World May Be Lucky to Get Worst Recession Since 1983

By Rich Miller

Oct. 13 (Bloomberg) -- The world may be heading for its worst recession in a quarter of a century -- if it's lucky.

A steep slump looks likely as the credit squeeze crunches economies from the U.S. to Singapore and panic engulfs global financial markets.

``It's certainly going to be the worst since the 1980s,'' says Bradford DeLong, an economics professor at the University of California at Berkeley who worked at the U.S. Treasury Department from 1993 to 1995. ``The hope is that it won't become the worst unemployment business cycle since the Great Depression.''

Of special concern: The two big bulwarks of the global economy in recent years -- U.S. consumer spending and the rapid growth of emerging markets -- may be finally giving way in the face of the 14-month-old financial turmoil.

That raises the odds that the coming economic decline will be long and deep, despite U.S. Treasury Secretary Henry Paulson's $700 billion financial rescue plan, similar efforts by European leaders and the coordinated interest-rate cuts engineered by Federal Reserve Chairman Ben S. Bernanke and other central bankers last week.

``This is the worst crisis I've seen in my 50-year career,'' William Rhodes, senior vice chairman of Citigroup Inc. in New York, told fellow bankers in Washington yesterday. ``We still have to deal with the effects on the real economy here and elsewhere.''

Slowing Growth

The International Monetary Fund's World Economic Outlook last week forecast that global growth will slow to 3 percent in 2009, from 3.9 percent this year and 5 percent in 2007. That would mean a world recession under the fund's informal definition -- growth of 3 percent or less -- although current IMF chief economist Olivier Blanchard declined to describe it as such.

One of his predecessors wasn't so shy. ``It's hard to imagine it not being the worst recession in at least 25 years,'' says Kenneth Rogoff, who is now a professor at Harvard University in Cambridge, Massachusetts.

``You can take most of the official forecasts for 2009 and knock two'' percentage points off of them, he adds. That would make it the worst slump since 1982, when the world economy grew 0.9 percent.

``We're heading into a global recession,'' Simon Johnson, also a former IMF chief economist and now a senior fellow at the Peterson Institute for International Economics in Washington, said last month.

Rate-Cut Pressures

Stocks rallied worldwide today after European governments announced measures to shore up financial institutions and central banks pumped unlimited dollar funds into the money markets. The Standard & Poor's 500 Index rebounded from its worst week in 75 years with an 11.6 percent advance, its steepest since 1939.

Even if the financial markets settle down soon, the deepening decline will put pressure on central bankers to cut interest rates further and on finance ministers to reduce taxes and boost spending.


``There will be more cuts out of all of the central banks,'' says Ethan Harris, economist at Barclays Capital Inc. in New York. ``We are looking at a global recession, and it isn't going to turn quickly.''

U.S. lawmakers, who already enacted one economic-stimulus package this year, will reconvene after the Nov. 4 presidential and congressional elections to consider another.

Stimulus

``We are going to do a stimulus,'' House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, said yesterday on the ABC News television program ``This Week.''

The U.S., where the 2 1/2 year-old nosedive in the housing market is now taking down the rest of the economy, is the epicenter of the global slump. Gross domestic product contracted in the third quarter and is set to shrink further in the fourth, according to a survey of 52 economists by Bloomberg News this month.

Consumer spending, after growing uninterruptedly since 1991, finally gave way last quarter in the face of rising unemployment, declining wealth and tightening credit.

Further Weakness

Further weakness seems to be in store. The jobless rate, already at a five-year high of 6.1 percent, may rise to 8 percent, says Jan Hatzius, chief U.S. economist at Goldman Sachs Group in New York. That would bring the cumulative increase in unemployment during the recession to 3.5 percentage points, second in the post-World War II era only to the 4.1- point increase recorded in the mid-1970s.

Household finances are also being pinched. The steep decline in U.S. stock prices last week alone wiped some $2.16 trillion from investors' wealth. And banks are getting stingier with credit: Borrowing by U.S. consumers fell in August by the most on record as lenders shut access to loans, according to data from the Fed.

The consumer pullback is already sending ripples throughout the economy. Vacancies at U.S. neighborhood and community shopping centers rose to a 14-year-high in the third quarter, New York-based real-estate research firm Reis says.

A sharp reduction in household spending could turn what is shaping up to be the biggest contraction since the early 1980s into something worse, Bruce Kasman, chief economist at JPMorgan Chase & Co. told a meeting of the Institute for International Finance in Washington yesterday.

`Fairly Significant'

The U.S. economy is headed for a ``fairly significant recession,'' and unemployment may peak at more than 9 percent, Microsoft Corp. founder Bill Gates III said at the Harvard Business School in Boston today.

Cracks are also showing up in the emerging markets, until now the dynamos of the world economy. The MSCI Emerging Markets Index fell 20 percent last week as global investors yanked money from countries such as Brazil and Russia.

Michael Mussa, another former IMF chief economist now with the Peterson Institute, says he has cut his forecast for emerging-market and developing-country growth next year to below 5 percent from 5.7 percent just two weeks ago. That would be the slowest since the Asian financial crisis in 1998 and would compare with an IMF projection of 6.9 percent growth for this year.

Emerging Markets

``The credit crunch has taken hold in emerging markets, particularly in central Europe and now in Latin America,'' Mexican central bank Governor Guillermo Ortiz told the IIF yesterday. ``This has happened in a few weeks, even days.''

Brazilian Budget Minister Paulo Bernardo said in an interview published yesterday by O Globo newspaper that the government may cut spending and postpone social programs as the financial crisis takes its toll on the economy.

Asia is also feeling the impact. Indian central banker Rakesh Mohan says his country's economy faces ``downside risks'' as global investors turn more cautious.

Even China is feeling the effects, as its exporters are pinched by slowing demand from the U.S. and elsewhere. Yi Gan, the deputy governor of the People's Bank of China, sees growth slowing to 9 percent next year from 10.4 percent this year and 11.9 percent in 2007.

``The financial crisis really has an impact everywhere in the world,'' he told investors in Washington yesterday.

That impact will grow the longer the crisis drags on. In a bid to restore calm to the markets, European leaders agreed yesterday to guarantee bank borrowing and use government money to prevent big lenders from going under. The Fed announced today an unprecedented push by central banks to flood the financial system with dollars.

``Time is of crucial importance,'' JPMorgan Chase's Kasman says. ``The longer we wait to implement the strategies, the more damage we can do to the world economy.''

To contact the reporter on this story: Rich Miller in Washington at rmiller28@bloomberg.net