• Our so-called overheating indicator declined in December to 5.9 from 7.3 in May. This is a more or less expected downturn (our main headline from May 2011: ”Some cooling down seems to become reality”). Almost 25 China experts from Asia, the U.S and Europe came together for this survey.
• GDP forecasts (%, average):  2011:  9.2;       2012:  8.3;      2012q4:  7.8;       2013:  8.0
• 62 percent of the panelists foresee that the currency RMB will see only a slight appreciation – up to 5 percent – vis-à-vis the U.S. dollar in 2012 – probably motivated by tougher conditions for exports.
• 92 percent of the panelists still conclude that there is a dangerous bubble on the real estate market (May 2011: 100 percent). Concerns about the Chinese stock market are now more limited.
• The panel’s grading of confidence in the Chinese economy looks as follows:
  (5 = very high confidence;  1 = very low confidence)
  3 years from now: 3.7             5 years from now: 3.4             10 years from now: 3.0

• Some other grading (10 = very high/good;  1 = very low/poor):
  Institutions: 4.9 (2010: 4.5)    Statistics: 4.8 (2010: 4.2)        Accounting: 4.6 (2010: )
  Transparency…in economic policy: 3.4 (2010: 2.8 )… in financial markets: 3.3 (2010: 3.6)

Read the full China Panel No 13, 2011 report

Det råder ingen tvekan om att hittillsvarande tillväxtprognoser för de relativt nya EU-länderna i Central-/Sydosteuropa och Östeuropa (EU10) kommer att behöva skrivas ned. Detta kommer också att betyda försämringar på arbetsmarknaderna. Dessa länders exportandelar till Västeuropa är helt enkelt för stora för att kunna komma undan den kommande stagnationen eller rentav recessionen i de gamla EU-länderna. Till detta kommer att en hel del EU10-länder har banksystem med stora västeuropeiska ägarandelar. Flertalet av dessa västeuropeiska banker kommer dock under 2012 – p g a stigande kapitalkrav – att agera mer försiktigt på kreditsidan, vilket också kommer att drabba kreditaspiranter i de relativt nya EU- marknadsekonomierna. Detta hot betyder ett speciellt ansvar för Swedbank och SEB i de baltiska länderna. De baltiska ländernas återhämtningsprocess skulle på allvar hotas av en förnyad kreditklämma.

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Last summer, forecasters believed in quite a decent economic growth in the relatively new EU-member states (EU10-countries) – somewhere between 3 ½- and 4% in 2012, i.e. almost in line with potential growth. Looking at the ongoing deterioration of Western European demand, there is every reason to believe that the new trend will have a negative impact on EU10 at least in 2012. Only a very limited GDP-growth rate can be expected for the whole group of countries – with Poland having the best odds to avoid a recession.

Another impediment to growth in this usually quite dynamic region is probably coming from Western banks which have significant or dominating market shares in the credit business of EU 10 countries. Now, the banks in Western Europé start up a period of consolidation and improvements of capital requirements. The will partly happen at the expense of credit volumes and risk-taking.

However, this procyclical behavior is not very useful for the banks’ corporate customers in EU10-countries. And it is – if taken too ambitiously – not beneficial in a macroeconomic sense either.

Two major Swedish banks, Swedbank and SEB, should this time – contrary to the period of 2006-2008 – stick to their responsibility vis-à-vis the Baltic states. Then, they did ”everything” to contribute to irresponsible credit growth in Estonia, Lithuania and particularly Latvia. This time when several big Swedish banks strategically look for a very high return on capital – maybe unrealisticly high – the risk of a too limited supply of new credits must not be neglected.    

Relatively low economic activity in the forthcoming quarters could also mean that stabilization or improvements of the mostly negative current account balances in EU10 may lead to premature positive conclusions. In other words: The ten (relatively) new EU-member countries have continuously to concentrate on structural economic policy that favors education, innovation, entrepreneurship, institutions, labor markets, new or improved products (more value-added) and also conditions for the working population when considering the demographic challenges. All this is needed to achieve fundamental improvements in current account balances.

