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World at risk of 'double dip recession'

Adrian Blundell-Wignall is the deputy director of financial and enterprise affairs at the Organisation for Economic Cooperation and Development (OECD).

In an interview with ABC Radio's PM two years ago, Dr Blundell-Wignall warned there was a giant rolling bubble of excess liquidity moving from market to market, inflating asset prices.

He warned unless the problems causing it were addressed, it would eventually burst with devastating consequences. And it did.

Now Dr Blundell-Wignall - who stresses these are his personal views and do not necessarily reflect those of the OECD member states - says the lessons of history are clear.

First, guarantee bank deposits and funding. Second, remove the toxic assets from the banks. Three, recapitalise the banks. But he says the world has ignored step two.

"Did we remove the toxic assets from the balance sheet of the banking system, anywhere? No, nowhere," he told ABC Radio's PM program tonight.

Instead, he says, governments and regulators have conspired in the use of a magicians' sleight of hand to hide the toxic mess.
Changing the rules

He says for example, the United States changed the accounting rules so banks no longer had to state the current market value of the toxic assets and no longer had to declare losses.

"If you can change the accounting rules and say, 'hang on, we don't have to declare any losses on this $700 billion, $800 billion, we can now declare that they're all book value'," Dr Blundell-Wignall said.

"So, it's really there and all those losses are going to be there but we don't have to declare it, and we won't have to raise any capital for it; it'll kind of be there just hidden behind the silk screen."

Dr Blundell-Wignall says the toll of bad loans is going to get worse, because claims of a US housing recovery are a false dawn.

"Every time the unemployment rate goes up when someone losses their job, they can't pay; obviously you can't; that's one of the biggest determinates of people having to default on their loans, and house prices being the other one," he said.

"It seems to me like there's still downward pressure there and we know the unemployment rate's going to lag the US by 12 to 18 months, so we know it's going to keep going up.

"So, bad loans are going to continue to happen; that's the credit crunch aspect."
Bailouts 'unsustainable'

He says Europe's banks are worse, with double the leverage of America's.

Dr Blundell-Wignall also says the efforts to rescue the world through massive fiscal stimulus and bank bailouts are unsustainable.

"When you add up the capital injections, the loans, the guarantees, the Federal Reserve actions and guarantees and so on, what you see there is the US has taken from the private balance sheet and put onto the public balance sheet, not 11 per cent of GDP, 80 per cent of GDP is what that all adds up to," he said.

Dr Blundell-Wignall says to top it off, there is a huge asset price bubble building in China and some other parts of Asia in the stock market and in property prices.

"So another one of the balls that has to be kept in the air is can China allow the bubble to keep bubbling? What we're talking about here is a race," he said.

"We've got to keep all those balls juggling in the air while the banks get rid of their underlying bad debt problems, whether they admit to them or not with the change in accounting rules."

He says there is a clear risk of a double dip recession and another credit crunch, but it is possible the world will muddle through, though not to healthy growth.

"If you can do all those things and the juggler on the stage does not drop one of the those balls, then you can see how you would muddle through," he said.
** the entire report has almost been transcribed here as I found it to be quite profound on my "feel", especially after reading the book on "Currency War" where the author was espousing various conspiracy theories ranging from the outcome of Napoleanic war to the not so distant past incidents like the approval of oil embargo in exchange for the US$ being used as the only oil currency thereby ensuring the US$hegemony, etc...

The current practice of the US govt's steadfast rescue of a few of their major banks at all cost calling them too big to fail, and by shifting bulk of the private debt to the public, and with the approach of QE, forcing the burden of shouldering the American debt to the rest of the world, in particular, to the US$ creditors, and now with this view of a Chinese property bubble and the ever increasing US debt (2.3 trn) and the incessant inflow of hot money - it's all reminiscent of how the Asian financial meltdown was created resulting their economies crushed - if you believe what the author is espousing...

All these conjectures are into the relatively far away future, but meantime and in shorter term, my gut feel all these while has been this global market rally is all about a "giant excessive liquidity created as a result of QE, roaming this earth searching for a market ripe for a speculative profit within a short time before moving on to another, gathering momentum and mass before it is halted by an invisible hand, resulting in great profit for some but disastrous result for many!"

Whoa! Look like it's time to hide?

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  1. haunting's Avatar
    Conflict as IMF reckons on slow recovery

    The IMF revealed its assessment had been disputed for being ''pessimistic'' and failing to recognise the economy would be boosted by demand for commodities and population growth.

