The Gathering Storm
Increasingly Bad News is Giving Rise to Serious Doubt. Is the World Economy Really on the Brink of Recession?
From 2004 to 2007, the world economy experienced an unusually long and strong boom, with growth rates of nearly 5% and with many countries participating. The European Union (EU15) recorded 2.4% growth on average during these years. In Germany, where growth averaged 1.8% during this period, some journalists proclaimed a new economic miracle. Now, however, increasingly bad news is giving rise to serious doubts; dark clouds are hovering over the United States, in particular. Is the world economy on the brink of recession?
In the US real-estate prices remain in free fall, and the banking crisis is still claiming new victims (Bear Stearns, IndyMac, First Heritage Bank, First National Bank of Nevada, First Priority Bank, Fannie Mae, Freddie Mac, etc.). In the banking world as a whole, expected write-offs now considerably exceed the €400 billion mark projected just last spring.
Unemployment, moreover, is rising at its fastest rate in seven years. Overall employment, which is still high in historical terms, has been declining continuously since the beginning of 2008. It is surprising that America’s stock market hasn’t crashed yet, since all other indicators are pointing downward. The Standard & Poor’s price/earnings ratio recently stood at around 20, well above the long-term average of around 16 since 1881.
Disturbing signals for the world economy have also come from recent surveys of economic activity. The IFO World Economic Climate index deteriorated in the third quarter of 2008 for the fourth consecutive time. That decline was primarily the result of more unfavorable appraisals of the current economic situation, but also reflected another downward revision of expectations for the next six months. Today, the index is at its lowest level since the fourth quarter of 2001.
The cooling of the IFO World Economic Climate index was particularly marked in Western Europe and Asia. This has dispelled hopes that Asia economic activity could develop separately from that of the US, thereby offsetting European exporters’ losses in America. In the third quarter of 2008, the Ifo index for Asia was at its lowest level since the attack on the World Trade Center in 2001, with particularly poor economic assessments coming from Japan.
In the US, the climate indicator declined again, after having sunk dramatically in the second quarter, bringing it to its lowest level since 1991. The University of Michigan’s Consumer Sentiment Index fell in June 2008 to its lowest level in decades and has since recovered only insignificantly. Also for the euro area, the Ifo Economic Climate index registered a dramatic decline.
Europe’s largest economy, Germany, is now going into the doldrums. The Ifo Business Climate index, which, though based on a survey for Germany, is regarded as Europe’s most important economic activity indicator, has been falling with few interruptions since the autumn of last year. It is now clearly in territory that implies an economic downturn.
In addition, export expectations for German manufacturing are heading south. Incoming orders in manufacturing, the most important indicator in the official statistics, fell more sharply in the first two quarters of 2008 than at any time since the beginning of 1993.
In the second quarter, the German economy shrank at an annualized, seasonally and calendar adjusted rate of 2%. All in all, there is now hardly any doubt that the economic upturn in Germany that began in the summer of 2005 is now coming to an end.
Amid this gloomy outlook, we anxiously look for encouraging signs. The price of crude oil, which hit a record level of $148 a barrel in July, has since fallen almost 25%, or $36. Whether recent developments in America’s economy give reason for hope is now the question. With an annualized 1.9% quarterly rise in GDP in April-June, growth was twice as high as in the first quarter (0.9%). This largely reflects the impact of $152 billion in tax rebates (roughly 1% of GDP), but, given the continuing and intensifying real-estate crisis, this boost to growth still does not mark a turnaround.
In Japan, with an economy of about half the size of the US, growth forces remain weak. In the second quarter of 2008, the Japanese economy shrank at an annualized rate of 2.4%, primarily due to weak exports.
With all this discouraging news, it is little comfort that some areas of the world are still displaying considerable growth rates: China is expected to grow by 9.5% this year and in 2009, with India growing by 8%, Russia up by 6.5%, owing to higher oil prices, and Latin America growing by 4.5% on average during this period. Unfortunately, the weight of these countries and regions is small; China, the biggest of them, accounts for only 5% of the world economy.
So the signs of a worldwide economic slowdown have increased. The American crisis is now spreading to other areas of the world. Former US Federal Reserve Chairman Alan Greenspan may be right when he says: "This crisis is different – a once or twice a century event deeply rooted in fears of insolvency of major financial institutions."
Hans-Werner Sinn is Professor of Economics and Finance, University of Munich, and President of the Ifo Institute.
Copyright: Project Syndicate, 2008.