From the G20 meeting to the European Union, the crisis is mobilizing the world's top governance bodies. Do you think that this crisis is being addressed with enough speed and precision?
The outcome of the G20 summit meeting is positive. No decisions were made about regulation, but this is in fact a good thing. This is not the time to reorganize the financial system hastily, because doing so would generate undesired negative consequences, and would distract us from the real issue, that is, halting the global recession. So the fact that governments have agreed on the principles that coordinated monetary policy as well as fiscal actions are necessary is a good thing. The IMF and the European Commission, which is pushing for a recovery stimulus package worth 1% of GDP and borne by each member state, are pushing in the same direction. In addition, the G20 press release specifies that everything possible will be done to safeguard global trade and the free movement of capital.This is most welcome, because protectionist measures at this time would lead us into a global depression. The weak point in these policy reactions is nonetheless the fact that getting broad and coordinated budgetary measures off the ground takes too long.
What is the origin of the global recession that the IMF has announced?
To understand why we are in a recession, we have to reframe the global economic outlook within its cyclical dimension.After the 2001-2002 recession, which was caused by excessive investment in information technologies in the developed world, the global economy picked up tremendous speed thanks to exceptionally strong growth in the major emerging economies like China, which were able to take advantage of global trade deregulation and begin to rise up from poverty. As a result, from 2003 to 2007 the global economy grew by 4.6% per annum on average, and per capita GDP by 3.4%, versus an average of 1.8% since 1970 for the latter. This exceptional growth led to an asset price bubble that was especially acute for real estate assets, and that generated severe bottlenecks, above all in the energy and commodities sectors. Inflated by excess demand, global growth became inflationary, causing an oil shock and pushing the major central banks into tightening mode.It is the past overheating of the global economy that is the primary cause of this recession.
So it isn't the subprime fiasco that is responsible for all of our woes?
Let's say that the subprime crisis involving high-risk mortgage loans that recently developed in the United States to ensure broader access to home ownership, followed by the credit derivative crisis that ensured, sharply exacerbated both the boom and the burst phases of the cycle. Since the summer, when liquidity dried up beyond the inter-bank lending market and choked several other channels of economic financing, the most recent being the markets for export credit and insurance the recession has been magnified considerably, to the point where we run the risk of altering its very nature.
What is the way out?
In a nutshell, there are two possibilities today: short deep, call it "deep V", or long deep, call it "extended L". In the first case, we are confronted with a recession, admittedly global and deep, but transitory. In the second case, the recession is not followed by a clear recovery and slides into a period of the economic doldrums, i.e., an extended period of very weak growth. If the wholesale credit markets the interbank market as well as the corporate bond market do not unfreeze in the months ahead, the recession could go from being a cyclical phenomenon to becoming one of general and widespread economic gloom. This would be a deflationary situation in which it would take a very long time to deleverage, as the Japanese experience has shown.
What is the most likely scenario?
The transitory recession scenario, the "deep V", seems to us to be the most likely scenario, rather than the "extended L".
First of all, the global recession is in the process of emitting its own antidotes.
For example, the sharp drop in commodity prices nearly 45% in the past year for crude oil and for metals represents a dual positive shock for the global economy. A demand side shock, since it reinforces purchasing power in the importing nations, where the propensity to spend is greater than in the exporting countries. A supply side shock, also, because it partly restores the return on capital for consuming industries. In addition, by setting aside the threat of inflation for now, lower commodity prices allow central banks to lower their key interest rates without ambiguity.
Taken alone, these natural factors would not be enough to kick-start demand. That is where economic policy comes in. Monetary policy coordination has been remarkable from this perspective, and is a cause for optimism in my opinion. Coordination in refinancing lending institutions by massive injections of liquidity, extended to a large number of economies via swap agreements, then maintained to offer direct support for demand through lower rates, or even via the adoption of a quantitative policy, as the US Federal Reserve is beginning to do. These policies are beginning to bear their fruit, as suggested by the timid return of liquidity to the primary corporate debt market and the narrowing of spreads between inter-bank and key rates.
The recognition by the G-20 that fiscal polices must be used to stimulate the economy is also a reason for optimism, because some of the major countries were reluctant.It remains true that, aside from China, which responded rapidly, most budgetary measures have yet to be seen, which puts the global economy in a perilous position over the months ahead.
Let's assume that the deep V scenario materializes. When can we hope to see the first signs of a recovery?
The leading indicators the ones we can glean from business surveys but also the equity markets could begin to anticipate an improvement in the situation by the second quarter of 2009. But it won't be until 2010 that the effects of recovery will become really tangible, particularly in the labor market.
What factors will help investors regain confidence and what are the best investment themes?
Investors have to be convinced that we will not see the "extended L" scenario come to pass, and for this to happen, we need to have broad fiscal stimulus packages in the key countries. In the United States, we expect a huge stimulus package that could begin to put a halt to the deflationary spiral as early as the second quarter of 2009, since the new Democratic administration and Congress will not function until January. This plan could send a good recovery signal for the US economy and hence for the world's capital markets, a fortiori if the measures are targeted to help the real estate market, which lies at the heart of the problem.
Elsewhere, the recovery plans are being rolled out. In China, for example, 600 billion US dollars should be injected over the next two or three years, the equivalent of 10 to 15% of its GDP. So domestic spending in China, and more specifically investment spending, is a top investment theme in my opinion. In addition, while the global recession is not sparing the emerging markets - that would have been paradoxical in a global economy we must not lose sight of the incredible development potential of the large emerging economies in a free trade system. Their infrastructure and productive equipment needs are immense, which is a second investment theme. It isn't really new, but I think it will rapidly bounce back.
At the end of the day, how does it look for insurers in general and AXA in particular?
As the big problems faced by AIG attest, it was the conglomerates who took the risk of selling credit derivatives to use the leverage effect that were sanctioned. AXA was smart enough to stay away from this activity, how lucrative it may have looked for a time. For the rest, I would say that insurers are investors that need to protect their assets. For this reason, the fall in equity and corporate bond prices is hurting them. Stringent solvency regulations are not making things any easier for them. But as structural long-term investors, the extreme aversion to risk that we are seeing in today's markets offers the most financially solid insurers.
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