It is certainly desirable that E(M)U leaders in their search for a revised EMU and stability model also seriously take EU10 countries into account. Now Europe is preparing its new structural economic policy model. In the longer run, this may lead to an happy end compared to the ongoing paralyzed reform process in the U.S. But E(M)U countries first have to manage their very depressed confidence and liquidity crises – a challenge that also EU10 now increasingly gets involved in.

Altogether, its seems to be premature to predict worsening conditions for long-term business in the Baltic Sea region and the other EU10 members. A structurally strengthened EU in its Western and Southern parts would be very positive for all EU10 countries and even the old member states. Such a development is still a realistic option some years from now – despite the current doomday talk by (mainly) anglosaxon financial markets.

There are only five options left to come out of the EMU crisis: eurobonds, the establishment of the EFSF as a bank with the right to issue bonds, the unlimited  possibility for the ECB to buy bad government bonds, the German view of claiming much better and/or secure fiscal consolidation than so far which may  - as a compromise – be combined with alternative one or two. I rule out the third solution as too bad and the fourth alternative alone as insufficient. Unfortunately, there is no solution with ”safe outcome”. 

EMU-krisen har inga någorlunda hyggliga eller säkra problemlösningar längre. Det finns endast fem tänkbara vägar att gå vidare på, samtliga behäftade med mer eller mindre osympatiska risker:

1)   euroobligationer (”straffränta” för de duktigaste EMU-länderna, då högre än hittills)

2)   ombildandet av räddningsfonden EFSF till en bank med emissionsrätt

3)   möjlighet till obegränsade uppköp av ”skräpiga” statsobligationer via ECB

4)   Tysklands hittills tilltänkta väg att kräva ännu bättre skuldsanering av de mest skuldsatta EMU-länderna – kombinerat med fortsatta räddningsaktioner i ett senare skede, möjligen också tillsammans med en reviderad strukturell EU-politik

 5)   kombinationen av två ovannämnda insatser.

För egen del vill jag helst se följande möjligheter, mestadels av pragmatiska (nöd-)skäl – och inte för att de ser ekonomiskt/institutionellt tilltalande ut:

- alt 1  (trots starkt principiellt motstånd)

- alt 2  (endast om entydiga gränser och definitioner för emissionsrätten kan hittas)

- alt 1 och 2 i kombinerad form

- alt 1 och/eller 2 i kombination med alt 4 (i mina ögon kanske den bästa praktiska lösningen för att få med Tyskland).

Som synes, förkastar jag – i motsats till många marknadsaktörer – alternativ 3 helt och hållet. ECB:s trovärdighet måste helt enkelt ges allt tänkbart stöd framöver. Det fås inte genom alternativ3. ECB-chefen Mario Draghis senaste kommentarer i detta sammanhang är ett uppmuntrande tecken.

Som sagt: Numera finns inga någorlunda hyggliga alternativ kvar. Den chansen har man försuttit. Politikerna har reagerat för långsamt på finansmarknaderna – och finansmarknaderna har visat otillräckligt förståelse för demokratiska beslutsprocesser.

Det får vi betala för idag!

There is strong reason for concern about the future of EMU and theoretically even EU. Only behavioral aspects may help in the attempt to foresee what possibly may lead to a positive turnaround. However, there are currently no plausible options that may ”guarantee” the turn of very depressed markets into new confidence areas. Or are there any forgotten opportunities? I have great difficulties to find them. Despite this fact, we should not underestimate chancellor Merkel’s mind for compromises and second-best solutions – particularly in the early morning hours – when her preferred solutions no longer are achievable.

1. Agera först – tänka sedan?

Finansmarknaderna har kommit till ett stadium, där de eftertryckligen fokuserar eller rentav satsar på EMU-systemets undergång. Eftersom finansmarknader sällan brukar arbeta med långsiktiga konsekvensanalyser, kan frågan inte undvikas om det överhuvudtaget finns reflektioner kring ett nytt valutapolitiskt och samarbetsinriktat system som kan fungera längre fram. Är det först och främst EMU:s undergång det gäller nu – och sedan får man se vidare?

