Jeffrey Garten, whose professional credentials include Juan Trippe Professor of International Trade, finance and business in the Yale School of Management; chairman of Garten Rothkopf (an international advisory firm); and former dean of the Yale School of Management, compares the current global financial crisis to “the eye of a massive storm.”
“We are at the beginning of a massive transformation of the global financial system,” Garten told participants of the recent Sourcing USA Summit in Austin.
“No part of the global economy is unaffected,” he said.
Garten admitted to being a bit more pessimistic about the worsening economic crisis than some of his colleagues. “I expect extremely strong headwinds,” he said, and long-term trends that will continue to influence global markets.
Garten told the group of cotton buyers and sellers from around the world that three to four decades of trade liberalization could be in peril. “The big question is whether we're at the beginning of a new system that will not be as friendly to global business,” he said.
Several issues contribute to the downturn, including the “deteriorating U.S. housing market, which is at the center of the global financial crisis. I see no light at the end of the tunnel for the next several months,” he said.
A decline in U.S. manufacturing also contributes to the economic downturn. “So does decline in production and employment in other countries,” Garten said.
He said the growing weakness in U.S. consumer demand is a big concern. “The U.S. economy is driven by consumption.”
He cited distressed finances as a critical element. “The (distress) level is so high that getting back to normal will require a high magnitude of change.”
He said other contributing factors include rising default rates, plummeting global growth and the collapse of the global economy. “We saw negative growth for the third quarter in all industrialized countries for the first time,” he said.
Garten offered three possible scenarios for the economic crisis and labeled them V, U, and L.
V is the most optimistic outcome with recovery within six to eight months. U is a bit more pessimistic and puts recovery off until a year-and-a-half to three years. L is a representation of a previous Japanese financial crisis that was long term and severe.
Garten expects the crisis to follow the U trend with recovery at about two years. “We haven't seen the bottom yet,” he said.
To accomplish that recovery, he suggested countries will need to cooperate on broad-based stimulus packages. “We also expect financial bailouts, a second wave of them.”
He said industrial bailouts may open a Pandora's Box. “After an auto bailout, we'll see a line of others. Where do we draw the line?” he asked.
He said countries must avoid falling into trade protectionism. “I'm worried about holding the line,” he said. “We haven't seen it yet, but pressure will mount.”
Garten said investment pullback is likely. “But we have to see a revival of private investment before we see an improved economy.” He said the ramping up of regional investment access across borders over the past few years has “come to a rapid halt.”
He said industrialized countries have depended too much on emerging markets to stimulate growth. “Those markets have been significant and account for 100 percent of global growth. That's unrealistic.”
Energy prices will jump again in the medium term, Garten said, because of lack of investment in infrastructure and exploration, as well as the demand from China. He also predicted that food prices will rise.
“We will see a new structure for the U.S. and Asian economies. We do not come out of a crisis the same as we went in.”
He said the United States may need to curb rampant consumerism. “The United States is a nation of consumers who don't save,” he said. “We have to curtail consumerism because current deficits are not sustainable. We are over-indebted.”
He said Asia faces a different challenge. “Domestic consumption has decreased and exports have increased. Asia's basic growth model is to export without enough emphasis on domestic consumption.”
Garten said the current crisis “is not a normal kind of recession that lasts for one to three quarters with a loss of 1 percent to 3 percent.”
He wonders if globalization will slow. “Is the last half century an aberration? I'm not sure.”
He anticipates “implications for diplomacy around oil” with producers like Russia and Iran.
Emerging markets will continue to play a significant role in long-term economies, Garten said. In 2000, world population stood at 6 billion, with only 1 billion living in “rich countries.” In 2050, world population will reach 9 billion and still only 1 billion will live in “rich countries.”
He predicted “astounding growth of cities. We will see either a total breakdown or a growth stimulus. I expect the latter. By 2050, two-thirds of economic growth will come from emerging markets.”
He said the growth will demand a “massive increase in investment in infrastructure, $41 trillion minimum within the next 20 years.”
Garten admitted that some experts posit a more optimistic case and project:
The market is just now beginning to understand government actions and will respond.
Global fiscal stimulus programs will work.
Cheaper commodity prices, especially oil, will help stimulate the economy.
The new U.S. president will have a positive effect on the economy.
“This more optimistic scenario represents a consensus of Wall Street Journal experts who believe we will come out of the recession in 2009,” Garten said. “I don't agree. I expect one-and-a-half to three years. Many predict only a year; I expect two.”
That extra year makes a big difference, he said. “A year could be a matter of survival for some companies.”
Garten said an even more pessimistic outlook, the L scenario, “is not out of the question. But long term, I'm more optimistic. I think the market will respond.”
And he expects the United States to lead the way. “The United States is flexible and can move quickly. If we see a turnaround in the United States, other countries will take their cue from us. Confidence here spreads through the (global) market quickly.”
He said China also is a key. “If China's growth drops below 8 percent, expect problems. If it stays at about 9 percent,” it will be okay.”
Garten said the worst-case scenario would occur if we have “a couple of false recoveries — if we seem to be out of the woods and then have another big financial institution fail. Also, if governments bail out industries we could see trade fallout. Instead of industries competing against each other, we may have governments competing against governments. I'm not pessimistic enough to think that will happen, but fear of the worst demonstrates healthy thinking.”
Garten predicted an extended period of low interest rates. “The government will do all it can to prevent long-term inflation and the challenge will be to mop up all that money when the economy improves or face inflation.”