The Tel Aviv 25 Index and the S&P 500 have both risen 20% above their lowest points. What is strange is that both markets reached their bottom on different dates. If it turns out that these lows are long term, it is reasonable that the US market may "test the low", in other words again fall in a way that threatens the low already reached but without falling much below it. That is what generally happens, but not always. It is also likely that the Israeli market will fall, although the TASE has already twice successfully tested the low, so it may not necessarily do so again.
Stock markets in emerging markets (measured by the Morgan Stanley Capital International Emerging Markets Index) have already risen 30%. There are a number of reasons for that, including the fact that these markets fell even more than the US and Israel markets. A more important reason is that after interest rates have been lowered hundreds of times around the world, interest rates in the emerging markets are still around 6%. These economies still have the option of a major lowering of interest rates, which is not an option for the US, Israel and Japan.
China's Shanghai Index has already risen 40% for reasons which have already been mentioned and also due to a substantial improvement in the Chinese economy. Therefore, the Chinese market may continue leading global markets upwards.
If it is possible to guess: the US market will test its low when the bank recovery plan that it has announced is not being implemented right away, or if it is clear that the fiscal plan is not being implemented, or if the Obama administration will pass its anti-business program, or if one of the car manufacturers collapses, etc. All these scenarios could happen in the coming days or weeks.
The Israeli Economy
Despite the problems of Israel's financial sector being more severe than most of the world because of the non-banking credit problems, the steps taken to help the sector have been the worst in the western world. They have been indecisive, minimal and not properly focused on their target. The steps have been muddled and there are even worse disadvantages.
The guarantees that the government is offering on bank loans are too little, and worse than that do not meet the real needs of the banks. What is required is a substantial, long term, increase in capital for banks and other financial institutions (such as insurance companies), including raising share capital. This is in order to push lenders to expand credit in the economy and increase credit to the real sector. It looks like this can only be achieved through legislation which will force these institutions to raise capital on the private market or government sources.
The debt recycling funds are even worse. Firstly, the sums are virtually worth nothing compared with the needs and worse than that the funds are based on deceiving the public. In the event that the fund managers cooperate with the institutional "investors", the government will in effect take all the risks while the profits, if there are any, will be divided up between the institutional "investors" and the fund managers. It should be explained here that an investor is the one who takes the risk, and not necessarily the person who put in the money, so that in the debt recycling funds the only investor will be the government with the profits, if there are any, going to others.
The funds are built that way because the institutions have lost heavily on the fall of corporate bond prices and therefore they are unable to take risks and thus cannot be investors. But in building the complex model whose only aim as I see it is to deceive the public, many months have been wasted and so far only one fund has been set up.
Regarding fiscal policy almost nothing has been done, except perhaps the agreement with Shas that will distribute money to the wrong places.
And as far as monetary policy is concerned the situation is even more dreadful, if that is at all possible. In the three months up to the end of February the means of payment grew (amount of money) at an annualized rate of 36% relative to the three months preceding them. This is an astronomical rate of growth. In terms of comparison, despite the massive injection of liquidity by the US Federal Reserve, the rate of growth over this period in the US was 25%. If the US economy recovers this year there is no doubt that inflation will rise, perhaps to 5% or more.
But Israel is not the US. The Israeli economy is small and volatile with a large foreign trade sector. Moreover, inflation expectations are built mainly on the experience of the past where in the US inflation peaked at 15-20% at the start of the 80s. Here inflation reached hundreds of percentage points. Therefore, if inflation will reach 5% there we can expect it here to reach far above that.
What is the reaction of the Bank of Israel to these threats? Several days ago the central bank lowered the interest rate again and announced that it would increase purchases of government bonds. In that way it will accelerate even more the growth in the money base (reserves injected from the bank) and the increase in means of payment. Warning: deflation is no longer the only danger here.
The Global Economy
For the past two months, I have identified positive signs in the American economy. These signs have even increased in recent weeks. They do not indicate that the economy has started to grow, but that the rate of contraction is slowing.
The surge in the US stock markets from the low point was initially a technical correction of an oversold market. Then came the Fed’s announcement that it would buy $1.2 trillion of government notes and mortgage-backed securities (MBS) in order to lower mortgage interest rates. This happened, and the interest rate fell to a new low. Finally came the Department of Treasury’s announcement of its bank rescue plan through the purchase of toxic assets something along the lines of Israel’s debt recycling funds plan but more sophisticated and on a scale appropriate to the problem, up to $1 trillion.
This announcement was very late in coming, but it sent the market upwards. It seems that the fact that economic figures have improved has not yet penetrated investors’ awareness and it may, if it continues, push the market forward.
