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Mikka Pineda identifies striking similarities in U.S. inflation attitudes between the mid-1930s, when the U.S. began to show signs of recovery from the Depression, and 2009. The report serves as a qualitative accompaniment to her Comparing Three Crises report published earlier this year. Pineda dug deep through news and magazine archives to construct an account of the subjective economic assessments prevalent in the mid-1930s. She compares quotes from the mid-1930s side-by-side with quotes from 2009 to show that Americans during the Great Depression voiced the same concerns about excess bank reserves, budget deficits, competitive devaluations and commodities speculation as they do today. Even dissenting arguments followed the same script in both eras. The eerie resemblance in the psychological and economic backdrop of the mid-1930s and 2009 - both historic junctures when recovery was thought to to have begun - suggests the U.S. teeters on the edge of a double-dip.

This week’s note is excerpted from a longer analysis piece RGE has just published examining U.S. President Barack Obama’s current trip to East and Southeast Asia. The full piece, which includes analysis of U.S.-North Korea relations, the U.S.-South Korea free trade deal, APEC’s integration process and looming questions about Myanmar, is available to RGE’s premium clientele here: “Obama Tours Asia with a Full Agenda” (login required).

President Obama embarked on his highly-anticipated maiden visit to Asia last week, furthering his efforts at global outreach. The trip comes as global leaders are reckoning with an unsynchronized exit from economic policies that have helped end the worst recession of the post-war era. Policy changes in Asia, particularly among major U.S. creditors, will be essential to rebalance global growth: APEC members (including those in the Americas) absorb 55% of U.S. goods exports and provide a major market for U.S. service exports, while Asia depends on U.S. consumers and foreign direct investment (FDI) to drive economic growth. With the trip, Obama aims to renew U.S. political and economic influence in a region that analysts claim was ignored by the previous administration, addressing key issues like economic cooperation, climate change, free trade and the regional balance of power. By spending nine days abroad as domestic issues like health care and unemployment vie for his attention, the president acknowledges the growing importance of the U.S. relationship with a rising Asia.

Obama’s first stop was Japan, a key U.S. ally and the host of a large (and increasingly contested) U.S. military concentration. Next, Obama stopped in Singapore, where he attended the APEC meeting. Obama, whose cap-and-trade legislation is stalled in Congress, was among the world leaders who accepted that a binding carbon emissions deal was unrealistic, saying the best that could be hoped for was a “politically binding” deal. On the sidelines of the APEC meeting, Obama met Russian President Dmitry Medvedev to discuss U.S.-Russia ties, the new arms control treaty and possible sanctions on Iran and North Korea. While in Singapore, Obama attended the first U.S.-Association of Southeast Asian Nations (ASEAN) summit, which was also attended by Myanmar’s leader, before arriving in China. His final stop will be South Korea, where talks of disarming North Korea may overshadow discussions on the U.S.-South Korea trade agreement.

Tensions and Reassurance in China

Ahead of Obama’s visit to China, U.S. officials have focused on a new goal of “strategic reassurance” that China will seek to maintain global stability as the country’s influence grows. A bilateral deal on climate change would have sent a powerful signal on this accord. Although U.S. and Chinese leaders signed several agreements on clean energy initiatives, in part because of job creation goals, neither side was ready to make any binding commitments on carbon reduction.

Similarly, the U.S. sought Chinese support on Afghanistan, Iran and North Korea, but no meaningful cooperative agreements have been aired publically. Over the past year, however, Chinese and U.S. leaders have been meeting more often than they have during past U.S. administrations, and linkages at all levels of governments have increased.

Trade and currency issues dominated the U.S.-China meetings, as they have in past meetings, though the relevant discussions were brief. The U.S. claimed a weak renminbi (RMB) would prevent the correction of global imbalances that both sides seek, but China put the blame on U.S. debt levels. This visit comes as market actors are increasingly pricing in a renewed gradual appreciation of the RMB over the next six months, as detailed in the recent RGE Analysis What Is China’s Exit Strategy? by Adam Wolfe and Rachel Ziemba.

Just before Obama’s arrival, a senior Chinese official criticized the loose U.S. monetary policy for the first time. As in their trade meeting in Hangzhou last month, China and the U.S. pledged to work together to avoid a trade war as pressure builds in both countries’ export sectors. As the global economy has begun to stabilize, the number of anti-dumping complaints has grown. Calm heads may prevail in the end, but, again, no strong commitments came from Obama’s visit or the meeting of trade leaders on October 29.

