This article contain some amount of financial jargon and is targeted at those with more than a passing interest in the financial markets.
If you roll back the clock a little and go back to back to examine a few fateful days in early August, you will realise that the massive losses and movement in financial markets took place over a 4 day period as if the world economy has dived down suddenly. After that, every one from Tony Tan to Tharman to LKY started talking about the impending double dip recession. Many Singaporeans including a group of developers started to get worried and went to the minister in charge of housing to persuade him to review the cooling measures so they can continue to make their millions. If you grab a man on the street and ask him, you will find he too knows that the stock market has plunged and recession is on the way. I too jumped same conclusion because stock market falls ahead of recessions. However, after sieving through the data, I think the future is more uncertain than depressingly bleak - it is not a bright future but is it going to get very dark very fast?
The event that cause most people to think that the global economy has taken a turn for the worse is the stock market plunge in early Aug 2011. But if you look at economic data from the US, it does not look that bad ....it hasn't looked good for months with things bumping along sideways and things did not really get any worse Here is my favorite realtime data that measures the realtime activity in the US economy - it is compiled by a group of researchers in UCLA (www.ceridianindex.com).
The chart tells us the US economy never recovered to where it was in end 2007 - it has plenty of spare capacity i.e. unemployment. The US economy did not recover all the way because some of the jobs lost in the housing sector e.g. construction, furniture, renovation etc did not come back as housing remains in a slump. Despite the blame Obama has been getting due to the high unemployment, it was the bursting of the US housing bubble and continued slump in the housing market that caused the unemployment in the US to remain stubbornly high. The chart also show us there is no massive deterioration in Jul 2011 just before the stock market sold off in early Aug 2011. There was a bigger economic deterioration in Aug 2011 caused by the market turmoil rather than the other way around - market was causing economic uncertainty rather than economy dragging down the stock market.
The US housing market never recovered at all since the housing bubble burst:
What really caused the stock market meltdown in Aug 2011? Those who are familiar will say it is due to the crisis in Europe. This crisis has been with us for more than a year and in Jul 2011, the Europeans came up with a plan to tackle this crisis called the EFSF (link to EFSF news), While this rescue fund is not a cure all, it is massive enough to help kick the can further down the road to forestall the crisis. There is sufficient money to completely take Greece out from the debt market for 2 years i.e. Greece does not need to go back to the market to raise funds until 2013.. So why did stock markets fall so hard in Aug 2011. The real reason, I believe, is linked to regulatory mis-steps that open the door for speculative attacks.
In Jul 2011, the EU published the results of a stress test that was suppose to show that its major banks are safe and sound. However, when the stress stress test results were examined closely, investors found a few things - many of the banks were holding large amounts sovereign debt and were very vulnerable (Forbes Report : Euro Stress Test Reveal 8 Banks Would Fail, 16 Barely Survive Adverse Conditions). Not very wise to let the whole world know how weak your banks are and where are their vulnerabilities.
The 2nd mis-step by the Europeans that also occurred in Jul 2011 was the failure to repeal the mark-to-market accounting rules. Until the recent past, banks account for the value of their loan portfolio based on various models that take into how the debt is service. For example if you owe the bank $30K in credit card bills due to overspending, your loan with the bank is good as long as you service it so the bank will account for this debt. Suppose a bank is holding Italian bonds these bonds are valued at full face value as long as Italy does not default on any of its debts. Mark to market account is different as it requires the bank to value these bonds based on market prices. Before mark to market was introduced in 2006, a few researchers warned that it can cause instability as a negative feedback loop can be constructed - it is widely believed to have caused the market shocks we saw during the Financial Crisis. The accounting rule change to allow some securities to be valued at cost known as IFRS 9 was put on the table in mid-Jul 2011. The EU was urged to give it the green light to ease the crisis - remember in Jul 2011, things were pretty stable but the proponents of this rule change wanted it in place to break any negative feedback look should the sovereign debt crisis worsen[EU's Barnier says won't budge on accounting rule]. This rule change was postponed by the EU to 2013 and the doors were thrown wide open for speculators to start manipulating the markets.
