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The coming financial pandemic
National Post (Canada) ^ | March 4, 2008 | Nouriel Roubini

Posted on 03/04/2008 7:54:09 AM PST by Gritty

Can the U.S. financial crisis be contained within America's borders? Nouriel Roubini says no--and explains how the contagion will spread...

For months, economists have debated whether the United States is headed toward a recession. Today, there is no doubt. The severe liquidity and credit crunch from the subprime mortgage bust is now spreading to broader credit markets, $100 barrels of oil are squeezing consumers and unemployment continues to climb. And with the housing market melting down, empty-pocketed Americans can no longer use their homes as ATMs to fund their shopping sprees. It's time to face the truth: The U.S. economy is no longer merely battling a touch of the flu; it's now in the early stages of a painful and persistent bout of pneumonia.

Canada and other countries are watching anxiously, hoping they don't get sick, too. In recent years, the global economy has been unbalanced, with Americans spending more than they earn and the country running massive external deficits. When the subprime mortgage crisis first hit headlines last year, observers hoped that the rest of the world had enough growth momentum and domestic demand to gird itself from the U.S. slowdown. But making up for slowing U.S. demand will be difficult, if not impossible. American consumers spend about $9-trillion a year. Compare that to Chinese consumers, who spend roughly $1-trillion a year, or Indian consumers, who spend only about $600-billion. Even in wealthy European and Japanese households, low income growth and insecurities about the global economy have caused consumers to save rather than spend. Meanwhile, countries such as China rely on exports to sustain their high economic growth. So there's little reason to believe that global buyers will pick up the slack of today's faltering American consumer, whose spending has already begun to drop.

Because the United States is such a huge part of the global economy -- it accounts for about 25% of the world's GDP, and an even larger percentage of international financial transactions -- there's real reason to worry that an American financial virus could mark the beginning of a global economic contagion. It may not devolve into a worldwide recession, but at the very least, other nations should expect sharp economic downturns, too. Here's how it will happen:

TRADE WILL DROP

If output and demand in the United States fall -- something that by definition would happen in a recession -- the resulting decline in private consumption, capital spending by companies and production would lead to a drop in imports of consumer goods, capital goods, commodities and other raw materials from abroad. U.S. imports are other countries' exports, as well as an important part of their overall demand. So such a scenario would spell a drop in their economic growth rates, too. Several significant economies -- including Canada, China, Japan, Mexico, South Korea and much of Southeast Asia -- are heavily dependent on exports to the United States. China, in particular, is at risk because so much of its double-digit annual growth has relied on the uptick of exports to the United States. Americans are the world's biggest consumers, and China is one of the world's largest exporters. But with Americans reluctant to buy, where would Chinese goods go?

China is also a good example of how indirect trade links would suffer in an American recession. It once was the case that Asian manufacturing hubs such as South Korea and Taiwan produced finished goods, like consumer electronics, that were exported directly to American retailers. But with the rise of Chinese competitiveness in manufacturing, the pattern of trade in Asia has changed: Asian countries increasingly produce components, such as computer chips, for export to China. China then takes these component parts and assembles them into finished goods -- say, a personal computer -- and exports them to American consumers. Therefore, if U.S. imports fall, then Chinese exports to the United States would fall. If Chinese exports fall, then Chinese demand for component parts from the rest of Asia would fall, spreading the economic headache further.

HOUSING BUBBLES WILL BURST WORLDWIDE

The United States also isn't the only country that has experienced a housing bust: Britain, Ireland and Spain lag only slightly behind the United States as the value of their flats and villas trends downward. Countries with smaller but still substantial real estate bubbles include France, Greece, Hungary, Italy, Portugal, Turkey and the Baltic nations. Countries including Australia, China, New Zealand and Singapore have also experienced modest housing bubbles. There's even been a housing boom in parts of India. Inevitably, such bubbles will burst, as a credit crunch and higher interest rates poke holes in them, leading to a domestic economic slowdown for some and outright recession for others.