China sent a political message by skipping some of the goodwill gestures that usually accompany a U.S. presidential visit. Ahead of the visit, Chinese dissidents were reportedly rounded up, a striking contrast to the token prisoner releases that tended to precede visits from Presidents Clinton and Bush. Likewise, Obama’s “town hall” meeting in Shanghai was not televised live across China as past U.S. presidential speeches were. In addition to asserting China’s desire to level the political playing field, the moves may reflect insecurity on the part of China’s leadership, stemming in part from concern that the domestic economic recovery remains “unstable, unbalanced and not yet solid.” Even if it is better positioned to resist U.S. pressures, China still has a limited ability to alter policy in Washington, in part because China’s pursuit of macroeconomic stability from the dollar peg constrains other policies, including reserve diversification. U.S. Secretary of Commerce Gary Locke has bluntly defended the designation of China as a “nonmarket economy” for antidumping cases.

Editors Note: The Following RGE premium content, "Latin American CDS: Fully Recovered, What are the Risks?" is available to paid clients.

Bertrand Delgado, Elisa Parisi-Capone and Alejandro Rivera, take a close look at Latin America’s 5 year CDS fundamental and counterparty risk dynamics.  They examine the extent to which counterparty risks explain the sharp movement in CDS spreads both during and after the crisis.  

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Christian Menegatti and Prajakta Bhide assess the latest U.S. retail sales data.  

Editor's Note: The following is excerpted from RGE premium content. The full analysis, "What is China's Exit Strategy" is available to paid clients.

As President Obama meets with Chinese leaders this week, external pressure is building on China for currency appreciation. But Chinese officials will be reluctant to undermine the nascent exports recovery, particularly if it seems to be ordered up from overseas. In this analysis, we look at the internal and external pressures on the RMB, China’s likely exit strategy from its extremely loose monetary policies and the consequences of such a move. 

President Obama's meeting with Southeast Asian leaders—including Myanmar's prime minister—on Sunday will reflect the new U.S. stance on countries with unsavory human rights practices: pursuing engagement rather than isolation. On the sidelines of the UN General Assembly in September, Secretary of State Hillary Clinton explained the change, acknowledging that sanctions without diplomacy had not accomplished U.S. policy goals in Myanmar, like swaying the military regime to free political prisoners and pursuing peace with ethnic minorities. She revealed the most novel aspects of the administration's new approach, however, at this week's APEC meetings in Singapore when she asked for help from China, India and Thailand—three of Myanmar's key economic partners—to pressure the military regime to allow free elections in 2010.

Countries with sanctions against Myanmar—including the U.S., EU, Canada and Australia—say that Myanmar’s investment and trade ties with China and other regional partners undermine the effectiveness of punitive trade restrictions. The construction of a multibillion dollar pipeline that will provide China with oil and natural gas and Myanmar's military regime with badly needed revenue stands to further minimize the sanctions' efficacy, and could also lead to further human rights violations through land confiscations or forced labor.

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Check out all the great contributions that were published during the past week on RGE’s Nouriel Roubini's Global EconoMonitor, RGE Analyst’s EconoMonitor, Finance & Markets Monitor, Peterson Institute for International Economics Monitor, Global Macro EconoMonitor, U.S. EconoMonitor, Emerging Markets Monitor, Asia EconoMonitor, Latin America EconoMonitor and Europe EconoMonitor.

On Nouriel Roubini's Global EconoMonitor, the RGE Analysts focus on expected growth and inflation dynamics to determine the course of monetary policy actions in advanced and emerging market economies.  Please read Global Monetary Policy Outlook.

On the RGE Analyst’s EconoMonitor, Katharina Jungen takes the twentieth anniversary of the fall of the Berlin Wall as an opportunity to review the progress of economic convergence between the former German Democratic Republic (GDR) and West Germany.  Katharina notes that due to its economy’s lack of dynamism, not only has the East been lagging behind its western counterpart, but it is also set to be overtaken by other post-communist economies.  In order to revive the catching-up process, which has practically been on hold for the past decade, Katharina argues that a redirection of financial aid from social security transfers towards supporting innovation in small firms is key.  Please read Germany, 20 Years On: Goals Reached?

In Another Bleak U.S. Labor Market Report, Arpitha Bykere and Christian Menegatti argue that U.S. job losses remain high despite easing in the recent months. Amid continued job losses, record low work hours and subdued labor compensation, consumer spending will remain weak, especially as the impact of policy stimulus fades. Sluggish hiring will keep the unemployment rate high for some time and contribute to the slack in the economy.