Hedge funds knowing the banks are unstable and carrying large amount of sovereign debt from the PIIGS European countries started shorting both the soverign bonds and bank stocks. As the bonds fell, the balance sheet of european banks deteriorated and they moved one step close to insolvency.....and a banking crisis is created from the sovereign debt crisis. Day after day European banks shares were sold off along with the bonds of PIGS countries cause a financial panic that spread around the world. The speculators were able to transform the sovereign debt crisis into a wider banking crisis and panic ensued causing US bank stocks to plunge - Buffett took the chance to buy some preferred stock in Bank of America in a really sweet deal. The market chaos started to affect business and consumer sentiment and caused an economic slowdown in Aug 2011.
The problems with the European countries are widely known since early last year. The huge debt will no doubt weigh on the European economy for years to come. The best way for them to manage it so they have some form of graceful degradation and give themselves a good chance to recover later on. They have to be mindful that there are "vultures and vandals" waiting to profit from EU's misery and spread this crisis to the rest of the world.
Like many, I thought that a double dip recession is a foregone conclusion - heck, even ex-MM Lee is talking about it. Relooking at the data, I think the outlook is not so certainly bleak. To be clear we are not in good shape ....but then the global economy has been in pretty bad shape since 2009 even as it starts to recover. The thing to note is the US never fully recovered and if you look at past recessions, they are often caused by the need to correct excesses of the good times. In 2000 we had the dot-com bubble that burst and that caused the recession. In 2008, it was the US housing bubble...remember everything was full steam ahead and extremely rosy in 2007. The 1998 recession was ushered in by a period of 'prosperity' that saw overinvestment and excessive borrowing in Asia. Today, we have 2 years of struggling growth in the US and Europe whose chonic debt problems has been economically painful for more than a year - many thought Europe was about to collapse a year ago in Aug 2010 ...we also had market turmoil then and there was talk of a double dip recession at that time. The global economy tends to leap into recession when things that were going very well then something goes wrong and everyone is caught off-guard ...a good example is the good times in 2000 of the dot-com bubble and 2007.
Rather than a leap into recession - leap from where? the global economy didn't climb up that much in the first place, we are going to see something more like a long drawn sluggish slow growth. We may still slip into recession but in a less dramatic way than in 2008....the American consumers and investors have been behaving as they are already in recession keeping cash and cutting down on their debts. What can get us into some trouble is mis-steps in Europe just like the ones we saw in Jul 2011 when they let their guard down. There are several factors that will help us trudge along - one is the policy "de-synchronisation" between the US and the BRICs countries. While the US has been cutting rates to record lows (now zero), China and India have been tightening and interest rates there are at multi-year highs. If global growth slows and inflation threat abates, China & India can get out of tightening stance and help move the global economy along. What will spur economic growth and create jobs in the US is the recovery of the US housing market which is still no where in sight. The other wild card is whether some equivalent of the computer/IT revolution emerges - it was suppose to be renewable energy an area that Obama stake some of his reputation by actively supporting but that turned out to be a false dawn. Other measures to such as the Fed's Operation Twist [Link] will support financial markets just like QE1 & QE2 and buy some time to allow the economy to recover but sustainable recovery will come only when the US housing market recovers.
In Singapore, the govt is still importing foreign labor to grow the economy by increasing head count. The painful rise in cost of living is no different from the pain caused by a recession - in a recession you fear the loss of your job but in reality most people get to keep their jobs during recession but see a pay cut or less bonus - during the 'good times', you get more bonus but the rise in housing cost or cars simply outstrips the extra you're getting. An economic boom these days means little to the ordinary Singaporean who usually just see painful rise in the cost of living relative to his wages. The govt keeps saying that GDP growth will generate more opportunities for Singaporeans but we have been there and done that in 2000 and 2007. There is a limit to how much Singaporeans can benefit from GDP growth given we have the most unequal distribution of wealth among developed countries. What we need is not more GDP growth, GDP growth at all cost or more focus on GDP growth. What will improve the lives of Singaporeans are reforms to our healthcare, transport, housing and medical care ...and we don't need to keep GDP growing at its fastest to do that. Does it matter if our economy is growing at 2% or 5% when people are still worried about whether they can afford hospital care when they are sick. Providing affordable universal healthcare and making our public transport more comfortable will improve the quality of our lives than 6% annual GDP growth which is meaningless to ordinary Singaporeans when you import 100,000 foreigners and pander to the demands of businesses to hit that target.