COMMODITY PRICES WILL FALL

One need only look at the skyrocketing price of oil to see that worldwide demand for commodities has surged in recent years. But those high prices won't last for long. That's because a slowdown of the U.S. and Chinese economies -- the two locomotives of global growth -- will cause a sharp drop in the demand for commodities such as oil, energy, food and minerals. The ensuing fall in the prices of those commodities will hurt the exports and growth rate of commodity exporters in Asia, Latin America and Africa. Take Chile, for example, the world's biggest producer of copper, which is widely used for computer chips and electrical wiring. As demand from the United States and China falls, the price of copper, and therefore Chile's exports of it, will also start to slide.

FINANCIAL CONFIDENCE WILL FALTER

The fallout from the U.S. subprime meltdown has already festered into a broader and more severe liquidity and credit crunch on Wall Street. That, in turn, has spilled over to financial markets in other parts of the world. This financial contagion is impossible to contain. A huge portion of the risky, radioactive U.S. securities that have now collapsed -- such as the now disgraced residential mortgage-backed securities and collateralized debt obligations -- were sold to foreign investors. That's why financial losses from defaulting mortgages in American cities such as Cleveland, Las Vegas and Phoenix are now showing up in Australia and Europe, even in small villages in Norway.

Consumer confidence outside the United States -- especially in Europe and Japan -- was never strong; it can only become weaker as an onslaught of lousy economic news in the United States dampens the spirits of consumers worldwide. And as losses on their U.S. operations hit their books, large multinational firms may decide to cut back new spending on factories and machines, not just in the United States but everywhere. European corporations will be hit especially hard, as they depend on bank lending more than American firms do. The emerging global credit crunch will limit their ability to produce, hire and invest.

MONEY FOR NOTHING

Optimists may believe that central banks can save the world from the painful side effects of an American recession. They may point to the world's recovery from the 2001 recession as a reason for hope. Back then, the U.S. Federal Reserve slashed interest rates from 6.5% to 1%, the European Central Bank dropped its rate from 4% to 2% and the Bank of Japan cut its rate down to zero. But today, the ability of central banks to use monetary tools to stimulate their economies and dampen the effect of a global slowdown is far more limited than in the past. Central banks don't have as free a hand; they are constrained by higher levels of inflation. The Fed is cutting interest rates once again, but it must worry how the disorderly fall of the dollar could cause foreign investors to pull back on their financing of massive U.S. debts. A weaker dollar is a zero-sum game in the global economy; it may benefit the United States, but it hurts the competitiveness and growth of America's trading partners.

Monetary policy will also be less effective this time around because there is an oversupply of housing, automobiles and other consumer goods. Demand for these goods is less sensitive to changes in interest rates, because it takes years to work out such gluts. A simple tax rebate can hardly be expected to change this fact, especially when credit card debt is mounting and mortgages and auto loans are coming due.

The United States is facing a financial crisis that goes far beyond the subprime problem into areas of economic life that the Fed simply can't reach. The problems the U.S. economy faces are no longer just about not having enough cash on hand; they're about insolvency, and monetary policy is ill equipped to deal with such problems. Millions of households are on the verge of defaulting on their mortgages. Not only have more than 100 subprime lenders gone bankrupt, there are riding delinquencies on more run-of-the-mill mortgages, too. Financial distress has even spread to the kinds of loans that finance excessively risky leveraged buyouts and commercial real estate.

There is also much less room today for fiscal policy stimulus, because the United States, Europe and Japan all have structural deficits. During the last recession, the United States underwent a nearly 6% change in fiscal policy, from a very large surplus of about 2.5% of GDP in 2000 to a large deficit of about 3.2% of GDP in 2004. But this time, the United States is already running a large structural deficit, and the room for fiscal stimulus is only 1% of GDP, as recently agreed upon in George W. Bush's stimulus package. The situation is similar for Europe and Japan.

