By: Nouriel Roubini
NEW YORK: Global financial markets in 2008 experienced their worst crisis since the Great Depression of the 1930’s. Major financial institutions went bust; others were bought up on the cheap or survived only after major bailouts. Global stock markets fell by more than 50%; interest-rate spreads skyrocketed; a severe liquidity and credit crunch appeared; and many emerging-market economies staggered to the International Monetary Fund for help.

So what lies ahead in 2009? Is the worst behind us or ahead of us? To answer these questions, we must understand that a vicious circle of economic contraction and worsening financial conditions is underway. The United States will certainly experience its worst recession in decades, a deep and protracted contraction lasting about 24 months through the end of 2009. Moreover, the entire global economy will contract. There will be recession in the euro zone, the United Kingdom, Continental Europe, Canada, Japan, and the other advanced economies. There is also a risk of a hard landing for emerging-market economies, as trade, financial, and currency links transmit real and financial shocks to them.

In the advanced economies, recession had brought back earlier in 2008 fears of 1970’s-style stagflation (a combination of economic stagnation and inflation). But, with aggregate demand falling below growing aggregate supply, slack goods markets will lead to lower inflation as firms’ pricing power is restrained. Likewise, rising unemployment will control labor costs and wage growth. These factors, combined with sharply falling commodity prices, will cause inflation in advanced economies to ease toward the 1% level, raising concerns about deflation, not stagflation.

Deflation is dangerous as it leads to a liquidity trap: nominal policy rates cannot fall below zero, so monetary policy becomes ineffective. Falling prices mean that the real cost of capital is high and the real value of nominal debts rise, leading to further declines in consumption and investment – and thus setting in motion a vicious circle in which incomes and jobs are squeezed further, aggravating the fall in demand and prices.

As traditional monetary policy becomes ineffective, other unorthodox policies will continue to be used: policies to bail out investors, financial institutions, and borrowers; massive provision of liquidity to banks in order to ease the credit crunch; and even more radical actions to reduce long-term interest rates on government bonds and narrow the spread between market rates and government bonds.

Today’s global crisis was triggered by the collapse of the US housing bubble, but it was not caused by it. America’s credit excesses were in residential mortgages, commercial mortgages, credit cards, auto loans, and student loans. There was also excess in the securitized products that converted these debts into toxic financial derivatives; in borrowing by local governments; in financing for leveraged buyouts that should never have occurred; in corporate bonds that will now suffer massive losses in a surge of defaults; in the dangerous and unregulated credit default swap market.

Moreover, these pathologies were not confined to the US. There were housing bubbles in many other countries, fueled by excessive cheap lending that did not reflect underlying risks. There was also a commodity bubble and a private equity and hedge funds bubble. Indeed, we now see the demise of the shadow banking system, the complex of non-bank financial institutions that looked like banks as they borrowed short term and in liquid ways, leveraged a lot, and invested in longer term and illiquid ways.
As a result, the biggest asset and credit bubble in human history is now going bust, with overall credit losses likely to be close to a staggering $2 trillion. Thus, unless governments rapidly recapitalize financial institutions, the credit crunch will become even more severe as losses mount faster than recapitalization and banks are forced to contract credit and lending. Equity prices and other risky assets have fallen sharply from their peaks of late 2007, but there are still significant downside risks. An emerging consensus suggests that the prices of many risky assets – including equities – have fallen so much that we are at the bottom and a rapid recovery will occur.

But the worst is still ahead of us. In the next few months, the macroeconomic news and earnings/profits reports from around the world will be much worse than expected, putting further downward pressure on prices of risky assets, because equity analysts are still deluding themselves that the economic contraction will be mild and short. While the risk of a total systemic financial meltdown has been reduced by the actions of the G-7 and other economies to backstop their financial systems, severe vulnerabilities remain. The credit crunch will get worse; deleveraging will continue, as hedge funds and other leveraged players are forced to sell assets into illiquid and distressed markets, thus causing more price falls and driving more insolvent financial institutions out of business. A few emerging-market economies will certainly enter a full-blown financial crisis.

So 2009 will be a painful year of global recession and further financial stresses, losses, and bankruptcies. Only aggressive, coordinated, and effective policy actions by advanced and emerging-market countries can ensure that the global economy recovers in 2010, rather than entering a more protracted period of economic stagnation.

Nouriel Roubini is Professor of Economics at the Stern School of Business, New York University and Chairman of RGE Monitor, an economic and financial consultancy

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TORONTO - Canada could lose more than 580,000 jobs within five years if Detroit's Big Three automakers go out of business -- most of them in Ontario, according to a Ontario government commissioned report. 
 
The review, prepared for Ontario's Ministry of Economic Development and released Tuesday, warns that the collapse of General Motors Corp., Ford Motor Co. and Chrysler LLC would send lasting shock waves through the economy.

If auto output by U.S.-based manufacturers in Canada were cut in half, at least 157,400 jobs would be lost right away, 141,000 of them in Ontario.
By 2014, job losses would rise to 296,000 nationally, including 269,000 in Ontario.

If production were to cease completely, 323,000 jobs would be lost immediately in Canada, including 281,800 in this province, rising to 582,000 nationally and 517,000 in Ontario by 2014.

The Ontario Manufacturing Council, a provincial government panel, commissioned the 11-page report, which was prepared by the Center for Spatial Economics.
The report paints a gloomy picture if the provincial government and Ottawa and Washington do not bail out the automakers.

Ontario Economic Development Minister Michael Bryant said Tuesday a proposed $3.4-billion Canadian ($2.8 billion) rescue package is needed to avoid a "catastrophic" chain of events.

"We are talking about CPR, literally, CPR for a company to avoid it from going under and causing a chain of events that would be catastrophic to the economy," Bryant said.
Bryant said Canada "is better off providing life support to GM and Chrysler, because the demise of auto in Canada is the economic equivalent of a nuclear freeze with catastrophic effects that would knock us into a deep recession."

Canadian Federal Industry Minister Tony Clement said last week that Ottawa and Ontario will provide the equivalent of 20 percent of whatever emergency aid the Bush administration gives to the companies -- a figure proportional to the number of vehicles produced in Canada.