In The Zombies are Coming... Again, Christian Menegatti and Elisa Parisi-Capone revisit the number and names of zombie banks in the U.S. as of Q2 2009.

In Revisiting 2009 Predictions for Equity Markets Monika Brown reviews and analyzes analyst predictions made in January 2009. A divergence in opinion between the large institutional managers and independent managers is noted.

On the Finance & Markets Monitor, Joseph Mason asserts that the discussion draft for financial reform released by the Senate Banking Committee doesn’t contain much that is worthwhile, and Mason argues that reform requires serious inquiry and understanding into the causes of the crisis; otherwise it is just a political exercise in the run-up to mid-term elections. Read In Crisis Inevitably Breeds Leviathan.

In Senate Bill Would Break-Up TBTF Banks, Barry Ritholtz takes a look at a bill that is gaining ground in Congress that would “break-up” big banks, addressing the too big or too interconnected to fail problem.

On the Peterson Institute for International Economics Monitor, Anders Aslund discusses the complaints that the CIS countries are having with Russia including Russia’s lack of respect for its neighbors’ territorial integrity, gas policy, trade conflicts, and financial issues.  Russia’s reputation as an unreliable and unpredictable partner is contributing to its increasing isolation on the world stage.  See The Leader of the CIS Is Lonely and Weak.

In India: New Letter and Spirit, Arvind Subramanian looks at the radical views of Jairam Ramesh, minister of state for the environment, as India struggles with its identity as an international player with the emergence of the G-20.

On the Global Macro EconoMonitor, James Kwak points out that productivity growth, which is often quoted in the media and is almost always referring to labor productivity, can be all over the map in the short term and especially during recessions; productivity often falls during a recession as output falls faster than companies lay off workers and spikes afterward because output is growing right while companies are laying off workers.  However, in the long term, productivity growth depends on thing like improvements in technology and business processes.  Read Productivity and Layoffs.

In If the Fed is Looking to Inflate Away Problems, What Should Asia Do? Edward Harrison presents a piece by Andy Xie who suggests that China and Japan should form a new free trade agreement.

In Parallels Between US and Japanese Economies Edward Harrison presents a clip of Marshall Auerback elaborating on the similarities between the U.S. and Japanese economies pointing to the misallocation of fiscal resources, crony capitalism, zombie banks, and low interest rates.

On the U.S. EconoMonitor, Fabius Maximus shows how ridiculous it is that most Americans vote their pocketbooks in elections to Congress and the Presidency.  See A Note about the US Economy and the Recent Elections (Yes, We’re Nuts)

In The Fed is Already Transparent, Mark Thoma presents a piece by Anil Kashyap and Frederic Mishkin who are worried that the Ron Paul proposal to audit the Fed will “cripple policy making.”  Thoma adds that the people are frustrated that they don’t feel the Fed is acting on their behalf, and Thoma offers some solutions to make the people feel that they have more influence.

In Inflation Expectations Continue to Inch Higher, James Picerno points out that it appears that the financial system has stabilized and the battle against deflation seems to have been won, but that doesn’t make it any easier to predict precisely how the Fed will act going forward.

Also on the U.S. EconoMonitor:

Unemployment Rate Illusion by Edward Harrison

Understatement of the Year: “Recovery Hampered by Unemployment” by Barry Ritholtz

On the Emerging Markets Monitor, Antonio Carlos Lemgruber recognizes the seriousness of the dollar party and recommends keeping an eye, as usual, on what is happening in the U.S.  Lemgruber sees these “negative” signs occurring as soon as the very beginning of 2010.  Read The Dollar Party.

On the Asia EconoMonitor, Anoop Singh wrestles with the mystery of Asian firms that save but don’t invest and households that hold wealth and don’t consume, which is contributing to global imbalances and constraining its long-term growth potential.  Singh offers corporate governance and financial sector development as vital clues, which present interesting policy implications.  See Asia's Corporate Saving Mystery.

In The IMF on Asia's Recovery and its Sustainability, Claus Vistesen argues that Asian countries “hold little promise in terms of providing a decisive engine for rebalancing through sustainable growth in domestic demand which exceed investment rate, and therefore is cautious on the overall sustainability of the recovery in Asia.

On the Europe EconoMonitor, David Smith reports that in the UK, the Bank’s new forecasts are more upbeat and predict higher inflation, while unemployment figures continued the very encouraging pattern.  See Bank Moderately Upbeat - Good Unemployment News by David Smith

In The Dollar As A Funding Currency, Edward Hugh discusses carry trades and exit strategies.