2. Anglosaxisk spekulation

Finansmarknaderna i London och New York har aldrig visat större sympatier för skapandet av EMU. Varje gång jag besökte dessa två stora finanscentra under andra hälften av 1990-talet, gav många traders och analytiker uttryck för sin oro att en enda EMU-valuta skulle hota deras jobb. Flertalet akademiker var minst lika skeptiska. Ironiskt nog måste nu många analytiker och handlare känna stor oro över att den pågående finanskrisen troligen kommer att utgöra en mycket större utmaning för deras jobb på finansmarknaden än vad en av själva finansmarknaden mindre pressad valutaunion förmodligen hade inneburit.

3. Inte enbart finansmarknadernas fel

Generellt betraktat finns det många syndare bakom den tidigare ”subprime-krisen” och dagens EMU-kris. Som de främsta orsakerna till den uppkomna – mycket negativa – situationen ser jag

- felaktiga, d v s för kortsiktiga incitamentsstrukturer för finansmarknadens aktörer

- övertro på s k perfekta finansmarknader (speciellt i USA och Fed, forskning inkluderad)

- omfattande kunskapsluckor hos banker, tillsynsmyndigheter och politiker (makro, aggregat)

- politikernas bristfälliga förståelse för de globala finansmarknadernas snabbhet och krav

- finansmarknadernas bristfälliga förståelse för demokratins beslutsprocessor, både vad avser   institutioner och tempo.

4. De europeiska misstagen

För egen del minns jag mycket väl en rad samtal med olika ECB-ledare som samtliga redan kort tid efter eurons start med emfas hoppades på ihållande finanspolitisk disciplin – men som likväl kände allt annat än trygghet på just denna punkt. Före detta förbundskanslern Gerhard Schröder har förvisso sina meriter för att ha fått Tyskland på en mer strukturellt inriktad reformkurs – men han och dåvarande finansministern Hans Eichel reagerade på tok för mjukt på Tyskland övertramp av stabilitetspaktens budgetnormer. Och ”givetvis” var det alltid något mindre stabilitetsorienterade Frankrike inte sent att följa efter Tysklands budgeteskapader. Hela tiden var EMU ett politiskt baserat franskt projekt med syftet att hålla det tyska inflytande i schack efter återföreningen 1990 (men hur är det nu med den saken?). Jag upplevde själv många gånger på plats, hur svårt det var för tyskarna att slita sig från den främsta återuppbyggnadssymbolen efter andra världskriget, den globalt ytterst respekterade D-marken. Det gäller att första detta historiska inslag.

5. De amerikanska misstagen

Jag läste nyligen boken ”Lost Decades: The Making of American Debt Crisis and the Long Recovery”, skriven av professorerna Jeffry Frieden (Harvard) och Menzie Chinn (Wisconsin). De två författarna kritiserar hårt Feds långdragna lågräntepolitik efter IT-krisen och den 11 september. Frieden och Chinn hänvisar också till hur lagstiftarna mer och mer ”avväpnade” förespråkarna av mer effektiva regleringar på finansmarknaden, vilket i sin tur bäddade för torftigt analyserade nya finansiella instrument och allt större risktagande.

6. Kommande amerikanska utmaningar

Man undrar osökt, hur finansmarknaderna kommer att hantera de amerikanska utmaningarna, när EMU-orkanen väl gått över. Det är ingen hemlighet att amerikanska analytiker och traders under de senaste kvartalen till nästan 100 procent fokuserat på EMU – och samtidigt mer eller mindre struntat i de egna problemen. Under min USA-resa i början av november fick jag tydligt uppleva på mikronivå, hur oroligt vanliga amerikanare (taxiförare, säljare, restauranganställda m m) ser på den personliga framtiden. En tullare frågade mig efter incheckningen på LA:s flygplats vad jag hade för yrke. När jag svarade ”professor in economics”, tillade hon allvarligt: ”Please stay here and tell Capitol Hill how to save this country”. Enbart faktumet att ”medicare”, ”medicaid” och ”social security” om cirka tio år kommer – ceteris paribus – att svara för mer än hälften av statens utgifter inger skräck hos många insiktsfulla människor.

