Which history?
If recent history were a reliable guide, we could look forward to a quick end to the economic crisis, at
least in the US. Downswings typically last only a handful of quarters and are then followed by
reasonable recoveries. Other countries haven’t always fared quite so well: UK downswings, for example,
persist a lot longer. Nevertheless, given the US experience, it’s no surprise that consensus forecasts
continuously suggest recovery is just around the corner.
We believe, though, that recent history is misleading. Already, the pace of decline in industrial
production in the world’s richest nations is on a par with the early months of the Great Depression and, as
such, is far worse than seen in typical post-war downswings. Given the huge policy stimulus launched
over the last 18 months, this is a disturbing result.
Our forecasts reflect this ongoing weakness. For the global economy in 2009, we are lowering our GDP
forecast from -1.4% to -1.9%. For the developed world, we now expect a 3.0% shrinkage compared with
a fall of 2.5% previously. The emerging world still expands – just – but at a paltry rate of 1.7%.
The crisis can be broken down into three main categories: the original banking crisis, a more recent
collapse in the demand for credit and what we call a geographical seepage. The dynamics associated with
the crisis suggest the need for a healthy dose of scepticism in the light of recent, slightly less
discouraging, signs in the US. Indications of stabilisation in US consumer demand and the housing
market need to be seen in context of haemorrhaging corporate profits, collapsing industrial production
and rapidly rising unemployment elsewhere in the world.
Capacity utilisation rates are at historic lows, inventories are, in many cases, at extraordinary highs
relative to sales given the attempts by companies in recent months to de-stock aggressively and, for
policymakers, the growing fear is deflation. Even if Tim Geithner’s plans to bolster the US financial
system prove successful, the US Treasury Secretary knows there is still a long way to go. Trust in the
financial system will take years to rebuild and, in the meantime, households and companies will be
looking to pay off debts and rebuild their assets.

It’s quantity, not quality
That central banks are embracing various forms of quantitative easing is telling. Quantitative easing is
being embraced most obviously because official interest rates are already at, or close to, zero and cannot,
therefore, fall any further. But the willingness to do so also reveals something about central bankers’
innermost fears. Once deflation takes hold, it is not easy to get rid of. It is the economic equivalent of
dry rot (as Japan knows only too well).
Of course, not all deflations are the same. Some deflations fall into the “good” category, being no more
than terms of trade improvements associated with, for example, lower import prices or improvements in
technology. These deflations lead to higher real wages and profits, leaving the suppliers of both labour
and capital happy and smiling. Others, though, are more worrisome, threatening higher unemployment,
lower profits and heightened insolvency.
We examine some of the main risks associated with an outbreak of deflation. They include rising real
debt burdens, indiscriminate redistributions of income and wealth, heightened sovereign default risk and,
most worryingly, nominal rigidities associated with wages and interest rates.
Deflation is, like inflation, ultimately a monetary phenomenon. Quantitative easing can work on two
separate counts: either the stock of money can be boosted or, alternatively, the velocity of the existing
money stock can be increased.
Either way, the central bank tries to pump credit into an economy by bypassing a moribund banking system.
The big problem now lies in identifying how much quantitative easing to do: because most variants involve
purchasing government securities, the danger is that previously trustworthy signals of inflationary expectations,

such as so-called breakeven rates, begin to malfunction. The scope for policy mistakes is, therefore, high. We
think those countries which aggressively pursue quantitative policies will have to pay a price in the form of
currency deprecation: as a result, we favour the euro over the dollar.
Redistributing the problem
A decidedly odd aspect of the crisis is its increasingly bizarre geographical distribution. The countries at
the epicentre of the crisis – the US, the UK, Spain and others which had overheated housing markets – are
certainly weak, but not as weak as many others. Why have countries with limited housing bubbles and
with, apparently, an absence of over-leveraged financial institutions, ended up in such trouble?
The collapse in demand which began in the autumn of last year has led to a massive reduction in industrial
sales, most obviously of cars and trucks. Inventory/sales ratios have soared as a result. In a desperate attempt
to get rid of inventories, companies have slashed production. In a world of outsourcing and off-shoring,
however, falling demand in one country may have a disproportionately large impact on production in other
countries. The US and UK, with small industrial sectors, are relatively insulated from this effect whereas the
likes of China, Taiwan, Germany, South Korea and Brazil are more heavily exposed.
More worryingly, a new form of financial nationalism is fast developing. Capital injections into western
banks come at a price. Governments and taxpayers understandably want banks to lend domestically in
response but, with persistent funding shortfalls as a result of the collapse in securitisation and the
weakness of interbank markets, higher domestic lending is often accompanied by reduced foreign
lending. It’s no longer simply households and companies hoarding cash: we’re now seeing nations
playing the same game.
This is particularly disturbing for emerging markets which have relatively small banking systems and
which, as a result, have become heavily dependent on cross-border bank lending, often provided by
western banks. A combination of western government lending “guidance” and rising risk premia in
financial markets has led to a collapse in some forms of cross-border lending. For example, syndicated
lending to emerging markets fell sharply in the final quarter of 2008 after years of rapid growth.
The lessons for asset allocation
We’ve already noted our preference for the euro over the dollar. To take a lesson from the 1930s, the
euro is more a Gold Standard currency. A stronger euro will do the eurozone no favours but that is the
price of pursuing a “hard money” policy when others are not.
We continue to enthuse about high grade corporate bonds even though we recognise that, for many
investors, the market remains illiquid. Government bonds need to be watched carefully: deflation should
keep yields low as, indeed, should quantitative easing but, increasingly, markets may be skittish about
sovereign risk. Meanwhile, although equities may offer the occasional rally, we’re not convinced about
their capacity to offer decent long-term returns. We suspect investors will increasingly treat equities like
high-risk corporate bonds. That means a return to a 19th Century world of higher dividend yields, leaving
us underweight in equities in our recommended portfolios.

目录

Key forecasts 6
Monetary & fiscal policy
assumptions 7
For those in peril…. 8
History favours recovery, but…. 8
Industrial production declines: the latest cycle compared 11
Why this crisis is different 12
Green shoots? 13
The ongoing threats 15
Deflation in view 17
M or V – it’s all about P! 17
Driving the process 17
About to go under 18
A rigid asymmetry 21
Breaking down breakevens 21
A distributional problem 23
Conclusions 26
Global economic forecasts 27
GDP 28
Consumer prices 30
Short rates 32
Long rates 33
Exchange rates vs USD 34
Exchange rate vs EUR & GBP 35
Consumer spending 36
Investment spending 37
Exports 38
Industrial production 39
Wage growth 40
Budget balance 41
Current account 42
Country and territory sections
US 44
Canada 46
Mexico 48
Brazil 49
Argentina 50
Chile 51
Eurozone 52
Germany 54
France 56
Italy 58
Spain 60
UK 62
Norway 64
Sweden 65
Switzerland 66
Hungary 67
Poland 68
Russia 69
Turkey 70
Saudi Arabia 71
South Africa 72
Japan 73
Australia 75
New Zealand 76
China 77
Hong Kong SAR 78
India 79
Indonesia 80
Malaysia 81
Philippines 82
Singapore 83
South Korea 84
Taiwan 85
Thailand 86
Vietnam 87
Disclosure appendix 90
Disclaimer 91
Contents