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Signalling Cycles & Present Financial Crisis Perspectives on a Financial Crisis Patrick McNutt www.patrickmcnutt.com The storybook…… • The world economy is now enduring a signalling cycle that probably began in the US on March 12th 2007 and it will continue to oscillate until either a market equilibrium (= continued recession) or a co-ordinated equilibrium is reached. The latter could be achieved initially at the G-20 Summits if a managed exchange rate regime was on the agenda and a loud unambiguous signal transmitted to the international investment and financial community, with escape clauses, of a managed regime 2009 to 2011. It’s the best we can do given the uncertainty in the world markets. Why signalling? • Financial and economic variables create cyclical patterns (CTL) • Government policy is necessary but not sufficient • Economic policy depends on policymaker’s commitment (PLT) • Signalling recognises that our economic system is dynamic Nasdaq Crash 2001 Post 2003 China Surplus $ US$, ¥en, YUAN, EURO Japan Middle East Banks Serving Global Products Sub-Prime and Ninja Loans Invest in US T-Bills US Interest Rates Low Property Boom Asset Bubble 2001 -2007 March 12th 2007 April 2nd 2007 New Century Financial Corp: Shares Suspended New Century file for bankruptcy Panic Actions Observed Only Financial Crisis Old view………. National markets Other economies C+G National growth National companies Signals in 2009/2010 • World of transient economies • EMs and ASLEEP v Anglo-Saxon • Moving from non-technology to technology sectors Signals to observe: • Corporate: Output ►demand ►income • China and Inflation • Correlation Shanghai Composite and S&P 500 Paradigm Shift occuring………. Global markets ASLEEP economies X Global growth Global companies Less emphasis on a national market (crowding-out): More emphasis on a global market (crowding-in): GDP = C + X + Corporate Investment => Focus on global growth Emphasis products & services with global reach => Focus on global companies: geography and industry Emphasis on Emerging markets in Asia, Latin America and Eastern Europe & Pacific Rim (ASLEEP) ASLEEP economies to account for at least 50% of global growth, 30% of world exports by 2010 Belief and Actions:More signals • All price variables are signals..interest rates, exchange rates, inflation • Biology of signals.. belief…action • Noise: Think x but do y Belief x Action y ‘Shoe-shine’ boy dilemma • Rational ignorance as investors react to noise and not to information • Paper wealth effect US$50trillion loss may reduce global GDP by 4% • Idiosyncratic noise: shoe-shine boy gives share tips • surplus nations ►nations in debt ‘Credible threat’ signalling language used…….. a) Debt-deflation trade-off Credible threats Beggar-my-neighbour deflation, devaluing currency to increase export competitiveness b) ‘Credible threat’ policy formulation Trichet at Jackson Hole, Wyoming, August 2005 uses ‘credible alertness’ to signal inflation concerns in the EU Debt & Financial Complexity Convoluted debt Deflation It’s ‘a safe banking system, a sound system’ Paulson July 20 2008 Reluctance to use D-word, R-word or is it a cycle? ’ Solutions Opportunities Critical Timeline: US and China 23 Mar 2009 1. China CB Governor raises the issue of the role of US $. Diplomatic language ‘lost in translation’ 22 June 2009 7 July 2009 3. BW theme of ‘new protectionism’ ; FT theme of ‘currency misalignment’ . 5. Italy and France no to ‘normal’ 17 August 2009 28 July 2009 15 July 2009 7 Signals that China biggest X than Germany 8. China US Strategic Econ Summit 11. IMF on Asian need to M. China signals ‘inflation’ 12. G20 Pittsburg Summit 2. G20 London Summit 4 China signal on ‘normal’ Agenda with exchange rates 22 Sept 2009 6. G20 Italy Summit 8 July 2009 9. Signals on WS ‘bull’ market 2 April 2009 5 July 2009 31 July 2009 10. Iron ore reaches $100 tonne spot 2 August 2009 Commitment to exchange rate targets 2009-2011 with escape clauses ….why? • Global growth will depend on world exports as domestic demand falls • Corporate earnings declining in Q1:3 2009 • EMs and ASLEEP economies will substitute export-led growth for more G • Beggar-my-neighbour policies emerge • China limited on interest rates moves due to capital inflows 2009 Policy A 2009 Policy B 2009 Policy A Solution 2011 Managed Exchange rates: US$ and RMB X and M world rebalance China signals inflation Deflation Debt Socialising losses 2009 Policy B Deflation Debt Socialising losses Solution 2015 Reflate Taxes, protectionism devaluation Managed exchange rates • Managed exchange rates to assist corporate earnings, Chinese inflation,international trade • Defines the degree of uncertainty • Export-led growth v Domestic demand • China, Japan, ASLEEP surpluses v US indebtedness Thank you for participating……… Sapere aude ‘That which one can know, one should dare to know’