7. ECB på väg att förlora sitt oberoende

Kommande tänkbara häftiga påtryckningar från marknadernas sida och eventuellt åtföljande åtgärder – speciellt mer eller eventuellt obegränsade uppköp av spekulationsdrabbade statsobligationer via EFSF/ECB – skulle tveklöst innebära ett ytterligare ett slag mot ECB:s oberoende och denna centralbanks primära roll som inflationsbekämpande institution. Med ett sådant ingrepp skulle två avgörande resultat från de senaste årtiondenas forskning ifrågasättas, det vill säga

- att oberoende centralbanker bekämpar inflation bättre än regeringsinfluerade

- att framgångsrik inflationsbekämpning via centralbanken trendmässigt ger bättre tillväxt.

I USA verkar man inte bry sig om dessa vedertagna konklusioner. Avseende ECB kan dock konstateras att denna centralbank fortfarande är ung med ett på endast mycket kort tid uppbyggt förtroendekapital. Det gör ECB mer sårbart. I det mer dogmatiska Tysklands ögon håller ECB:s förtroendekapital på att förstöras eller allvarligt skadas. Därför bekämpar Merkel och Bundesbank införandet av euroobligationer. Detta är en aspekt som icke delas av finansmarknaderna. Det återstår att se vilken position kommer att visa sig som den rätta.

8. Kan marknaden överhuvudtaget övertygas?

Ytterst bör man komma fram till frågan om marknaden överhuvudtaget kan övertygas av kommande åtgärder – vilket utseende dessa än må ha. Erforderliga stöd- och räddningsinsatser har blivit rörliga mål. Finansmarknadernas huvudscenario tycks vara eller bli att EMU spricker. Mycket pengar håller på att satsas på detta scenario. Nobelpristagaren Paul Samuelsons tidigare beskrivning av globaliseringen som ”ruthless economy” kan mycket väl vara på väg att verifieras på ett dramatiskt sätt.

9.  Psykologi dominerar

Ingen framtidsbedömning avseende EMU-krisen kan numera göras utan psykologiska infallsvinklar. För närvarande kommer finansmarknadspsykologi (”behavioral finance”) till full användning (”preference for certain news”, ”representativeness”, ”herd mentality” m m). Den avgörande frågan är just nu: Vad kan få finansmarknaderna att tro att en positiv vändning är på väg att inledas? Något givet svar på denna fråga finns inte längre. Idag behövs helt säkert mer övertygande bevis än för ett år sedan. Chansen till ett mer positivt och mindre kostsamt behandlingsrecept missades redan för ett år sedan.

10. Otäcka alternativ – eller finns det en ”deus ex machina”?

Det är uppenbart att EMU-försvaret har börjat vackla. Vilka steg än tas, så kommer reaktionerna att vara mycket osäkra eller rentav negativa. Övertygande åtgärder kan inte längre förutses – inte ens om ECB till sist skulle ges möjlighet till obegränsade uppköp av kvalitetssvaga obligationer.

Ännu så länge håller Tyskland – i synnerhet Bundesbank – emot. Men det får inte heller förbises att Angela Merkel i första hand är pragmatiker. Jag håller det inte längre för helt osannolikt att förbundskanslern byter fot om euroobligationer framstår som den absolut sista utvägen eller chansen (vilket finansmarknaderna anser redan idag)! Till en sådan situation har man dock ännu inte kommit. Alltjämt dominerar hos tyskarna – och speciellt Bundesbank – rädslan för skadliga långtidseffekter. Kanske kommer Merkel och Sarkozy till sist likväl hitta en kompromiss, kanske med en tidsbegränsad lösning eller dylikt. Merkel – som verkligen är en tuff förhandlare med stark kondition under småtimmarna – är som sagt ofta öppen för kompromisser, när bättre alternativ inte kan längre uppnås.

Det andra alternativet – ett fortsatt tyskt ”nej” till obegränsade obligationsförvärv för ECB och istället med sikte på andra lösningar – skulle möjligen ha ännu mer dramatiska följder, kanske eller troligen innebärande ett forcerat anfall mot Frankrike. Faller Frankrike, faller väl hela EMU. Det är mot denna bakgrund jag inte helt vill avvisa tanken om ovan nämnda kompromiss med Merkel som huvudaktör.

