Assessing the impact of government actions worldwide.
Governments around the world are taking steps to stimulate national and regional economies and reverse the effects of the global economic crisis. Given the amount of money involved and the connectivity of the capital markets, the effectiveness of these government actions will determine the speed and strength of the recovery.
The stimulus programs vary by region. Some plans provide immediate cash or tax breaks for residents, others a cash injection for banks and/or a long-term investment in the country’s infrastructure. Following is a brief summary of the key programs in the Asia-Pacific, European and North American regions. All monetary figures are in U.S. dollars.
Japan: Asia’s largest economy unveiled a $16.5 billion package of credit guarantees and small-business loans in August 2008. That program was followed in October by a wide-ranging, $275 billion plan encompassing expanded credits for small businesses, cash paybacks to consumers and reduced payroll deductions and highway fees. In February, the government introduced a $22 billion proposal that includes controversial cash handouts of $135 for each resident, support for ailing banks and loans to the unemployed.
China: As the world’s fastest growing economy, and a major exporter and importer, China has garnered a great deal of attention with its massive $585 billion stimulus scheme, introduced in November. Representing 7% of China’s gross national product, China’s stimulus package is seen as critical to the country’s ability to keep its economy moving forward fast enough not to stall. The government’s plan focuses on a mix of infrastructure (roads, railways, airports and the power grid) and social programs.
Early signs indicate the efforts are taking hold. According to The Economist, investments in Chinese railways, roads and power grids in January and February rose 30% in real terms from a year earlier. In addition, the People’s Bank of China reported that Chinese banks issued $237 billion in new loans in January, double the volume of the year-earlier period.
Australia: Unlike many countries that are already in recession, Australia is trying to avert one. Its $42 billion plan, introduced in February, includes cash for workers and families, as well as money earmarked for long-term infrastructure projects.
Germany: Europe’s largest economy introduced two economic stimulus packages, a $40 billion plan in November and a $62 billion initiative announced in January. Together, these plans represent 1.6% of Germany’s GDP. The plans include subsidies for the purchase of environmentally friendly vehicles, cuts in income taxes and medical insurance fees and investments in the country’s infrastructure.
France: A $33 billion plan, equal to 1.3% of the country’s GDP, announced in December, includes money for hundreds of small infrastructure projects and targeted aid for airplane manufacturer Airbus and nuclear energy giant Areva.
United Kingdom: After injecting more than $730 billion into the banking sector in October, the U.K. government cut its value-added tax from 17.5% to 15% in November.
Efforts by Hungary and other Eastern European countries to get Western European nations to agree to an additional Europe-wide stimulus package that would help countries such as Hungary, Ukraine, Latvia, Lithuania and Estonia out of their sharp economic slides have failed. Several Western countries have balked at taking on additional risks themselves.
United States: The $787 billion package passed by the U.S. Congress in February is by far the world’s largest government stimulus plan. The initiative represents 5% of U.S. GDP. A breakdown of the package by the House Ways and Means and Senate Finance committees shows that 38% of the plan is in the form of targeted aid, such as an increase in Medicaid funding, money for schools and an extension of jobless benefits. Tax cuts, including payroll tax credits and tax credits for first-time homebuyers, represent another 38%. The remaining 24% targets infrastructure and modernization programs. In February, the Treasury came out with a four-point plan to stabilize the financial system. It was initially met with skepticism leading to a one-day, 5% decline in the stock markets. However, the late-March release of specific details on all four aspects of the program and, in particular, the $1 trillion Public-Private Investment Program, led to a one-day equity market rally of 7%.
Targeted capital infusions into a number of large banks and other financial institutions are key to several stimulus efforts. For example, AIG, ING and UBS received much-needed cash from the U.S., Dutch and Swiss governments, respectively. Although the global economy remains weak, these initiatives have helped bolster those firms financially and avoid a repeat of the collapse of Lehman Brothers last September.
“These de facto nationalization efforts are important elements of the recovery plans,” says Robert Browne, chief investment officer, Northern Trust. “Many governments are concluding that banks, given their depleted capital reserves, are not in a position to wait out this downturn. The governments recognize the risk that things might get worse before they get better. The Fed’s recent move toward quantitative easing is another important step toward avoiding this risk. These actions give the banks time to work through the crisis.”
