Global Economic Recession And Low Carbon : A Complex Mixture

By: Andrew_McKillop

Keynesian Boom and Bust - Like we know, the recent and continuing massive spending spree by nearly all G20 governments and their central banks, described as "fighting recession", is also called Keynesian. One important point is that Keynesian-type deficit spending as a way to fight recession was never applied as Keynes himself recommended and advised, simply because he explained it in such strange ways, and because the idea of deficit spending did not become official policy and mainstream economic thinking in his lifetime. To be sure, arguments can be made that 'the Bretton Woods world', creation of the IMF and IBRD, state economic interventionism and macro management, and sometimes micro management of local economies and sectors inside them, were all 'Keynesian inspired'.

The recent and current big government spending spree is something different. Present ways of using borrowed and printed money is more like the camel, designed by a group of engineers and artists who think they made a horse, which can only surprise by its unsuspected traits and character. So different in fact, the Apprentice Sorcerors now believe their camel called 'Keynesian deficit spending' is outrunning the recession.

Over the past 4 months or so the war of words has raged on whether then end of the recession can be declared. Green shoot anticipation has itself perhaps changed the nature and type of recession we are experiencing, as equity and commodity traders have enthusiastically recycled chunks of the Keynesian largesse they have received, directly or indirectly. In any case and until very recently they have rejected the warnings of doomsters like Marc Faber and Nouriel Roubini, but like warnings of the wolf inside the sheep pen, one day it might really be there, if we wait long enough.

As Faber, Roubini and other pessimists always remark, the basic question remains unresolved. Can the global economy recover from unprecedented public, corporate and private debt, a global credit system that gives a much more solid impression of death than the recession, and the continuing extreme under performance, to put it politely, of the housebuilding, airplane, shipbuilding and car industries ? However, few if any observers ask this question: has the recession already mutated, in part due to anticipation of its end, the ways it has been fought, and also in part due to wrong interpretations of what it is and how it operates ?

Is the Recession Global ?

The debt and credit crunch, the imploded car industry, declining or agonizingly slow growing house sales and commercial realty are only choicer parts of the list wheeled out by doomsters. They usually go straight on to claim these nails in the coffin of recovery are more or less similar in any country, both inside the OECD and the Emerging Economies.

Supporting this argument to a certain extent China's Shanghai exchange, now an Asian benchmark, has firmly switched to caution and consolidation, after a few month's enthusiasm that the recession is over. Indian markets, as ever, are much more opaque and ambiguous on how India's economic outlook is evolving, supposedly in a context of a strongly growing real economy, but Latin American markets are closer to the new OECD and Asian market paradigm. In other words and worldwide the winds of caution, or fear that markets overdid their enthusiasm in the past few months, are now on the rise.

This outlook however makes exactly the same quick mental leap used by analysts in the OECD countries. The stated or unstated assumption is that stock and primary product markets run together and reflect the same basic 'upstream' changes in the real economy, rather than crests and slumps in exuberant day trading. The new conclusion is the real economy is hard to read, it might still be contracting, so finance markets need to backtrack.

From a purely theoretical standpoint, the quantity of public money thrown at the bank and finance sector should have generated an extreme or massive rebound in that sector, with at least some significant trickle down to the real economy. This trickle down is now the pressure point, but the evidence and data is so incoherent and contrary that the only honest reading is that emerging markets are probably even further disconnected from their real economies, than OECD markets. The signals were already fuzzy, but since late 2008 financial noise, vibration and friction has taken over. It is now harder than ever to sound out the real economy, as Roubini and Faber, and many others sometimes make a point of noting.

How Fast is Rebound ?

One argument used by today's big deficit spenders, who call themselves 'Keynesian inspired', is the recession slope was almost vertical in late 2008 and early 2009, so why shouldnt the rebound be symmetrical and equally fast ? Going a little further with this rationale and adding a few frills of Keynesian type magic, that he called 'multipliers', the gargantuan and unprecedented amounts of public cash used in a variety of ways to fight recession could generate a fantastic peak of growth.

Some observers running this idea through their PCs claim we could soon see a remake of the Volcker boom of 1983-84, when this Fed chairman finally cut US interest rates to single digit rates after extreme double digit highs, and 'unleashed growth'. This growth attained a surely unrepeatable 7% annual rate for 5 quarters, in the US economy.

Conversely, high interest rates are today almost impossible to imagine in any future scenario. How could any OECD central banker cut rates like Volcker did, by 5% or 7% or more over a year, today? Despite this reality barrier, warnings came from Bernanke at Jackson Hole that the rebound could or might be very inflationary, and fiscal tightening could soon be needed. There is only one, but very important missing detail: the rebound has to come, first.

Just as important as the question of timing the rebound, the type of rebound expected by governments and central banks is far from clear or defined. In other words, an inflation free finance, bank and insurance sector rebound could take place with possibly, or probably a lot less spending than the claimed amounts reported by the IMF as already spent or engaged by G20 governments (perhaps $ 4 000 billion to midyear 2009). Conversely a real economy rebound might be very inflationary if it came fast, but above all could be so slow that cynical observers will call it a camel, not a horse.