President Bush's fiscal stimulus package is too small to make a major difference today, and what the Fed is doing now is too little too late. It will take years to resolve the problems that led to this crisis. Poor regulation of mortgages, a lack of transparency about complex financial products, misguided incentive schemes in the compensation of bankers, wrongheaded credit ratings, poor risk management by financial institutions -- the list goes on and on.

Ultimately, in today's flat world, interdependence boosts growth across countries in good times. Unfortunately, these trade and financial links also mean that an economic slowdown in one place can drag down everyone else. Not every country will follow the United States into an outright recession, but no one can claim to be immune.

- Nouriel Roubini is chairman of RGE Monitor and professor of economics at New York University's Stern School of Business.


TOPICS: Business/Economy; Editorial; News/Current Events
KEYWORDS: economy
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To: TLI

Body need Foods water and Shelter. Oh and guns and plenty of ammo to protect them.

Might be hard to trade that gold for a sack of potatoes.

Were not there yet but it does not hurt to be prepared.


21 posted on 03/04/2008 8:42:44 AM PST by Bailee
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To: Gritty
>>
Can the U.S. financial crisis be contained within America’s borders? Nouriel Roubini says no—and explains how the contagion will spread...
<<

It is not so much “contained” or “contagion”, for the root issue is that every single central bank in the world issues money that is “borrowed into circulation”, that is fiat money that in the final analysis is simple government counterfeiting of private wealth.

This is exacerbated by fractional reserve banking that also creates money out of thin air in a different way, but one that has a many-fold leverage factor based on bank capital. When capital expands, lending can expand by a factor of 20x or even 30x. When capital contracts, which it did by a large factor when CDOs of sub-prime mortgages were written off in large measure, then lending must contract by a factor of 20x or even 30x.

Long ago, economist Ludwig von Mises understood that this is the cause of our "normal" boom-bust business cycle.

22 posted on 03/04/2008 8:44:29 AM PST by theBuckwheat
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To: Gritty
>>
President Bush’s fiscal stimulus package is too small to make a major difference today...
<<

All the proposed “stimulus” packages are all the same: borrow money and give it away. It would be far more productive and take a lot less time to accomplish if Bush would just insist that everyone go out and get a $1000 cash advance on their Visa Card.

When someone doesn’t understand the very nature of wealth and money, they are foolish to believe that such self-stimulus can be satisfying. Government is the largest single drag on the economy. It is amazing that we can prosper with more than a third of our income being dissipated in such foolish ways.

The best way for government to “stimulate” the economy is to cut spending and cut taxes by a $150 Billion. If $150 Billion is good $900 Billion would be better. Indeed, why stop there?

23 posted on 03/04/2008 8:52:17 AM PST by theBuckwheat
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To: Sherman Logan

I made a hunk of change from mid-70s to 80 investing in gold. For a time, this market makes me happy b’cause I’m doing the same thing now. I’ll be watching carefully for the exit, however, just as in ‘80.


24 posted on 03/04/2008 8:55:37 AM PST by cinives (On some planets what I do is considered normal.)
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To: Gritty

Slippery Slope there.


25 posted on 03/04/2008 8:56:53 AM PST by RightWhale (Clam down! avoid ataque de nervosa)
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To: Bailee
[Body need Foods water and Shelter. Oh and guns and plenty of ammo to protect them.]
 
The Church forms an extended family which lessens the need to defend the basics from covetous neighbors - and it provides structural organization for communities of neighbors to mount an organized defense against covetous outsiders.
 
This Strength is one of the reasons Marx sought to "Eliminate the Opiate".

26 posted on 03/04/2008 8:58:33 AM PST by Etoo (I regret that I have but one screen name to sacrifice for my country.)
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To: Gritty

Looks like my Y2K survival bunker will come in handy after all. The end is nigh!


27 posted on 03/04/2008 9:06:29 AM PST by stinkerpot65 (Global warming is a Marxist lie.)
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To: Petronski

This guy is a bear of epic proportions. He wrote the article posted on FR a couple weeks ago basically predicting a total meltdown in the financial system.

Unfortunately it seems the bears are consistently being proved correct of late.