In this week’s note, we take a look at some recent monetary policy trends in advanced economies. This content is excerpted from a longer piece, “Global Monetary Policy Review” (requires login), which includes in-depth analysis of when the world’s emerging markets might shift interest rate strategy. This longer piece is available exclusively for the use of RGE’s clients.

Last week was a busy one for the Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of England (BoE). Policymaking is tricky when different asset classes are sending very different signals about the economy. However, those different signals are themselves a byproduct of policy. In the U.S., bond markets are discounting a sluggish U-shaped recovery or even a double-dip recession, while risky markets are signaling a strong V-shaped recovery ahead.

Which is right? While RGE leans towards the U-shaped camp, we do not expect risky assets to invert their course as long as the Federal Reserve commits to maintaining “exceptionally low levels of the federal funds rate for an extended period.”  So the policy dilemma is one of having to maintain “exceptionally low rates” given the still very difficult real economic conditions, but with the danger of an increasing disconnect between risky asset valuations and the economy–which could eventually snap back and compromise economic and financial stability in the medium term. While this environment reignites the debate on whether central banks should target asset prices or not, RGE maintains that Fed fund hikes are a story for end of 2010 or Q1 2011.

The Bank of England kept its rate on hold at 0.5% for the 8th consecutive month in November with another hold almost certain in December. As the UK economy failed to pull out of recession in Q3 2009, a rise in interest rates is unlikely to occur before Q2 2010; a view supported by evidence in the money markets. The Monetary Policy Committee did move to increase the program of quantitative easing, asking the Chancellor of the Exchequer, Alistair Darling, for an extra £25 billion to be pumped into the economy, bringing the total amount to £200 billion. With interest rates remaining at a historically low level and public finances precarious, quantitative easing has replaced traditional monetary and fiscal policy as the favoured tool of policy makers. The extra £25 billion is likely to act as the final push with the Bank of England attempting to revive an economy operating with spare capacity. It is unlikely that any further increase in quantitative easing will occur, barring a severe economic shock.

The ECB, meanwhile, stayed on hold at 1.0% in November. ECB president Jean-Claude Trichet expressed concern over the excess volatility and strength of the U.S. dollar. Nonetheless, further rate cuts seem unnecessary as signs of economic stabilization and a deceleration of deflation have emerged. Broad money supply growth continues to decelerate and credit to households and non-financial businesses is contracting. The ECB will continue conducting the QE operations it started July 6, but December may be the last tender for its 12-month refinancing operation. Trichet signaled as much, saying "not all our liquidity measures will be needed to the same extent as in the past."

While global monetary policy easing was synchronized, tightening does not need to be.  Australia embarked on its rate tightening phase earlier than other developed world central banks. It raised rates twice, in October and November, by 25 basis points each. Australia avoided a recession in 2009 thanks to commodity restocking and prompt fiscal and monetary easing. Australia will likely remain on a gradual easing path, however, until the strength and sustainability of its recovery becomes clearer. Extra government subsidies for home purchases sparked a buying boom that raised Australia's mortgage debt level to a new high. The expiry of those subsidies at the end of 2009 and the increases in interest rates could restrain the recovery of domestic demand. On the other hand, recovering export demand and the expansion of a Treasury program to buy resident MBS may help offset the decline in direct support to home buyers.

Following in the footsteps of the Reserve Bank of Australia, which was the first among advanced economies to hike rates, Norges Bank (Norway's central bank) recently increased its key policy rate by 0.25 percentage points to 1.5%. The executive board's strategy sets the key policy rate interval at 1.25% - 2.25% until its meeting in March 2010. Given the Norwegian economy's mild downturn and strong recovery prospects, monetary tightening was expected. Norges Bank cautioned that a stronger krone could slow its expected pace of rate increases.

In October, the Bank of Japan (BoJ) adjusted its policy to reflect the modest improvements in credit markets and the economy. Due to thawing corporate credit markets and very weak demand* at the BoJ's special facilities to purchase corporate bonds and commercial paper, the Bank of Japan decided to allow those programs to expire at the end of 2009 as planned. Further purchases would only distort corporate debt pricing as liquidity returns to the market. As a safety precaution against potential disruptions to corporate credit for businesses that cannot access market funding, the Bank of Japan extended until March 2010 its program to offer unlimited low interest rate loans to banks, collateralized with corporate debt. However, at the behest of the Ministry of Finance, the Bank of Japan will keep purchasing government debt. Like other central banks that engaged heavily in unconventional easing, the BoJ will roll back its targeted easing programs before resorting to the blunter tool of rate hikes. The BoJ reiterated its view that deflation will grip Japan until 2011, hence the policy rate will likely stay on hold throughout 2010. See Bank of Japan's Exit from Monetary Easing: Strategies and Timing.