Kan det då finnas ett mirakel som idag ingen tänker på? Det ter sig svårt att komma på några exempel. Jag kan för närvarande inte se någon ”deus ex machina” som man kan hitta i den grekiska mytologin. Som ovan antytts, måste psykiskt väldigt labila finansmarknader övertygas. Psykologin spelar m a o en nyckelroll. Jag vill dock nämna tre inte helt omöjliga – men i dagsläget ej särskilt sannolika – inslag om hopp. Dessa skulle kunna vara

- snabbare och framför allt kraftfullare budgetförbättringar i de svaga EMU-länderna än vad allmänt antas;

- att ett flertal nya regeringschefer inom drabbade EMU-länder kan åstadkomma klart snabbare budgetframsteg än vad för närvarande förväntas;

- en ganska lindrig och/eller mycket kortvarig kommande konjunkturförsvagning som gör alla kommande åtstramningar mindre smärtsamma.

Har jag glömt något annat positivt som teoretiskt skulle kunna hända? Kanske konkreta nya unions- och/eller samarbetsplaner för EMU/EU? Väntar nyfiket på andra idéer, kanske mer realistiska sådana.

Sammanfattningsvis: Finansmarknadernas pågående attackstrategi kan möjligen innebära kortsiktiga vinster för (giriga) spekulanter. Höga långsiktiga kostnader för EMU:s eventuella sprickande kan dock bli mycket negativa för Europa. Detta genuina högkostnadsalternativ i sina värsta former sopas idag mer eller mindre under mattan. Hur som helst, vi alla vinner på att åtminstone EU kan hållas ihop. Det kan gälla miljön, framtida exogena chocker,, handelspolitik (men ej med hjälp av protektionism) eller den framtida skarpa konkurrensen med Kina och andra emerging markets.

Observera att emerging markets nyligen passerat det magiska 50-procent strecket vad gäller andelen i den globala produktionen! Europa tappar redan idag terräng på den globala arenan.

Summary

1. Two major financial and economic crises in the Western hemisphere within four years must be considered as tough and unusual events. During the first crisis from 2007 to 2009 – the so-called American subprime crisis with its global contagion on the real economy  – emerging markets succeeded quite well to counteract the big challenges on economic growth – in China, for example, by substantial growth packages and stable exchange rates instead of a slightly appreciating currency. There were visible downturns of GDP growth in a number of emerging economies – but these downturns  were quite short-lived.

2.  Now, the world is confronted with crises in some European countries and significant problems for the euro. Again, challenges are considerable for the financial sector, and – possibly or probably – for the real economy (investment and consumption) in most European countries – with concrete global contagion risks as well.

3.  Looking at important signals from emerging economies so far – for instance at the indices for the development on stock exchanges – they have  been moving considerably downward (MSCI – 18% in the first three quarters of 2011). This is more or less in line with the average downturn of European stock exchanges. Brazil, China, India, Taiwan, Argentina and Chile belong to the main losers in the emerging market area, whereas Russia, Indonesia, Malaysia, Korea and Mexico performed relatively well in this harsh financial climate. Consequently, we can note that emerging markets do not always show homogenous developments during the ongoing European and global nervousness.

4.  What makes the difference between the above-mentioned positive groups of emerging countries and the more negatively reacting ones?  In my eyes, this split – at least when watching the stock exchanges – into the two categories of emerging countries is not really transparent. Could it be that Russia, Indonesia, Malaysia and Mexico are all oil-producing countries (but not Korea!)? This causality seems to be weak. Obviously, more analysis is needed, also when regarding the poor performances of the stock exchanges in China, India and Brazil – as much in three out of five BRICS countries. In some cases, previous rapid upturns may have led to some kind of normalizing downturns.

5.  In general terms, however,  it is obvious that emerging countries with strong macroeconomic fundamentals (low inflation, good performances of the balances of current account and governmental budgets, etc.) tend to be less negatively affected by speculators and to be preferred – using the term of former Nobel Prize winner James Tobin – by the increasing number of risk averters.

6.  I have been writing it many times before – but would like to repeat it: financial and economic stability begins at home, in emerging economies as well. So does the resilience of emerging economies to Western/global exogenous financial and economic shocks. Furthermore, resilience is also a function of the distribution of exports and domestic demand. Strongly export-intensive emerging countries are, of course, more sensitive to economic shocks from Western economies than developing economies that have more concentration on domestic consumption and investments.

