Gazelles and Turtles

Hans-Werner Sinn
Internet article by Hans-Werner Sinn, Project Syndicate, 26.08.2010

MUNICH – The world’s worst post-war financial crisis is over. It arrived suddenly in 2008, and, after roughly 18 months, vanished almost as quickly as it had come. Bank rescue programs on the order of €5 trillion and Keynesian stimulus programs on the order of a further €1 trillion staved off collapse. After falling 0.6% in 2009, world GDP is expected to grow this year by 4.6%, and by 4.3% in 2011, according to International Monetary Fund forecasts – faster than average growth over the last three decades.

The European debt crisis, however, remains, and markets do not fully trust the current calm. The risk premia that financially distressed countries must pay remain high and signal continuing risk.

Greek interest rate premiums relative to Germany on ten-year government bonds stood at 8.6% on August 20th, which is even higher than at the end of April when Greece became practically insolvent and European Union-wide rescue measures were prepared. The spreads for Ireland and Portugal have also been rising, even though by the end of July it seemed that the gigantic €920 billion rescue package put together by the EU, the eurozone countries, the IMF, and the European Central Bank would calm the markets.

The world is currently divided into two groups of countries: those that are off to a strong recovery, and those that lag behind and are signaling new problems. The BRIC countries – Brazil, Russia, India, and China – are in the first group. Even Russia, where the upswing was difficult and hesitant, is expected to grow by 4.3% this year. China remains the champion, with a growth rate around 10%.

The second group consists of countries with debt problems, above all the United States. While the US is expected to grow by 3.3% this year and by 2.9% next year – roughly the long-term average for the past 30 years, this cannot be called a self-sustained upswing, given that the fiscal deficit is expected to reach a breathtaking 11% of GDP this year, before easing to a still-high 8.2% in 2011.

While the US no longer suffers from rising unemployment, the current 9.5% jobless rate is very high for the US, roughly double its level before the recession. The problem remains the real-estate market, whose collapse caused the crisis. The Case-Shiller index for single-family homes seemed to have recovered in spring 2009, after a 34% decline relative to the last boom. But home prices since then have been flat and show no visible trend.

Construction of new single-family homes in May 2010 was at its lowest point since this indicator’s introduction in 1963. Commercial real-estate prices fell from May to June this year by an alarming 4%. All this has negative implications for US consumption, for the building industry, and for the banking system.

Moreover, despite the recent banking reform legislation, the US has not yet resolved the structural deficiencies of its capital markets. The main problem is that the flow of foreign credit has been impaired because US mortgage-backed securities and the derivatives based on them have become nearly unsellable everywhere.

That market has simply disintegrated, with annual emissions volume plummeting 97% – from $1.9 trillion to just $50 billion – between 1996 and 2009. Nearly all (95%) of housing finance in 2009 had to go through the state agencies Fannie Mae, Freddie Mac, and Ginnie Mae to prevent a complete collapse of the US economy.

In Europe, the picture is also mixed. The former boom countries – Greece, Ireland, and Spain – remain in recession, and their GDPs will continue to shrink. The unemployment rate in Spain, one of Europe’s large economies, has sky-rocked to 20% and still shows no sign of improving. The Spanish economy contracted by 3.6% in 2009, and is expected to shrink by 0.4% this year. For Finland, Britain, and Italy, below-average growth rates are expected.

But Europe’s biggest economy, Germany, is experiencing a surprisingly strong economic upswing. The Ifo business-cycle indicator is now clearly in “boom” territory, with regard both to expectations and to assessments of the current situation. In fact, in its 50-year history, the indicator never climbed as steeply as it has over the past 12 months.

Germany, the laggard of Europe for many years, is expected to grow by about 3% or more this year, while the average of the EU-15 (and the EU-27) stands at only 1.1%. The German labor market, too, has shown a miraculous turnaround. The unemployment rate, now at 7%, is slightly lower than it was even at the peak of the last boom, in autumn 2008, and is expected to decline.

On the other hand, France, Europe’s second biggest economy, is struggling. Its unemployment rate is currently 10%, and GDP growth this year will be in the vicinity of 1.3%, only slightly above the EU average. Whereas Germany’s unemployment rate is now a bit lower than in the last boom, the French rate is significantly higher than in the last slump (2004-2005).

The explanation for this divided world is that countries like Greece, Spain, and the US, which experienced a long boom financed by huge capital imports, now face growing difficulties in finding foreign finance. By contrast, countries that exported capital now enjoy an excess of liquidity because capital is shying away from “saturated” countries. This excess supply of credit results in additional consumption and investment, triggering a boom.

The western world is currently experiencing a process of portfolio rebalancing, which is reversing the international ranking of growth rates relative to those before the crisis. Former champions are now limping around the track; former turtles are sprinting like gazelles.