Policymakers around the world have not shown understanding of the current crisis. It is the end of a two decade-long bubble. It is the end of the asset-based economy. It is the end of productivity dividends from IT revolution and globalization. Perhaps one tenth of the income in the global economy was from bubble activities and is permanently lost. The income will shift elsewhere. The resulting demand is different. The supply side has to change to meet a different demand mix in the post bubble economy. If governments don’t understand, the world may suffer a lost decade ahead. No, it is not Japan in the 1990s. It is Japan of the 1990s plus inflation, aka stagflation.
Stock markets around the world have fallen close to or below the lows of November 2008. Concerns over bank bailout uncertainty and deepening recession drove the decline that reversed the 20% bounce from the lows of November 2008. The delays in releasing details by the US Treasury on its bank bailout plan led to suspicions that it didn’t know what to do yet. The exposure of European banks to Eastern Europe caused concerns over their solvency. If big global banks remain mired in bad assets, credit system won’t function normally, and the global recession has no hope to end soon.
On the economic front, the news is grim: Japan’s GDP contracted by 3.3%, Euro-zone 1.5%, and the US 1% in the last quarter of 2008. The US fared better because it piled up inventories, which would lead to a worse situation later. The global economy probably contracted by 2% in the last quarter of 2008 from the previous quarter, the worst decline since the World War II. The first quarter of 2009 won’t be better. The January trade data of East Asian economies already cast a dark shadow over the quarter. All the data are portraying a global economy amidst collapsing.
Three forces are driving the collapsing. First, the collapse of Lehman Brothers triggered a sharp increase in credit cost. Its impact was similar to increasing interest rate by 3-5 percentages by all the central banks together. To cope with high cost of capital every business has been running down inventory, which is the cheapest source of fund raising. In commodity industries, inventory unwinding has been dramatic. Most commodity users kept inventories high out of fear of price rise or for speculation. When commodity prices reversed, they were stuck with a depreciating asset and had to run it down as quickly as possible. I suspect that this force accounts for half of the economic contraction at present.