7.  There is no doubt:  foreign investors try to find the most solid markets when risk aversion is the melody of the financial investors’ community. Thus, more risky emerging markets suffer from this kind of re-consideration of investment strategies. At least in the case of China, the mood of financial investors has become somewhat more cautious during the course of 2011 – due to persisting high inflation, overheating and banking fears. India suffers – as usual – from the twin deficits in the current account and the public deficits. Brazil, on the other hand does not. Finding more causality in the economic  and financial behavior and reactions of emerging countries to financial and economic shocks from advanced countries could actually become an interesting research topic.

8.  Another interesting issue: To what extent are (foreign) investors influenced by major commodity resources in an emerging country, both when it comes to their FDI and more short-sighted portfolio investment? Still, it seems to be difficult to see some major decoupling from Western industrial trends in mainly commodity-producing countries. At the same time,  we should not forget that strongly commodity-producing emerging countries also can have an impact on the economy of many other emerging countries that have no mentionable commodity production potential.

9.  Summary:  emerging markets are not always homogenous in their development of GDP changes as a reaction on major financial and economic turmoil in Western countries. All emerging countries have economic conditions on their own. For this reason, (foreign) investors and analysts should work with each and every emerging market separately – and not treat them as homogenous groups of countries, even if economic short-trends sometimes may look homogenous.

10. Different economic conditions in emerging markets in a political and macroeconomic sense also mean varying economic resilience to Western economic shocks. Automatic economic growth cannot be achieved by any country in the globalized economic competition of today. Or as professor Dani Rodrick recently put in a widely observed speech in Jackson Hole on August 25-27 this year when regarding more long-term  growth perspectives:   “As the empirical literature on growth has documented, convergence (of growth between advanced countries and emerging countries; own comment) is anything but automatic. It is conditional on specific policies and institutional arrangements…”.

Figuring out how new policies affect the economy both in the shorter and longer run are crucial to policy decisions. The organization of historical data in this context – managed by the two laureates – is certainly a masterpiece. Sure, many times expectations are rational as Sergent assumes. But I also would like very much that “bounded rationality” – as the great Herbert Simon once put it – can become an integrated part of future economy modeling.

Looking four years back, this highest economic award went twice to macroeconomic research (Krugman, Sims/Sargent), one to microeconomic issues (Diamond/ Mortensen/Pissarides), and once to microeconomic results (Williamson) together with an interdisciplinary approach (Ostrom).   

What will happen next year? I could imagine that focus will be put on corporates, finance/banking, econometrics, economic growth or economics with links to other sciences like psychology, health or the environment. However, I need much deeper reflections to produce my next list of candidates and – hopefully – to find again the relevant research areas and economists that may be awarded.

Areas that could be interesting this year are particularly growth theory from both the microeconomic and the macroeconomic angle, business cycle research and private consumption – but also theory of firms, theory of incentives, and still some parts of finance and – as always – certain important macro- and microeconomic methodological and econometrical breakthroughs. I would not rule out economic research topics with interdisciplinary links to psychology, politics, law and regulations, the environment and health – despite the recognition of sociology two years ago.

Most of text of this article is in Swedish – but foreign readers can watch headlines in English above the three specific tables with my own favorite candidates (at the end of this paper). Most candidates come again from the U.S. From there, Paul Romer, Robert Barro, Elhanan Helpman, Gene Grossman, Christopher Sims, Jerry Hausman, Lars Peter Hansen, Kevin Murphy, Robert Hall, Oliver Hart and Robert Shiller are my own favorite candidates. If the award goes to Europe, the French economist Jean Tirole (Toulouse) should be the most probable candidate and Alberto Alesina and Richard Blundell his main European challengers. From Asia, I consider Avinash Dixit as the main candidate and still Jagdish Bhagwati as his main Asian challenger.

Totally, I present three lists of personally  favored candidates: a very narrow one (page 6, 10 candidates), a relatively narrow one (page 6, around 20 candidates)  and a broader one (page 8, around 40 candidates). 10 thinkable joint combinations of names and areas are taken up as a new approach – but analysts of my tables should concentrate more on the three other lists. We will have to see whether the next Nobel Prize winner(s) more belongs (belong) to the group of economists with scientific breakthroughs or to the group of researchers that are linked to more current topics like Kenneth Rogoff and Carmen Reinhart. The first group has been dominating so far – and will most probably continue to do so.

