Thursday, August 21, 2008

Nobel Winners Expect Crisis to Further Weaken Growth

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By Simon Kennedy, Bloomberg

Nobel Prize-winning economists including Myron Scholes and Joseph Stiglitz predicted the credit squeeze will inflict more pain on global growth and Goldman Sachs Group Inc. projected half of the world economy faces recession.

``There will be a global recession,'' Scholes said in an interview today at a conference in Lindau, Germany, featuring 14 Nobel laureates in economics. Stiglitz forecast the world economy would continue to perform below its potential for some time, resulting in a ``social loss'' through weaker employment.

A year since the U.S. housing slump sparked about $500 billion in credit-market losses for banks globally, the world's largest economies are all stumbling as rising borrowing costs combine with record commodity prices to sap growth.

The U.S., Japan, the 15-nation euro area and the U.K. are ``either in recession or face significant recession risks in the months ahead,'' Goldman's London-based international economist Binit Patel said in a report to clients today, noting such nations account for half of the world economy.

The ``worst is yet to come,'' said Hong Kong billionaire Li Ka-shing in Hong Kong today. The credit squeeze is turning Li ``very conservative about acquisitions,'' he said.

Bank Collapses

Lone Star Funds, the Dallas-based private equity firm, today agreed to buy IKB Deutsche Industriebank AG after the German bank was felled by the subprime mortgage crisis. Bear Stearns Cos., the fifth-largest U.S. securities firm, has already collapsed, while the bonds of regional banks such as National City Corp. and Keycorp are under pressure on expectations of more fallout.

``The financial sector needs to shrink,'' said Kenneth Rogoff, former chief economist at the International Monetary Fund, in an interview in Singapore yesterday. ``I don't think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job.''

Rogoff also said ```the worst is yet to come in the U.S.''

The U.S. index of leading economic indicators declined in July, suggesting the slowdown will deepen in the second half of the year, and Europe's manufacturing and service industries contracted for a third month in August, data released today showed.

U.S. Outlook

The outlook for the U.S. economy will prove a hot topic when central bankers and economists gather tomorrow for the annual Federal Reserve conference in Jackson Hole, Wyoming. ``The economy has really shown one sign after another of weakening,'' Harvard University Professor Martin Feldstein said in an interview in Jackson Hole today.

Citigroup Inc. economist Steven Wieting said in a report today that every U.S. downturn of the last six decades has been linked with a global slump. Economists at UBS AG led by Larry Hatheway this week cut their forecast for global growth next year to 2.9 percent from 3.1 percent, close to the 2.5 percent deemed a world recession.

Patel at Goldman Sachs sees the chances of a global recession at no more than 20 percent given his expectation that China's economy will continue to grow about 10 percent this year and next.

``Continued robust, albeit slowing, growth in China and the rest of the emerging markets'' will deliver world growth of 3.6 percent next year after 3.9 percent in 2008, said Patel.

Growth Forecast

Global growth next year will be the slowest since 2003, with no rebound until 2010, according to a forecast released today by Global Insight Inc. in Lexington, Massachusetts. The research firm expects the world economy to expand 2.8 percent next year, and may revise that number lower. The world economy expanded 2.7 percent in 2003, according to Global Insight data, which uses market prices to compute gross domestic product.

``The housing market downturn in the U.S. and in parts of Europe, the lingering effects of high oil and commodity prices, the credit crunch and the global stock market correction will slow the world economy to a pace not seen since 2003,'' said Sara Johnson, Global Insight's managing director of global macroeconomics.

The situation has deteriorated over the past year and requires immediate action on the part of policy makers, said Paul McCulley, a fund manager at Pacific Investment Management Co.

``I think we are probably in a worse situation from the standpoint of the real economy and the financial system,'' McCulley told Bloomberg Television in an interview from Jackson Hole. ``We've got serious stuff here that requires serious policy.''

Blaming the Fed

Stiglitz, a professor at Columbia University, blamed U.S. and international regulators such as former Federal Reserve Chairman Alan Greenspan for failing to restrain an explosion in financial innovation and lending that led borrowers to rack up debt they couldn't repay.

``It was a massive failure of the brains of the economy,'' said Stiglitz. ``There was a party going on and the regulator with the same mindset of those in the party didn't want to be a party pooper.''

Nobel laureate Daniel McFadden, who teaches at the University of California, said in Landau that a financial equivalent of the U.S. Food and Drug Administration should be established to monitor and certify new financial instruments. Scholes warned against a ``rush to regulation,'' arguing ``the cost of regulation may be far greater than its benefits.''

To contact the reporters on this story: Simon Kennedy in Lindau, Germany, at

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