    Federal Treasury believes the Australian economy is on track to grow by 2.25 per cent in 2010-11 and by 4.5 per cent in 2011-12. Despite recent strong economic news, Mr Swan remains cautious about declaring the economy out of danger.

    The Reserve Bank last week upgraded its growth forecasts, abandoning earlier recession warnings and foreshadowing a series of interest rate rises to keep the recovery in check.

    But the report said the IMF's view was that ''the recovery will be slow'', predicting the economy would shrink by 0.5 per cent this year before limping forward by 1.5 per cent in 2010.

    The IMF was also at odds with Treasury on the outlook for Government debt.

    It said net Commonwealth debt was still expected to peak at 15 per cent of GDP in 2013, before falling to 10 per cent by 2019.

    Treasury has predicted net debt of less than 4 per cent of GDP by 2019.

    The IMF also predicted the budget would be in deficit for nine years, instead of the seven-year run expected by Treasury.

    A spokesman for Mr Swan said the IMF had based its forecasts on ''technical assumptions'' and had failed to fully take into account Australia's position as a commodity exporter in the Asian region.
    ** I am with the IMF this time although I have always been critical of their assessment in the past. The assumption made by Swan that Australia is a commodity exporter in the Asian region although is valid, but I believe he has failed to consider the impending slow down of commodity imports from China, partly as a result of overstocking, partly as a result of the Chinese plan on credit constriction to curb asset bubble...

    It is not hard to gauge who is right given time, probably by the end of this calendar year the numbers from ABARE and RBA will be able to shine some light into the impact of the Chinese move.

    In the commodity export front, both BHP and RIO will be able to show us if they have fallen victim to China's retaliation, although at this point, the news from China seems to indicate that CISA is running out of option but to accept the 33% discount. With IO price out of the equation, the remaining factor would be the sales volume and possibly the sales of coking coal and energy coal to China... with all these variables yet to be determined, I am not quite sure if Swan's assumption above would hold water.

    Looking at the bright side is his prerogative as the treasurer and as a politician, but, sometimes that has nothing to do with reality, esp with all the recent unhappy exchanges with China - there is a cost and price for everything, if he still doesn't know this by now.
  2. MRC & Co's Avatar
    But if the Chinese are undertaking measures to transfer some of that credit from their 'casino' and into the real economy, could this not boost commodity demand?
  3. haunting's Avatar

    Yes it would and indeed it has, if we were to look at the rise of commodity prices as a result of the stimulus implementation. And this is where it begins to worry many Chinese scholars and economists - they see there is a mis-allocation of resources, with many of these easy credits flowing into property and stock speculation instead of flowing into the real economy, hence they are raising their concerns which prompted the recent Chinese central bank's announcement of more stringent control on lending; causing a big plunge in the stock market btw, it is having an impact on the speculators and the speculative money staying in the market.

    This is just the stock market I am talking about here. The property side may be is reacting in a similar fashion except it is harder to tell since I don't know if there is an equivalent indicator such as the SSE index.

    Just give it 6 months, I think we will find out.
  4. MRC & Co's Avatar
    Yes, but my point is, if these conditions are put on credit in China, we could see more of this credit flow into actual consumption and production through demand for real assets as opposed to financial assets.

    I think this is what the Chinese are trying to do, to re-direct finances away from stocks/property and so stop another bubble of their own and actually boost their real economy instead (which will boost trading partners such as Australia).
  5. haunting's Avatar
    I see your point. But this scenario is constrained by the Chinese system, they don't have a very effective wealth distribution system like those in the more advanced countries such as Australia. To improve that it would need them to change a fair bit of policies like tax rate, welfare, etc... not sure if the Chinese leadership is into such major changes. They are quite reserved and conservative when come to changing the social rules.
  6. haunting's Avatar
    LaRouche's Four-Power Proposal...

    the primary thrust of LaRouche's comments dealt with the global financial crisis and LaRouche's unique solution to resolving it. "LaRouche emphasized that the world financial crisis has already arrived at a breaking point," Ju writes, "and that any efforts to try to save the old system would be fruitless. 'The only feasible solution is to conduct bankruptcy reorganization, and return to a national credit system,' LaRouche says, pointing to U.S. bankruptcy laws, which are tailored to put bankrupt firms back on a stable footing, and assist them in overcoming their difficulties. 'What is now needed is to utilize bankruptcy proceedings that would permit a country as quickly as overcome the troubles created by the financial crisis.' "
  7. haunting's Avatar
    Adrian Blundell-Wignall's caution of a potential of double dip recession has caused quite a change in my big picture view and since then I have been turning more cautious and critical with most "happy and optimistic" news and have been discounting most of the "good news" reported in the local media esp on good company outlook etc...

