. The scale and time frames are a GDP contraction of 10% or more or one that lasts more than three years.

Finland suffered a depression on all three measures in the three years to 1993. It was unhealthily dependent on the Soviet Union which was collapsing at the time. Through radical action to reshape its economy and build new relationships it became a far more sophisticated, resilient and wealthy country.

This is in a sense a microcosm of the challenge now facing the global economy.

Here are two views of the issues:

"The financial and economic crash of 2008, the worst in over 75 years, is a major geopolitical setback for the US and Europe," Roger Altman, a former US deputy Treasury secretary, writes in the latest issue of Foreign Affairs. "Over the medium term, Washington and European governments will have neither the resources nor the economic credibility to play the role in global affairs that they otherwise would play."

And the latest report from the US National Intelligence Council concludes: "By 2025, the international system will be a global multipolar one with gaps in national power continuing to narrow between developed and developing countries.

"The international system as constructed following the Second World War will be almost unrecognisable owing to the rise of emerging powers, a globalising economy, an historic transfer of relative wealth and economic power from west to east, and the growing influence of non-state actors."

The next three columns will consider the impact on New Zealand of these seismic shifts in global economics and politics; the corporate response; and the government response. 

- © Fairfax NZ News