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Abstract / Summary                                                                                                                                       

The predictability of financial crises is widely regarded as low, particularly in academia and at central banks.  This dominating belief should, however, in many cases be considered as a flight from trying to acquire improved skills – skills that are greatly linked to market psychology (behavioral finance) and the understanding of history and macrofinancial aggregates. Sure, behavioral finance has gained some reputation in the past 10 or 15 years. But its benefits are still undervalued, particularly when trying to recognize exuberant financial markets and the risk of bursting asset price bubbles at an earlier stage.

The above-mentioned areas of financial markets research have been insufficiently integrated in the forecasting and risk management of financial institutions as well. It is time to accept that the neoclassical model – which still dominates financial modeling – can no longer be applied as nicely as it has in the past. It has been obviously the case in Sweden that the financial crises of the early 1990s and in the latter part of the past decade were caused by overconfidence, control illusion and flock mentality – but also by shortcomings in management and corporate governance. The first failure meant severe austerity for Swedish households, the second for the Baltic countries – particularly in Latvia. Research on the banks’ management failures remains underdeveloped.   

There is no evidence whatsoever that these two serious Swedish banking crises were not foreseeable. Only 17 years had passed between the eruptions of the two crises.  The question is when and under which circumstances financial decision-makers and authorities should listen to the usual minority of warning voices. And how (certain) warning voices can/could be heard more effectively, both now and then. Rating institutes are obviously unable to play this role. They often make things even worse.

Another important conclusion is that economists should be more “in house-oriented” and inform their top management regularly about issues that will or may affect their financial institution. Top managers, on the other hand should take the time to meet economists – and stop hiding their own frequent shortcomings in macroeconomic and macrofinancial skills.

Certain conclusions from this paper can also be drawn for China, India and other emerging markets.

Key words:  Financial crisis, behavioral finance, forecasting, China, India, management and corporate governance  JEL:  C 00, E 44, E 58, G 28, G 34, G 38, N 24, O11, O12, O 53

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I samband med den amerikanska ”subprime”-krisen och dess globala eskalering för numera 3-4 år sedan kunde Kina nästintill uppträda som räddare av världsekonmin. Kinesiska stimulanspaket i storleksordningen 600 miljarder USD och en extrem kreditexpansion medförde att Kina lyckades uppträda som viktig tillväxtoas även under det svåra konjunkturåret 2009 – med positiva återverkningar på många företag i övriga Asien, USA och Europa. Det ter sig emellertid osannolikt att Kina återigen skulle kunna  uppträda som tillväxtmotor vid en eventuell förnyad global konjunkturförsvagning som följd av kaoset på världens finansmarknader.

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During the first part of the still ongoing global financial crisis – which started four years ago – China was able to stimulate its economy by a 586 billion USD package, a simultaneously extremely loose credit policy and a temporarily stop of the country’s cautious appreciation policy. The big question is whether China can “rescue” the world economy once more if the U.S., Japan and Europe again suffered from a severe weakening of economic  growth. The most probable answer is:  no – for the following reasons:

1.The state of China’s public finance is – officially – still favorable. Recently, however, doubts have risen about the real public debt situation, particularly when it comes to provincial and local indebtedness. Furthermore, a lot of public financing is done outside the official budget process and, consequently, not part of reported government debt.

2. The fast credit expansion in past years has risen the risk of future bad loans considerably. Estimates say that total loans have increased from 120 percent of GDP to as much as 175 percent in the past three years. If these numbers are roughly correct, there is really an urgent need to achieve a markedly slower credit growth for the time being in order to avoid future huge credit losses.

3. An urgent need to achieve a substantially slower growth of Chinese bank loans comes also from China’s accelerating inflation problems. CPI rose by 6.5 percent in July – and by more than 7 percent in the rural areas where people’s income is clearly lower than in the urban regions. Even worse, food prices went up by almost 15 percent. Unfortunately, poor people are most sharply hit by this development. Inflation is the worst enemy for income distribution in China – a phenomenon that certainly is very much disliked by China’s political leadership as well. In  other words: there is no way for China to conduct a visibly more expansionary credit policy any time soon unless GDP growth is really coming in bad regions. This can be said even if the peak of CPI increases may be reached in the forthcoming months.

