In these two reports, the IMF draws a disturbing picture of the risks weighing over the global economy. It analyses and comments at length the following trends: US real-estate bubble collapse, US economy recession, US Federal Reserve’s dilemma regarding interest rates developments, long-term fall of the dollar, long-term rise of oil prices. These are precisely the economic and financial indicators used by LEAP/E2020 to develop its forecast of a crisis.
Collapse of US real-estate bubble
LEAP/E2020 – 15/03/2006
« The housing bubble really starts to burst… Some of the predictions made by LEAP/E2020 have already become true, including the bursting of the housing bubble in the US (new home sales were down 5% in January 2006 compared to January 2005, the first time in 5 years this has happened; and the inventory of homes available for sale represents a 6-month supply since 1998). The end of the housing bubble will progressively impact US household consumption, which is highly dependent on growing mortgage-mortgage based household debt. In parallel, the slowdown in the housing sector will directly affect employment, since this sector alone has accounted for 40% of private jobs created over the past five years in the United States.» (GlobalEurope Anticipation Bulletin N°3, 15/03/2006)
IMF, 13/09/2006 :
« IMF services estimate that the possibility of a more abrupt slowdown in the housing market could result in 1 more percentage point withdrawn from GDP growth compared to the baseline scenario. Though house prices’ faltering in other countries such as Australia or the UK, after rises steeper than those recorded in the US, were absorbed until today and caused only minor and short-term economic slowdowns, it is however still to be feared that a more abrupt adjustment of the housing sector could start weighing more heavily on the US economy. » (Translated from Perspectives de l’Economie mondiale, FMI, 13/09/2006)Economic recession in the US
« To raise US interest rates in order to fight against inflation and to preserve the credibility of the Dollar (since it is only the differential in the interest rate with the EU and Japan that now maintains its relative value), but to accelerate the collapse of the growth of the United States economy, by making the real estate bubble (which is already deflating quickly) explode, and by disrupting up household consumption (on which the essence of the US growth has rested for 5 years). Inflation, high interest rates and growth at half-mast, even recession, this is a well-known situation which prevailed during the Seventies: stagflation » (GlobalEurope Anticipation Bulletin N° 6, 15/06/2006)
IMF, 13/09/2006 :
« Households in so-called “arms-length” financial systems are more vulnerable to rising interest rates and declining asset prices. So, for example, during previous housing busts in countries with more arm’s length financial systems, consumption growth typically slowed from an average of 3 percent (year-on-year) at the start of the bust to zero two years later. The slowing of the U.S. housing market is a key risk for the U.S. and global economic outlook. » (Perspectives de l’Economie mondiale, 13/09/2006)
US Federal reserve’s dilemma over interest rates
LEAP /E2020, 15/06/2006 :
« Awareness of the deadlock in US rates policy: towards stagflation or towards hyper-inflation?The financial and stock exchange players are now focusing on a single indicator, the evolution of the interest rates fixed by the central banks, and in particular that of the American Federal Reserve. Indeed, because of the United States’ central role in the world financial system, they play the part of the catalyst of hopes and fears; and their financial authorities will, during this phase II, accelerate the crisis. The US government and Federal Reserve have indeed conducted their economy and the whole of the financial markets towards a total dead end. The return of inflation has led to an increase in interest rates everywhere in the world, and the loss of confidence in the real American economy (with the background, the general loss of confidence in the United States) imposes a dramatic choice between two solutions with painful consequences… »
(GlobalEurope Anticipation Bulletin N°6
IMF, 13/09/2006 :
« The context is particularly demanding for the major central banks which are at the basis of global stability. In the US, the situation is difficult, as inflation grows while the economy slows down, and the US Federal Reserve must continue to follow closely future data while it must communicate clearly on its estimation of the market situation. » (Perspectives de l’Economie mondiale, 13/09/2006)
Steep and long-term fall in the Dollar