After having to hike interest rates aggressively in the 2006– 2008 period, most central banks from emerging market economies had to undo them rapidly from the end of 2008 to Q3 2009, as output gaps widened significantly and inflation and inflation expectations collapsed as a result of the global crisis. Moreover, currencies experienced strong appreciating pressures from the end of Q1 2009 onwards, facilitating the dovish monetary policy reaction. Now that the worst of the global crisis seems to have past, macroeconomic policies are loose, and economic activities are healing, central banks are facing the difficult task of carefully implementing exit strategies, while avoiding exacerbating appreciative pressures on their currencies and trying to control asset inflation and bubbles.

Asian central banks will be the first among emerging markets to tighten monetary policy as capital inflows and loose policies since late 2008 are raising liquidity and asset inflation. But goods inflation will remain within the central banks’ target in most countries amid a slow recovery in domestic demand, weak credit growth in Asia ex-China, and an output gap. This will delay interest rate hikes into 2010, especially in the export-dependent economies, and constrain aggressive tightening until domestic and external demand improve further. Until then, Asian central banks will continue to fight credit and asset bubbles via liquidity absorption and regulatory and prudential measures, such as in real estate.  Countries that are less export-dependent and have attractive asset markets—India, South Korea and Indonesia—will be the first ones to hike rates and allow currency appreciation. In November 2009, Taiwan banned foreign inflows in time deposits and might resort to further capital controls. If hot inflows maintain their momentum, other Asian countries might use enforcement or regulatory measures to manage capital flows.

In Latin America, there is a marked differentiation on the speed of the economic recovery; however, most countries will experience slow closing of the output gaps over the next year.  Moreover, stable if not strong currencies (BRL, CLP, COP, MXN, and PEN) and limited upward wage pressures should help in containing probable external supply-side shocks emerging from commodity prices and limit inflationary pressures sparked by recovering domestic demand. Although inflation and inflation expectations will bounce back, central banks will most likely achieve their inflation targets in 2010. Nevertheless, monetary authorities will start moving away from a very loose monetary policy stance toward a neutral one in 2010 in order to safeguard medium-term inflation expectations once the recovery has gained momentum.  In this light, central banks mainly will target the monetary policy rate.  However, upward adjustment in other monetary policy instruments (reserve requirements and margin reserve requirements) will likely be implemented.  Those central banks that have acted the most aggressively and face potential surprises to the upside in growth and inflation will initiate the mapping out of excessive accommodation sooner than the rest. 

Rate hikes in Central and Eastern European (CEE) countries are expected to lag those in other emerging market regions given the particularly sharp downturn in the CEE and prospects for a weak recovery. Many central banks are still in easing mode, amid economic contractions and easing inflation. Uneven growth prospects across the region mean monetary policy paths will vary.

Aside from Israel, which in August became the first country globally to begin raising interest rates, Middle East and Africa will remain effectively on hold until late in 2010. Most of the GCC countries peg to the U.S. dollar and thus import U.S. monetary policy. Meanwhile despite the inflationary impact of a weak dollar, tight domestic credit conditions will restrain a liquidity surge.

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 * As of Sept. 30, only 100 billion yen of commercial paper (CP) was offered for the BoJ to purchase - just 3% of the 3 trillion yen allocated by the BoJ for the CP purchasing program. Only 300 billion yen of corporate bonds was offered for the BoJ to purchase - just 30% of 1 trillion yen allocated for the corporate bond purchasing program.

In evaluating market predictions from the beginning of the year, there is usually an opportunity to point out which analysts got it right and which got it wrong, amid a broad range of predictions. For 2009, however, most analysts predicted a small recovery in the equity markets, a low-risk bet after the S&P 500's drop of almost 40% in 2008 and similar moves in global equity markets.

This prediction trend among institutional analysts turned out to be too cautious. Most expected only a small recovery in the S&P 500, which is currently up 18% on the year. A few cautiously recommended emerging markets, while others underweighted the sector. None forecast the huge rally in the BRIC nations–Brazil, Russia, India and China–which posted gains of 65-100%. The exceptions to the rule were independent managers like Marc Faber and Felix Zulauf: Faber scored with emerging market equities, while Zulauf’s choices, the Hong Kong and Singaporean markets, have both risen about 50% YTD.

Analysts' Predictions for 2009

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