4. The bubble in the real estate sector of the metropolitan areas still does not seem to be disarmed. New stimuli for construction activities are really not needed.

5. Finally, China needs some cooling down of its investments in order to optimize investment efforts again. In the past three years, a significant number of investment projects were not really the most urgent ones. Capital allocation has to be improved which assumes less generous quantities for new credits.

Summarizing the aspects of this blog should not mean that China will be facing a poor development later this year and/or in 2012. My own survey from June with China specialists from all over the world predicts a GDP growth on average by 9.0 percent this year (q4 this year: 8.4 percent) and by 8.6 in 201. This seems to be realistic – and not bad after all.

The Chinese Economy – 20 Burdening Conflicts of Goals
Summary / Abstract
During 2010, China became the number two country in the world measured by total GDP (in PPP terms).
Without a doubt, GDP growth has been impressive since the start of the opening-up policy in 1979, particularly in the past decade. However, China’s extremely rapid economic growth has also had its price.
This is expressed in the many different economic imbalances – but also in a substantial number of conflict of goals for Chinese economic policymakers. Thus, one big question concerns the strategic areas that will dominate Chinese policy in a shorter and longer perspective. The other big question is to what extent policy priorities can really be achieved. Finally, one should raise the question whether the officially desired priorities contribute to a healthier trend in the Chinese economy.
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During the spring of 2011, global financial markets finally became more concerned about possible unhealthy developments in the Chinese economy, drawing focus away somewhat from previous pure GDP analysis – which, by the way, mostly happened without really considering the statistical shortcomings of the GDP numbers (see also my new discussion paper from May 2011 with the title “Benefits from improved Chinese statistics in a European/global investors’ perspective”, SNEE). Now, global economists increasingly consider Chinese inflation and the risk of bursting real estate bubbles in (metropolitan) Chinese cities. However, the interpretation of the Chinese economy is still strongly underdeveloped in our part of the world. This is understandable, since it takes years to get a feeling for Chinese economic reality and the conflicts that – in Western eyes – may impede the speed and correctness of the official policy answers.
It is also important to understand that the Chinese are not looking for rapid changes but tend to prefer more cautious, gradual approaches. This is the traditional, cultural background which sometimes may be well-justified – but which many times does not fit the “rules” of the global economy or vice versa. For example, we can see these days that global financial markets do not even appreciate the – compared to
Chinese conditions – relatively fast EU reactions on currently existing difficulties in the Euro zone.
Looking at the situation today, twenty Chinese conflicts of interest could easily be singled out in this paper. They are presented below. This situation is worrisome since the other big country with burdening large economic imbalances – the U.S. – still depends largely on huge capital inflows from China. Many steps have to be taken in order to decrease this special global imbalance between the two leading economies in the world from today’s frightening levels. Chinese conflicts of economic policy objectives play an important role in this context. They appear as follows (in no particular ranking order):
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LNU’s China Panel Survey No 12 – May 2011:
“Some cooling down seems to become reality”
Summary
• Our so-called overheating indicator rose in May to 7.3, up from 7.1 in October 2010
(10=extremely overheated). Around 25 China experts from Asia, North America and Europe participated once again in the survey.
• GDP forecasts (average): 2011: 9.0 %, 2011 q4: 8.4 %, 2012: 8.6 %. The outlook for
2011 is roughly unchanged – but a notch weaker for 2012 than last fall.
• 44 % of the panelists predict that the RMB will have a slight appreciation against the U.S. dollar in 2011 up to 5 % and 44 %, as well as a more visible one (by more than 5 %). The latter share has been growing since last October.
• 100 % of the panelists think that there is a dangerous price bubble on the real estate market (Oct 2010: 95 %).
• The panel’s grading of confidence in the Chinese economy looks as follows:
(5=very high confidence; 1=very low confidence)
3 years from now: 3.7 5 years from now: 3.3 10 years from now: 3.2

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