Vol 10, No 3 - Financial Planning Association of Malaysia

ECONOMY
July - September 2010
Of Double-Dip and Macro Rebalancing
By Anthony Dass
Brewing risk of a potential
double-dip
The worst of the global economy from
the economic crisis viewpoint has been
avoided as a result of prompt and massive
worldwide stimulus policy. Global growth
for 1H2010 was in a firmer footing,
resulting in the upgrading of global
growth by the International Monetary
Fund (IMF) to 4.2 percent from its earlier
projection of 3.9 percent (-0.6 percent in
2009).
Even so, new fears have started to emerge
as we draw closer to 4Q2010. First, it has
become more glaring that neither the
European sovereign debt crisis nor the
banking sector crisis has been resolved
as both mutually reinforced each other.
While the authorities needed to backstop
banks, the banks themselves owned large
amounts of peripheral government bonds.
Clearly, the obstacles to a real solution for
the banking and sovereign crisis were
formidable.
The brief breather from the stress test
in July was perceived to be the circuitbreaker
which provided transparency
on the banks’ exposures and served
as a catalyst for consolidating and
recapitalising the banking system.
Investors, however, are doubtful about
the stringency and relevance of the
test. As such, buyers of the Greece
government bonds still revolved around
the European Central Bank (ECB). Also
investors are still wary of Ireland’s
government bonds in view of the state of
their banks, which are still in substantial
difficulties. Portugal’s government bonds
are trading at their widest spreads over
Bunds (German bonds); and many
European banks are still depending on
ECB for liquidity support.
The U.S. economy, meanwhile, has
entered into a rough patch, but analysts
believe it will only be temporary. Still,
downside risks are evident for the near
term. Hence, the U.S. Federal Reserve has
shifted its focus from an exiting strategy
to the possibility of doing more by: (1)
buying more securities;
(2) committing to lower
policy rates for a longer
period; and (3) reducing
the interest rate on bank
reserves.
This simply means its exit
strategy mode would
most likely be in 2011. But
the risk of a double-dip
recession is flaring, with the
odds rising quickly. The U.S.
1H2010 real gross domestic
product (GDP) was below
trend, with expectation of
a much slower growth in
2H2010. And even if the
economy technically avoids
a double-dip, we believe
poor job creation; rising
unemployment; larger
cyclical budget deficits; a
further fall in home prices;
and banks’ larger losses
on mortgages, consumer
credit and other loans
would create the uneasy
recession feeling.
China’s policy tightening
to deal with its economic
overheating and the rise in goods and
asset inflation are showing signs of
slowing down growth. Also, the growth
slowdown of advanced economies and
the weakening of the euro will further
dent Chinese growth in 2H 2010. Simply,
this means the world’s leading growth
locomotive would slow down its growth
from above 11 percent to 7 percent rate
by end-2010. Such a scenario would be
bad news for export growth for Asia as
well as other commodity exporters who
have been relying on China’s imports.
An important victim from a slower Chinese
economic growth will be Japan. Domestic
demand remains weak as real income
growth is anemic. Japan is seen to be
relying heavily on exports to China for its
economic growth. That’s not all. Japan is
also expected to suffer from low potential
growth as a result of the lack of structural
Buyers of the Greece government bonds still revolved
around the European Central Bank (ECB).
reforms as well as ineffective government,
reflected by the frequent change of Prime
Ministers (four Prime Ministers in four
years and compounded by large public
debt, ageing demographics and the
strengthening yen.
Clearly, the fear of double-dip is
accelerating. Should the U.S. economy
expand at a mediocre 1.5 percent, while
both Europe and Japan grow closer to
zero than 1 percent, and China sees a
slower growth of below 8 percent, it will
create a strong feeling of a double-dip.
Any additional shock would then push
the fragile global economy’s growth
close to stall speed and into a full-fledged
double-dip. Should this happen, we can
expect the sovereign problems in Europe
to deteriorate further, thus leading
into another round of risky asset-price
correction, while global risk aversion and
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