A Slew of Rescue Plans
The improvement in the American economy, which is now also supported by gains in the stock market through the wealth effect, is the result of a number of factors, each of which alone could have pulled the economy from recession, were this an ordinary recession.
These factors include the Troubled Asset Relief Program (TARP), which has injected vast capital into the banks, as well as into the large troubled insurance company American International Group Inc. (NYSE: AIG) and the carmakers. An additional capital injection into the banks was created by having the Federal Deposit Insurance Corporation (FDIC) extend insurance on the banks' loans. In addition, the Fed injected large sums into the financial system, as did the European Central Bank (ECB) and the Bank of Japan. There is also the Term Asset-Backed Securities Loan Facility (TALF), which aims to generate credit to consumers and small businesses. TALF has only just gotten underway, but it will undoubtedly help.
If all this were not enough, there is also the abovementioned Fed plan to buy bonds. In my opinion, this program is ultimately doomed to fail because of the projected rise in inflation expectations, but temporarily, at least, it has already led to a lowering of mortgage interest rates.
Another important plan is the Public-Private Investment Program (PPIP), announced by the US Department of the Treasury a few days ago. The objective of this program is to buy toxic assets, i.e. mortgage backed securities for which there is virtually no market at this time. A number of agencies are collaborating on this plan: Department of the Treasury, the Federal Reserve Bank, and the FDIC, as well as private investors. The plan’s structure resembles the Israeli debt recycling plan, but with a bit more sophistication and on a completely different scale. Its main drawback is the lack of certainty as to whether and when it will be effective; in other words, when will it start to buy assets. Some analysts believe that this will not happen before late summer. If that is the case, the stock market will be in for a bitter disappointment.
To these programs, one ought to add the fiscal stimulus package, whose big drawback is that most of it will only be effective in the years to come. Finally, the plunge in the price of oil to a quarter of last year’s peak is also a critical factor that will encourage the economy.
The Slew of Risks
Is all this enough to ensure a rapid recovery by the American economy? That is not certain. In my opinion, there are many and varied risks. Among these is the fact that the various stimulus plans, while possibly (relatively) good, suffer from poor timing. For example, the fiscal stimulus plan will only come into effect in the last quarter of this year, with the rest being implemented in the coming years. TALF is only now being implemented and the PPIP will only be applied, maybe, toward the end of the year.
Another problem is that a serious plan is needed to help mortgage holders who cannot meet their payments, and housing construction industry in general. The plan now in the legislative process is too small and too complicated to help anyone.
Conclusions
In conclusion, the American economy cannot continue its recovery without some improvement in the economy in the rest of the world, which is in freefall. This is mainly because an important part of the recovery in the United States is due to a substantial improvement in the American balance of trade and balance of payments caused by the collapse of housing prices, (I will explain the connection at another opportunity). This trend will likely continue, despite the appreciation of the dollar and the recent rise in oil prices. However, the very improvement in American foreign trade means deterioration in the rest of the world, which is why the American economy, even if it recovers, cannot pull up the global economy as it did in the early 2000s.
I have few hopes for the Japanese economy because, as I predicted back in 1995, I expect that it will continue to slide in the middle and long term. It is nevertheless still possible to hope that that it will succeed is checking its current freefall.
Europe has already begun taking extensive fiscal measures and monetary measures (by the ECB), but they are too hesitant, too small, and too late. For these reasons, the road to recovery is still far off.
The situation in China, in contrast, is radically and favorably different. There are clear signs that the Chinese economy has substantially improved, and may have already begun to grow. How has China succeeded where the United States, Europe, Japan, and Israel have failed?
The answer is obvious: Communism.
China has undertaken massive fiscal and monetary measures just like the rest of the world, but has added an additional tiny item: the government ordered the banks to increase loans. China is China, and in contrast to the rest of the world, when the government gives an order the banks obey. It is a pity that because of China’s trade surplus policy, this will not really help the rest of the world, unless China carries out what it has been promising to do for several years now: encourage domestic demand. It is clear, nonetheless, that the Chinese recovery will help Japan and the rest of Asia.
All in all, therefore, there is a reasonable chance that the global economy especially the American economy will stabilize during the coming quarter, and that it will begin to grow later this year. However the risks to this optimistic forecast are great.
As for the stock market, an adage on Wall Street states that the stock market loves to climb the wall of worries, and it is doing so this time round, too.
Mike Astrachan is an Israel-based economist.
Published by Globes [online], Israel business news - www.globes-online.com - on March 31, 2009
© Copyright of Globes Publisher Itonut (1983) Ltd. 2009