    In as far as these reported good outlooks are concerned, my view is most of the stocks have either been fully "priced" in accordingly, or they are not far off, with some probably gone beyond fairly priced. In fact, if you were to pay more attention, some of the lesser, more speculative stocks are almost at their old peak (previous bull peak), or not far from it. This observation is telling me this (could be wrong as usual) - there is a very high component of speculative money swimming underneath all these runaway rallies.

    ... gotta say I find it hard to accept the market's current behaviour - rallying like an established bull. In 2007, after three years of continuous growth, yes; but not presently where most economies are still in stasis and laden with bad debts and the financial system loaded with grossly inflated assets.

    This can't be right! You can hide your debt but you can never make it disappear - not when the Chinese and others are holding stacks of IOU from the Yanks. These debts will behave like iron ball chained to the ankle of the American economy making sure it can't race like before.

    If the Japanese economy has set a precedence for all these, then, it is telling everyone, the US and the EU economies have still yet done what is required of them - the need to remove all the bad assets from the banking system and restore the banks back to their full health, or they face years of deflationary threat due to a weaken banking system, compounded by a drastic reduction in consumption, which constitutes close to 70% of the US economy...

    Back to the market, if you find it hard to accept any pessimistic argument at this point, well, I don't blame you because the market exuberance can easily sweep anyone up with all these daily rallies with stocks reaching new high almost every other day... well here's something to dampen your enthusiasm.

    Check this out - by Nick Radge, who took a historical journey back to the future of the market and he says "read my lips - be careful".
  8. haunting's Avatar
    A normal economy calls for normal interest rates

    ** thought the title of this piece supports my argument very well!
  9. haunting's Avatar
  10. haunting's Avatar
  11. haunting's Avatar
    Another US shock lurking in commercial property

    ** worth a read. Locally, this issue has been raised a while back. Watch the banks that are exposed.

    Also check out this report for some background info...
  12. haunting's Avatar
  13. haunting's Avatar
    America’s Japanese banks

    “We know lots of mortgage loans are underwater,” he says, describing the situation where the value of collateral has fallen below the principal balance of a loan. “A majority of the loans banks are holding were originated at the height of the bubble, when securitization broke down.”

    When securitization markets were fully functional, banks had been able to package and sell their loans to investors. When those markets buckled, banks were forced to eat their own cooking — much of it rancid.

    Banks argue that loans should not be marked down if they’re still “performing.” As long as borrowers are meeting their contractual obligations, there’s no reason to take a writedown. The problem is, this gives banks an excuse to extend, amend and pretend. They can make concessions on loan terms or delay foreclosure notices, if only to maintain the fiction that borrowers will make good.

    With real estate prices likely to fall, and stay, 40 percent below the peak, borrowers have a big incentive to renege on their side of the bargain. This is how we become Japan. Emergency bailout facilities allow banks that otherwise would have failed under the weight of bad loans to hold those loans to maturity — pretending the bad ones will be paid off in full over time.

    In reality, many loans will default and banks will bleed capital for years. Take commercial real estate. As the Congressional Oversight Panel has reported, few CRE loans that were originated at the peak will qualify for refinancing when they mature. Banks can pretend they will, carrying the loans at values far above what will ever be paid back...
    As the Japanese can tell you, this is just a recipe for stagnation. Thanks to a debt bubble that authorities refused to deal with decisively, that country is now entering its third consecutive lost decade.
    ** from memory, real Japanese reform in their banking system came about in 2003/04 when newly elected PM, Junichiro Koizumi took action to force a consolidation in the sector, in the process, the "bad banks" were absorbed into the good ones; still the efforts were inadequate in that the Japanese economy has never recovered fully, where consumers are reluctant to spend and deflation and stagflation seem to be perennial problems to the economy.

    Check these out if you want to find out more:

    The Japanese Lost Decade
    Japanese asset price bubble

    ** if the Japanese "experience" is setting a good precedence for the USA, it seems the Obama's team is following the foot steps of the Japanese experiment to the "tee", and if nothing unusual were to turn out and if there is none of the "think out of the box" remedy and solution are forth coming, it is only natural for simpleton like moi to come to this conclusion...

    The king is dead! Long live the king!

    ...it will be a miracle that the US economy could avoid a Japanese outcome!
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