As a wise person told me, though, its never as good as it seems during good times, and its never as bad as it seems during bad times. We’ll find out in the next 12 months how true that is.


28 posted on 03/04/2008 9:21:09 AM PST by VegasCowboy ("...he wore his gun outside his pants, for all the honest world to feel.")
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To: VegasCowboy
I don't know what to do with my 401k or my roths but I do know to start putting stuff away while I can....I never go into town unless I stop at a store and buy something that is on sale that can be stored for some time...the basics mostly....tomato sauce, salt, pepper, canned goods, paper goods, laudry soap.....

buy it when it is on sale only...that's the only way to get around inflation....

I also recommend having a few gallons of gasoline around...just in case you need some but it would be out of you way to go into town at that time....this applies moslty to people that live outside of town.

29 posted on 03/04/2008 9:46:49 AM PST by cherry
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To: alexander_busek
>>Can the U.S. financial crisis be contained within America’s borders?<< Well, for starters, we could build a BIG WALL.

That's the ticket! We aren't building a wall to keep out illegals, were building it to contain the recession!
30 posted on 03/04/2008 10:08:30 AM PST by jimmango
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To: TLI
I strongly suggest that folks invenst in hardware commodities.

I am reminded of the parable of the ant and the grasshopper. The one enjoys the summer, yet carefully provides for the winter (the ant). The grasshopper frolics and does not prepare. Not the best analogy but..... It does not hurt to be ready for any crunch. My experience of the average person is that only when things happen that are bad, do they wish different.

My own suggestion that will not be taken- of course (chuckles) is that people try to minimize any unnecessary debt. Sure a mortgage is a tough one and indeed an automobile, both mostly necessary.

Watch that credit card debt says I.

31 posted on 03/04/2008 10:26:17 AM PST by Peter Libra
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To: Peter Libra
Whoops! quoting you accurately

I strongly suggest that folks invest in hardware commodities.

32 posted on 03/04/2008 10:29:14 AM PST by Peter Libra
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To: Bailee
Might be hard to trade that gold for a sack of potatoes.

Yep. Much easer to swap a 20 round box of 308 or 223 for a bushel of tators and kid goat.

33 posted on 03/04/2008 11:06:16 AM PST by TLI ( ITINERIS IMPENDEO VALHALLA)
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To: Gritty
So we all suffer because the banks loaned money for over inflated homes to people who can't afford their mortgages?

Let's not forget Bank of America and Citibank loaning money to illegals who don't even have a social security number.

So we all pay for the Nation's big banks stupidity and greed. What's worse, is that those of us who have invested in these failing banks and hold stocks or 401 k's, end up being the victims who will end up losing our hard earned money.

sw

34 posted on 03/04/2008 12:04:46 PM PST by spectre (spectre's wife)
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To: spectre

Sadly, it appears so.


35 posted on 03/04/2008 12:46:25 PM PST by Gritty (Rule by the people is threatened if they're unable to gain a plausible grip on reality-Tony Blankley)
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To: cinives

Me too. This go-round I bought a bunch of it at $280/oz about 4 years ago. I wish I had bought a lot more.

My dad keeps trying to get me to sell some and “take some money off the table”. I told him last night “yeah, you told me that at $700/oz too”.

It has so far to fall before it wipes me out that I can afford to wait for a firm exit sign.

LQ


36 posted on 03/04/2008 12:57:40 PM PST by LizardQueen (The world is not out to get you, except in the sense that the world is out to get everyone.)
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To: LizardQueen

I bought higher, at around $483, so for my purposes when it gets down to 920 or so then I’ll probably exit.


37 posted on 03/04/2008 1:07:52 PM PST by cinives (On some planets what I do is considered normal.)
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To: TLI
> ammo

Ammo isn't hardware -- it's a consumable!

38 posted on 03/04/2008 3:27:20 PM PST by NewJerseyJoe (Rat mantra: "Facts are meaningless! You can use facts to prove anything that's even remotely true!")
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