This basic questioning, which we can call "Did we go too far ?", does not openly surface, but was already the main concern underlying J-C Trichet's comments at the August 21 Jackson Hole meeting. That is Trichet seeks a "credible exit strategy" from hyper debt, which was not the main official concern of Ben Bernanke at the same meeting. Trichet, we can surmise, already fears the sequels of hyper debt more than the perhaps weak bounce in inflation brought by a short rebound.

Low Carbon Certitude

One thing on which all analysts and commentators have to agree, either in public or private, is that calling the end of the recession is almost impossible. Nobody knows because the real economy has become a black box.

On the other hand, G20 leadership determination in moving the global economy to low carbon is only rising, in fact taking on the trappings of crusader zeal. The coming Copenhagen climate summit in December will see ever tighter carbon emission limits being set across the economy and across the world, a possible international carbon tax or trade tariff, and further, large financial and economic aid to Cleantech in both OECD and emerging economies. As with IMF estimates and forecasts of anti-recession spending and engagements, which range from imaginative to flexible but are always large, future low carbon spending by the G20 will be large but numbers are unsure.

Underlying all this is certitude. Even if they dont know what is happening to their real economies, G20 leaders and their science advisers are sure and certain that world climate is changing for the worse, remedial action is urgent, and spending must be large. The closely linked stalking horse of Peak Oil does not openly figure in the rationale and reasoning offered for ever-rising, increasingly massive spending, and muscular legislation to force energy transition away from the fossil fuels, but surely adds yet more impetus to what will be huge long-term intervention in the economy.

Ironically or not, G20 led climate change mitigation effort is already the focus of rising wails from 'Austrian school' boys, who have thrown in the towel on railing about the Keynesian largesse of 'recession mitigation' deficit spending, perhaps because of its almost unbelievable size. Focusing on smaller sums, perhaps soon rising to $ 500 billion a year (according to the 2009 Davos Forum) and used by G20 governments to speed energy transition through 2010-2020, the Austrian crowd rightly underlines the distortions this will create. As a rough guide, if this spending attained $ 500 bn a year, this would be about 25% to 33% above total annual spending by the world's oil and gas industry in recent years. More important: would it be possible to ramp up to this level of spending on alternate energy and fighting climate change, so soon?

How this spending will be financed makes appeal to Keynesian miracles. Some G20 leaders, borrowing from Lord Stern's creative accounting, already have one-liners prepared for press conference grillings, of the type that spending now will create beneficial climate and environment multiplier impacts by about 2030-2050. Also, to be sure, they promise shorter-term low carbon multipliers for the car industry, in the shape of electric cars, and large net gains, over a certain time horizon, in the employmet market through shifting away from oil, and to a lesser extent coal or gas.

The Cycle Amplifies

Forecasting when or if the recession will end is almost impossible: we can only be sure of incertitude, as honest analysts say before making any comment. Probably one major cause of this is the massive size of 'Keynesian type' spending that has been engaged, but other factors are surely in play. We now have an onrush of low carbon spending, legislation and industrial change, joining the overhang of Keynesian recession mitigation largesse, or excess.

The simplest read-out from this is increased uncertainty, faster global economic change, and rising volatility for any market, anywhere. Adding the ongoing anti-recession spending to the climate change mitigation spending that is now starting, in pure theory we should have double digit inflation within weeks or months ! This in fact will not happen, proving again if needed that the economy is a black box.

Market volatility, however, is easy to forecast because it would be close to miraculous to not have a constant onrush of conflicting and contrarian signals, in this new context, forcing market operators to more than usual excesses of fear and hope. As we know, any period of high volatility generates or gives way to another cycle. The only problem is judging what shape and form the new cycle will have, and which way it is tilted.

Cycle theory could or might suggest the next stable cycle should be resolutely expansionary, but creating such heavy upward correction as it drives out the previous, that no smooth and clear cycle can emerge for several quarters ahead. This whipsaw profile would be set, well into 2010, easily and alternately absorbing and reinforcing switchbacks of sentiment driven by climate change spending, Keynesian spending, oil and gold price peaks and crashes, the US dollar's feats of volatility, the Euro's feats of volatility, and so on.

No doubt converging with the worst flights of pessimism from Faber or Roubini, we can be sure that little prevents a reset of world finance markets, given the massive surgery they have selfinflicted, and had forced on them, in the past 18 months. The reset could only be down, and could be by 33% or more, perhaps a lot more. From this new base, however, the long-term cycle can grow high and with decreasing volatility.

How the correction is made will be of course be traditional. An October crisis driven by external change, generated in the political, policy, social, geopolitical, climate or environmental domains. If the process started soon, this October 2009 but slowly at first, it could extend 3 quarters or more, before any winning cycle emerges and forces out the volatility - making for interesting trades !

By Andrew McKillop

gsoassociates.com

Project Director, GSO Consulting Associates

© 2009 Copyright Andrew McKillop - All Rights Reserved
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