“Many governments are concluding that banks, given their depleted capital reserves, are not in a position to wait out this downturn. These governments recognize the risk that things might get worse before they get better.”
— Robert Browne
Chief Investment Officer, Northern Trust
Despite the variety and scope of the stimulus packages, more needs to be done, says James D. McDonald, chief investment strategist, Northern Trust. “There’s a need for expansion of the global stimulus efforts. To use IMF statistics, the expected stimulus benefit to the U.S. in 2010 is 2.9% of GDP. In Europe it’s only 0.8%, and in Japan it’s only 0.4%,” he notes. “There has not been anywhere near as aggressive an approach taken in most other countries as there has been in the United States.”
Wayne Bowers, chief executive officer, Northern Trust Global Investments in London, sees a number of remaining challenges. For example, he cites the global risk of a collapse of certain Eastern European countries if their fellow countries don’t help them out. “If Eastern Europe defaults, that would pull down the Western European banking system, which would have a significant impact on the U.S. financial system,” he says. “The probability and risk of that scenario increases without any serious centrally coordinated global response.”
“The central banks are going to be cautious about unwinding monetary policy relief until they are completely convinced of a broad economic recovery.”
— Wayne Bowers
Chief Executive Officer, Northern Trust Global Investments in London
When the many stimulus efforts do take hold, there will be a fresh concern: inflation. “The central banks are going to be cautious about unwinding monetary policy relief until they are completely convinced of a broad economic recovery,” Bowers notes. But by then, inflation could be soaring again.
Another more pressing risk is protectionism. A number of countries have touched off concerns by others by addressing -- and protecting -- specific companies within their borders to the possible detriment of competitors elsewhere. The very fabric of cooperation within the still young Eurozone could be threatened by an every-country-for-itself mentality.
In the face of this global turmoil, many investors remain defensive. “Because of the dysfunctionality of the credit markets and the cloudy economic picture, many investors remain defensively positioned on a tactical basis,” McDonald says. “We have seen a substantial overweight in cash and a resulting underweight on the equity side. A good number of investors are keeping the hatches battened down until there is some evidence of the situation improving.”
“We have seen a substantial overweight in cash and a resulting underweight on the equity side. A good number of investors are keeping the hatches battened down until there is some evidence of the situation improving.”
— James D. McDonald
Chief Investment Strategist, Northern Trust
Another important element for the economic turnaround is liquidity, which is key for economies to be able to gain traction again. Browne notes the importance of the Term Asset-Backed Securities Loan Facility (TALF) program. The U.S. Treasury program is designed to increase credit availability and support economic activity by facilitating renewed issuance of asset-backed securities (ABS) collateralized by consumer and small-business loans.
“The fixed-income markets have been lacking what I would call substantial sustainable liquidity,” Browne says. “We think the announcement by the Federal Reserve to expand its financing to the legacy securities market is material. By providing non-recourse funding to hedge funds and other eligible investors, the odds are improving that these securities can get lifted from balance sheets and help us see two-way flows in the credit markets once again.”
Liquidity also is vital for investors such as pension plans, endowments and foundations that must face annual funding commitments. Having sufficient liquidity available in the form of cash holdings not only allows these institutions to honor their commitments, it also provides comfort and confidence to invest in higher-risk securities, Browne notes.
Bowers says there are two key indicators to monitor: global house price valuations and job creation. “Seeing those two basic indicators start to change could signify a turn in global economic conditions. But for now, job layoffs are continuing and household asset values are deteriorating,” he notes.
In terms of economic recovery potential, it is generally believed that emerging markets are more promising than developed markets outside the United States. So, when a recovery takes hold, many analysts believe emerging market economies, followed closely by the U.S., could lead the way.
“The United States went into the downturn first, and has had the most coordinated policy response and fiscal response of any of the major economies,” McDonald says. “In my view, the odds of the United States being among the first out are high. I think that the eventual weight of all the different programs that the Fed is putting into place will finally get us to a tipping point where credit creation starts to improve measurably.”
Numerous individual programs targeted at small areas have had limited success, but only in those areas that they’ve targeted, McDonald adds. “The U.S. has to get to the point where the mass of all the programs results in some self-sustained improvement.”