The Summer of LUV revisited
In July, Stella Dawson, Reuters’ global treasury editor, posted some thoughts on what she called the Summer of LUV, a description of a three-pronged global economic recovery based on the idea of different patterns in the United States, Europe and Asia. Since then her LUV thesis has been picked up widely. Here is her update (as originally published in The Times newspaper).
Financial policymakers won round one. Their $5 trillion, shock-and-awe campaign of tax cuts, spending programmes and super-cheap official money has wrested the global economy from the jaws of a deep and damaging depression. Now the real test begins: withdrawing this massive monetary and fiscal support without letting their economies slide back into recession.
The outlines for the withdrawal strategy started to take shape this week from major central banks. Many analysts this summer were looking for a LUV-shaped global recovery. That’s LUV as in a long, slow and L-shaped recovery in Europe (steep drop, flat-lining); a U-shaped rebound in the United States (the same but an earlier recover); and a V in Asia, namely a steep downdraft, then off to the races again.
But in recent weeks it started to feel more like a V-shaped one. China is powering ahead and set to deliver 8 percent growth this year. The United States posted a robust 3.5 percent upswing in the third quarter. Australia, Norway and Israel are sufficiently confident that they have started raising interest rates again. Manufacturing and services indices worldwide for October turned upward.
But the underlying factor remains that this economic recovery, whatever shape it might be, is a drug-induced one. It is kept alive by the unprecedented injection of money into banks coffers and citizens pockets. Only when the extraordinary measures are withdrawn will it become clear whether economies truly have regained resiliency.
Central bankers have tip-toed into those waters. The Federal Reserve last Wednesday said it will trim the amount of mortgage agency debt it buys to $175 billion from $200 billion, a minor adjustment in a $3 trillion market and one it described as technical in nature. Nevertheless, it marks its second baby step toward weaning the U.S. housing market, the epicentre of the credit crisis, off life support.
The European Central Bank on Thursday joined in. President Jean-Claude Trichet said markets did not expect the ECB in December to renew its special programme of lending unlimited funds to banks for one year at very low rates. Decoding central bank speak, that means it is getting ready to withdraw support. Only the Bank of England on Thursday cranked up the machine. Yet its 25 billion pound expansion of asset purchases from banks to 200 billion pounds was half the increase expected. Little surprise it decided on more support when U.K. output has fallen by 6 percent since the start of 2008 and the country remains in the grip of its worst recession in at least 50 years.
But LUVers needn’t worry. Inventory rebuilding lies behind much of the stronger-than-expected growth countries have enjoyed in the past six months. Real, sustainable demand is shaky. In the U.S. for example, factory inventories grew in October but new orders, exports and delivery times all fell, suggesting a one-off boost. GDP numbers also were driven by government home purchase incentives and the cash-for-clunkers car buying programme, which is expiring. The consumer cannot pick up the slack when personal debt remains high, unemployment rising and home foreclosures continue at the rate of one filing per 13 seconds.
So little wonder stock markets after rocketing ahead for seven months have slipped and the VIX index, or fear gauge, is rising. The second phase of the rebuilding from the credit crisis has only just begun. LUV hurts.