US recession will dwarf dotcom crash
Edmund Conway – Telegraph.co.uk January 29, 2008
The recession facing the United States is of a scale that dwarfs the dotcom slump.
The slowdown will cause a damaging regulation backlash as governments attempt to compensate for the financial pain facing families. Britain faces a similar plight, though it may avoid as deep a slowdown as the US.
The views of Stephen Roach, one of the world's leading economists, now heading the Asian wing of Morgan Stanley, would have seemed outrageous at last year's World Economic Forum.
It is a sign of the times that they are now close to the consensus. This year's event has been dominated by discussions of the stock market slump on both sides of the Atlantic, the Federal Reserve's emergency interest rate cut and the SocGen fraud disaster.
But underlying everything has been the silent truth that the US is facing a very possible recession, and is fast having to adapt to a far less enjoyable economic climate.
"We have, as relatively sophisticated, well-developed economies, gotten hooked on credit as never before," said Roach, speaking about the UK and US. "If we had been running our economies the old-fashioned way, for example, where saving and consumption were funded by income, maybe we wouldn't be in this mess we are in now.
"Maybe the growth we have been realising has been something of an illusion predicated on levering our assets, and unfortunately we didn't fully understand the risks we were taking on. The US may be in recession right now. The UK is not?. The US has more vulnerablility to a post-bubble shake-out today than it did seven years ago, and [more] than in the UK."
The reason this crunch will be so much worse, he said, is that the chunk of the economy which is shuddering to a halt - homebuilding and housing dependent consumption - is six times bigger than the spending on IT, which triggered the last one.
"The magnitude dwarfs anything we saw seven years ago."
The endgame, he said, is an "average recession" meaning just over a year's worth of economic shrinking - three times the depth of the recession seven years ago.
While Roach's views are now close to those of the majority, they are not shared by everyone. Nigel Doughty, of Doughty Hanson, for instance, suspects many of the Davos crowd have become overly pessimistic this year.
"I think everyone is being too gloomy about 2008," he said. "This year could be a lot better than many expect for both the US and the UK. I suspect 2009 is the year to be more worried about."
Much depends on the reaction of policymakers, who are already considering imposing new regulations on banks, whose use of sophisticated financial products contributed to the crisis.
Roach added: "There will be sand put in the gears of financial market innovation. Some of it will be justified but it will go too far. It's a significant risk."
US investment banks, meanwhile, are already having to turn to sovereign wealth funds (SWFs) from Asia and the Middle East to provide an unprecedented injection of funds to keep them afloat. Roach sees it as part of a wider question. "We are dealing with an incipient recession. Who's going to fund us? We don't have the wherewithal to fund it."
With SWFs in the spotlight, debate has raged this week over whether they ought to be more transparent, and to issue a voluntary code of conduct about their investment plans, but Roach said: "Why are we singling out sovereign wealth funds? Why shouldn't we ask the same of hedge funds, private equity or any other group of investors?
"Is it because these funds are coming from the Middle East, from China - areas that make us uncomfortable. Is this not thinly-veiled financial protectionism?"
Perhaps a silver lining - at least for the British Government - is these issues have distracted attention from Northern Rock, though Roach hasn't forgotten.
"I think it raised some unfortunate questions about the credibility of the Bank of England. Policymakers don't like to make mistakes - to go one way one day and change course the next. Mervyn King made a mistake. He will have to live with this."
Last updated 02/02/2008