Now it is looking like V for victory over recession - Times Online

Now it's looking like V for victory over recession - Times Online

Based on the evidence I have seen this month, it looks as though the world moved out of recession in the second quarter. When we see the evidence for this, in the third-quarter data, it is likely that many areas will have returned to close to trend growth.

Just as many people responded to my column of August 10 suggesting that I was seeing things through some hazy, rose-tinted lens, I expect that many will respond in the same manner this time. In my last piece, I dubbed this recent crisis the “Facebook Crisis”, its true distinguishing characteristic being lots more emotional and subjective judgments than during others. It is likely that, for a while, actual evidence of recovery will again be met by scorn from many quarters, not least because unemployment, which matters most to those affected, will be the last signal to turn.

Opinions about the crisis finishing are also likely to continue to vary by country. Some will escape — indeed, may already have escaped — less damaged than others. In this regard, the UK might be more challenged than some countries, although this might not be as insurmountable as people assume.

Look at the evidence. For a start, after the release of many countries’ second-quarter GDP accounts, the OECD, the club that includes all the main rich countries, estimates that GDP fell slightly, by 0.1 per cent in its area. They also suggest that GDP fell by 0.1 per cent in the narrower super-rich club of the G7 countries (although Canada doesn’t report its performance until today). For both groups, this is a vast improvement over recent quarters, reflecting some encouraging signs in the “older” countries that make up the narrow club. In particular, Japan, France and Germany all positively surprised, with Japan showing close to a 1 per cent quarterly gain, as exports and consumption both recovered. Within the larger developed countries, both the UK and US stood out as among the weaker, which, in view of the housing and banking-based nature of the crisis, is really what many would have expected.

Going beyond the G7 and the OECD, the reason I can say that the world moved out of recession (at least technically, as measured by positive or negative changes in GDP) is that China showed an extremely large bounce in the second quarter (Q2). The Chinese authorities reported a 7.9 per cent year-on-year increase in Q2 but, shown on the same basis as much of the developed world, ie quarterly change, the rise in China was even more impressive. On the same basis as the United States reports, which is quarter-to-quarter change annualised, we reckon that China rose by an astonishing 16.5 per cent in Q2. Even though they are “only” 7 per cent of the world total GDP, given how close to flat the leading economies were, a much smaller increase would be enough to turn the world positive. A number of other significant emerging economies also seem likely to have experienced positive growth in the quarter, such as Brazil and India, but we are yet to get the details.

What about the current quarter, Q4 and the future? Many are starting grudgingly to concede that the world is doing better, but it is fashionable to argue that any recovery will be very weak. Just as many argue that the infamous W-type pattern of a so-called double dip is possible. Well, frankly, anything is possible. But looking at the objective evidence, as opposed to the subjective and emotive, a V seems more likely now than a W. What is the evidence?

In my last piece, I showed a chart of our Goldman Sachs Financial Stress Index, the GS-FSI. It showed systemic financial stress back down to levels not seen since spring 2007, before the crisis erupted. We don’t have a new index level since my last article but the behaviour of most of the components continues to improve.

We use two other important leading indicators to monitor our forecasts. For more than 20 countries, we use Financial Conditions Indicators, so called FCIs, as lead indicators. While the exact construct varies for different countries, they typically include short and long-term interest rates, the latter often corporate bond yields (these two tend to take up 80-90 per cent of most indices), the exchange rate and a stock market indicator as a wealth effect variable. In many countries financial conditions tightened dramatically in late 2008 and continued to do so despite efforts by policymakers to stimulate their economies. Struggling banking systems and fears of systemic failure rendered policy, for a while, less effective than normal. However, partly because of the persistence of policymaking efforts, many FCIs have started to improve sharply, especially in the all-important United States. Historically, a 100-basis point move in our US index would equate, all else being equal, to a 1 per cent increase in US GDP within 12 months and a 0.6 per cent increase in global GDP. In 2008, our US index deteriorated, we believe, more than ever before, hence the collapse of global GDP. Now the US index has recovered more than 75 per cent of the tightening which suggests, all else being equal, that 75 per cent of what was lost should be recovered.

Crucially, our FCI for China has exploded on the back of very aggressive Chinese monetary and fiscal stimulus and it stands more than six percentage points easier than last November. Not surprisingly, indicators sensitive to financial conditions have shown dramatic advances in recent months, with, perhaps, car sales the most powerful. In the UK, because of the important role played by the exchange rate as well as the actions of the Bank of England, UK financial conditions have also eased sharply and many sensitive indicators, including consumption, have shown a response.

The final indicator we use is our own proprietary Global Leading (economic) Indicator, the GLI. Based on some high-frequency reported data, such as US weekly job claims, South Korean exports and a number of business and consumer confidence surveys, it aims to predict changes in industrial production three to six months ahead, just like the OECD version. Ours is quicker and doesn’t include interest rates, the yield curve or equities, so can be used by asset allocators.

Since March, close to the time that developed stock markets bottomed, our GLI has shown a vigorous bounce and, indeed, for the past two months the monthly increases have been the sharpest we can find. The chart of the monthly changes, as you can see, looks pretty much like a V, not a W. Right now, it suggests a much stronger bounce in the world in the next six months than consensus and, along with other data, is why in our latest forecasts we predict that world GDP will recover by 4 per cent in 2010. This will include the UK because, despite all its challenges, it is an economy small and open enough to be greatly influenced by the rest of the world.

• Jim O’Neill is Chief Economist at Goldman Sachs


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