Global Economy Free-Fall May Be Ending, Krugman Says

By Jason Folkmanis

May 21 (Bloomberg) -- The global economy’s “free fall” may have ended, which could in turn hurt the U.S. dollar, Nobel Prize-winning economist Paul Krugman said.

The world economy is projected to shrink 1.3 percent this year, the International Monetary Fund said in April, reversing a previous forecast of 0.5 percent growth. Still, confidence in the global economy has jumped to the highest level in 19 months, based on a Bloomberg survey last week.

Interest-rate cuts by the U.S. Federal Reserve, moves by the Fed to buy assets such as mortgage-backed securities, and government stimulus spending have eased the crisis, Krugman told a seminar today in Ho Chi Minh City, Vietnam. The American economy may expand “slightly” in the second half, he said, citing a slowdown in the pace at which jobs are being lost.

“Just about all of the economic indicators out there are suggesting that the free-fall has come to an end, that we’ve stabilized,” said Krugman, an economics professor at Princeton University in New Jersey. “Probably the worst in terms of shocks to the system is over.”

Singapore’s economy shrank less than initially estimated in the first quarter, signaling the nation may be past the worst of its deepest recession since 1965. The Bank of Japan may tomorrow raise its assessment of the economy for the first time since July 2006, said economists including Yasunari Ueno from Mizuho Securities Co. in Tokyo.

Easing Stress

Measures of stress in financial markets have eased, Krugman told today’s seminar.

“The acute stress that we had last fall after the failure of Lehman has been reduced,” he said. “Interest-rate spreads on commercial paper are way down, interest-rate spreads on corporate debt are down a little bit. The spread on interbank lending is down.”

The London interbank offered rate, or Libor, for three- month dollar loans fell 3 basis points yesterday to 0.75 percent, the British Bankers’ Association said, the 35th straight drop. The Libor-OIS spread, a gauge of banks’ reluctance to lend, narrowed to 55 basis points, the least since February 2008. It was as high as 364 basis points in October.

Global purchasing managers’ indices have improved, as have industrial production figures in the U.S. and freight-loading figures at major ports, Krugman said.

“All of the indicators are telling the same story,” he said. “Things are getting worse, but they’re getting worse more slowly.”

Bounce or Stay?

While the first year of the current global economic crisis resembles the first year of the Great Depression, further declines along the lines of the 1930s-era financial collapse are unlikely, Krugman said.

“I don’t think we’ve hit bottom, but the bottom is not too much further below us,” he said. “My big concern is that we don’t hit the bottom and bounce, we hit the bottom and stay there. It’s not obvious where recovery comes from.”

A global economic stabilization may hurt the U.S. dollar, as will external American deficits, Krugman said.

“The U.S. dollar is going to fall quite a lot, or at least significantly,” he said. “The demand for dollars has been temporarily inflated by the crisis. Good news is actually bad news for the dollar. If things stabilize, then the safe-haven demand for dollars falls off.”

China’s government in March suggested the creation of a new international reserve currency to replace the dollar.

“I view the Chinese agitation about a new currency as basically an attempt to have somebody rescue them from their own investment decision,” Krugman said. “China bought too many dollars. Now it’s looking at it and saying, ‘we’re going to lose a lot of money on this investment’.”

To contact the reporter on this story: Jason Folkmanis in Ho Chi Minh City at folkmanis@bloomberg.net