A glooming bright future for the non-financial sector

Which is likely to be true?

The Paulson Plan, whatever its final form, will not bring this upheaval to an early end. The consequences are clearly spreading from Wall Street to Main Street. The recent performance of nonfinancial stocks indicates that investors are well aware of the fact.

So comparisons with the Great Depression, which have been of academic interest but little practical relevance, take on new salience. [...]

It is hard to avoid concluding that the Fed erred disastrously when deciding that Lehman Bros.

Or:

The non-financial sector today looks nothing like it did in 1930. The weak correlation between asset prices and non-financial sector performance and the strong profitability of today’s non-financial capital are two good reasons to scoff at the idea that the non-financial sector will collapse because of the recent events on Wall Street, and even better reasons to scoff at the Bernanke-Paulson-Bush idea that a massive bailout of financial firms is the key to avoiding a non-financial collapse.

[...]

The Treasury and the Fed should let Wall Street drown alone, to be replaced by new financial service providers who can swim as robustly as are non-financial American businesses.

Before pointing to the authors, take a look at the graphs below. That's the Brazilian stock market main index (IBOVESPA) and the tipping point is just after US House of Representatives' rejecting the edited version of the Paulson plan. This is relevant not only because of the time frame, but because the Brazilian stock market has evolved a lot in the past years and - unlike its Russian counterpart, for instance - had not faced severe swings in a long time. Oh, and the fact that I'm Brazilian may have something to do with it...!

It would be great if the markets were always efficient and we could let havoc take place, relying confidently in creative destruction. This, however, is not the case and professor Barry Eichengreen's warning - that US unemployment rate may reach 2 digits - should be taken very seriously. He's the author of the first quote, taken from And now the Great Depression, at Vox Eu. Professor Barry Eichengreen, from University of California, Berkeley, has been frequently quoted these past days thanks to his Anatomy of a Crisis. He seems to be inspired and we'll be keeping an eye out for more insights.

The second quote is from Casey Mulligan's Wall Street Will Drown Alone. His core argument can be found in Greg Mankiw's A Note of Optimism. Oh, yes, professor Mulligan is from (surprise, surprise!!) University of Chicago.


PS: After writing this, the Bovespa reopened... Let's see where it goes now.

RIO'S VOICE: Growth and development styles?

From the WSJ "Brazil Says ‘Não Obrigado’ to China-Style Growth Rates":

At the International Monetary Fund meetings, most ministers points to the 10% growth rate of China with a mixture of envy and awe. But Brazil’s finance minister Guido Mantega says 5% will do just fine. “I don’t know if it’s desirable to grow more than 5%,” he said in an interview. “We prefer to grow at a medium rate.”

My first reaction was to wonder who could possibly believe that. I couldn't, and I'm Brazilian! If Mr. Mantega's claim were true, we would be willing to forego half of the income per period we could have if growth rates were equivalent to Chinese ones. Keeping the pace, Chinese will double their GDP in 7 to 8 years, while it will take us around 15 years to double ours. Everything else equal, that roughly translates into twice as much time to double our standards of living, and why would anyone go for that?

According to the WSJ article, it seems as if Mr. Mantega is concerned about inflation, which is easier to keep under control when growing moderately because of lower demand pressures, and about being able to lower interest rates:

At mid-level growth rates, he said, it was easier to keep inflation under control – and provide additional incentive for Brazil’s central bank to lower the country’s sky high interest rates. The Brazilian benchmark Selic is now 11.25%, down from 19.75% in Sept. 2005.

“The conditions are there so that interest rates can head toward levels in civilized nations,” said Mr. Guido, by which he said he meant a nominal rate of 7% to 8%

But wouldn’t that ignite inflation?

I'll ignore the contradiction this time. Important to note now, however, is that China's 10-year high inflation is well within Brazil's target of 4.5% ± 2 p.p. It is possible to grow fast while maintaining prices under control, as long as the economy is not growing beyond it's potential rate. [For those thinking of accelerating inflation in China, remember growth was also accelerating past 10% a year.]

Funny enough, the other day I ran into China Daily's op-ed "China is on the right path to development". From what I wrote above, one could think I would agree with it, and that was my impression at first too, however the title of the article is rather misleading. Instead of focusing on the policies and institutions allowing for Chinese growth, the author in fact discusses the responsibilities that come along with the country's rise.

He declares that "the current international economic order and rules, which were mostly formulated by Western powers to reflect their interests, do not work well for the realization of China's long-term and strategic interests", and goes on to essentially state that China ought to abide by its own commitments, but shouldn't give in to "ceaseless demands from Western powers for further opening and reform".

Unfortunately reality is not so easy to deal with. Policies that benefit a country at the expense of its trading partners will certainly lead to retaliation, as history has shown over and over. The US Congress has already indicated it will pass a bill raising tariffs if the Chinese don't revalue the Yuan, recent events also indicate China's beggar-thy-neighbor policies are irritating the Europeans. Soon, Brazil and other nations will follow. The China Daily's article seems to ignore how others interested parties react to China, and it would be wise to remember these words from the World Economic Outlook of April 2006:

Even as linkages between economies grow, far too many governments are putting the slightest domestic constraint above any international interest. Others are reviving beggar-thy-neighbor policies, except they are now on the capital account—shielding large swathes of their own economy from corporate takeovers while encouraging their own companies to take advantage of the continued openness of others.

This is dangerous, short-sighted and sub-optimal. As Raghuram Rajan (Economic Counsellor and Director, Research Department, IMF), "I hope good sense will prevail".

And what about Brazil? Well, one can debate all day which development style to use. The most serious problem with our minister's statement is that we cannot talk about a style of growth when there is no growth to begin with! I have a feeling we will come back to this some time soon...