LEAP /E2020, 15/02/2006 :
« The most conservative evaluations give €1 to $1,30 US Dollar by the end of 2006. But if the crisis reaches the scope anticipated by LEAP/E2020, estimates of €1 for $1,70 in 2007 are no longer unrealistic
(Alert Global Systemic Crisis
, LEAP/E2020, 15/02/2006)
IMF, 13/09/2006 :
« Concerted efforts of all parties would contribute to an orderly reduction of global imbalances. An orderly adjustment, initiated by the private sector, based on significant rebalancing of demand across countries, associated to a new depreciation of the dollar and appreciation of currencies from the many surplus countries (namely some parts of Asia and oil-producing countries), is still the most probable outcome. Some risks remain though of a disorderly adjustment which global economy would pay a heavy tribute to. » (Translated from Perspectives de l’Economie mondiale, FMI, 13/09/2006)
Long term rise in oil prices
LEAP /E2020, 15/04/2006 :
« According to LEAP/E2020, the real novelty this week is the acknowledgement by a growing number of economic and financial players of two facts that they used (or pretended) to ignore until now:
1. that the oil barrel will no longer fall below 50$
2. that there is inflation now in Japan, in the United States and in the European Union, making the rise of interests rates unstoppable and US deficits unmanageable (totally out of any control). »
(GlobalEurope Anticipation Bulletin N°4
IMF, 13/09/2006 :
« In the baseline scenario, oil prices should reach $75 a barrel in average in 2007, i.e. a price close to the records reached at the beginning of August. As underlined in previous editions of Outlook, the global economy has been able until today to absorb properly the rapid rise of oil prices, because the latter largely resulted from a vigorous growth in the demand rather than from constraints affecting the offer, and central banks were therefore credible enough to insist on the basic inflation rather than on the global one. The declining energetic intensity of global production compared to the 70s has contributed to reduce the impact of rising oil prices. But unused capacities are very meagre these days, therefore factors likely to affect the offer play a growing part in rising prices, and a significant complication in one big oil-producing country or the escalation of security problems in the Middle-East could entail a new leap in prices, » (Perspectives de l’Economie mondiale, 13/09/2006)
In addition, a number of ideas suggested by LEAP/E2020 seem to have been taken up in the last IMF report on the global financial situation.
Indeed, last February, LEAP/E2020 suggested that the impact of the unfolding crisis would be particularly important for operators holding dollars assets. In its report, the IMF publishes very interesting figures on the distribution of these dollars assets, which confirms LEAP/E2020’s estimations: « It is also the Europeans who own half of the credits priced in Dollars in the world (10,000 billion out of the 20,000 in total). This shows that the strings of a Dollar’s confidence crisis are not so much pulled from Asia. Like in the Iraq crisis where the Europeans thwarted Washington’s attempt to use the UN, it is in Europe too, especially in the case of a military strike on Iran, that a chain-reaction leading to a radical rejection of the US policy by public opinions could be triggered »
(GlobalEurope Anticipation Bulletin N°2
, 15/02/2006) and illustrates the fact that the UK is by far the most exposed country in Europe.
The IMF comments the situation as follows:
“A low-probability but potentially high-cost risk to the global financial system is that a dollar decline could become self-reinforcing and hence disorderly. In other words, foreign investors could conceivably sell their U.S. asset holdings into a dollar decline, leading to further losses and further sales of U.S. assets. The data on foreign holdings of U.S. securities show that foreign investors’ exposures to U.S. assets are large and growing.» (Global Financial Stability Report, 12/09/2006).
Jaime Caruana, IMF's monetary and capital markets department
director, wonders about financial operators still under-estimating the risks and providing analyses based on continuity despite the numerous breakpoint indicators. This situation reflects exactly the Global Systemic Crisis 4-phase process described by LEAP/E2020 in GEAB N°5 (15/05/2006)
, where the June-November phase, so-called ‘acceleration phase’, has all players gradually – and reluctantly - realise that all hypotheses supporting their opinions on the global system are vanishing. Both IMF reports are themselves an important part of the acceleration phase.