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IMF predicts the unpredictable

Headline reports of the stark admissions, predictions and warnings in the two latest reports from the International Monetary Fund (IMF) literally overshadow the impact of the developing financial and economic crisis on the world’s population. A third report, also released this week, for the weekend spring meetings of the central bankers and finance ministers has been almost universally ignored.

The World Bank’s global monitoring report report deals with the results and prospects of action on the Millennium Development Goals (MDGs) such as child and maternal mortality, poverty, malnutrition, education, climate change, sustainable development. It’s not really surprising that nobody is paying them much attention now, since progress on the MDGs has always been made contingent on extracting crumbs from an ever-expanding capitalist economy.

Now the blunt statements from the IMF’s Global Financial Stability report and World Economic Outlook (WEO) tell us that “the financial market crisis that erupted in August 2007 has developed into the largest financial shock since the Great Depression”.

Headlines refer to the $945 billion predicted losses to the banks and other financial institutions arising from the US sub-prime mortgage crisis. But you should put this together with a muted, unquantified reference in the WEO to “rising questions about the soundness of the credit-default-swap market’”, which has played a big role in the so-called spreading of risk. Some put the size of that market, now effectively worthless, at $45 trillion, dwarfing the sub-prime losses. Doesn’t bear thinking about.

And, as “both of the financial system’s twin engines [the banking system and the securities markets] are faltering at the same time” the present credit squeeze could “mutate into a full-blown credit crunch”, warns the IMF. Especially as the huge injections of additional liquidity by the Federal Reserve and other central banks intended to ease the problem appear to be having the opposite effect – credit is becoming less available and more expensive.

With the US already in a recession, the IMF has revised its previous predictions for growth sharply downwards offering a 25% chance of a global recession. But is this a prediction dependent on the success of proposed co-ordinated action by a broad group of countries, or is it what might happen if such multilateral initiatives fail? It is just not clear. At least to me.

What the newspapers don’t report is that the IMF points to “a collective failure” to appreciate the extent of growth of credit and “the associated risks of a disorderly unwinding”. In other words, all those who were supposedly in a position to steer the global economy failed to see the dangers of a 60-year boom made possible only by a ballooning of credit in a variety of forms.

So why aren’t they all resigning? And why should we believe any of the predictions they are now making? Like this one: “All the advanced economies are expected to face serious consequences if deepening losses to bank capital and a further loss of confidence in structured financing were to transform the current credit squeeze into a full-blown credit crunch.” The IMF also admits that no previous episodes of distress in the finance sector “provide much guidance for the current unprecedented situation”.

As the mathematically-based econometric models they use for prediction aren’t up to the job, they’ve invented a new one based on “a combination of negative shocks” just to see what might happen. They consider three related shocks:

• A temporary shock to consumption and investment from a further tightening of credit conditions while the financial system goes through a protracted rehabilitation period during which capital and credibility are repaired after extended financial turmoil.
• A permanent downward shift in expectations for long-term productivity growth in the United States.
• A shift in investor preferences away from US assets.

Once again, the global consequences of this combination of shocks - a deeper and longer recession - don’t bear thinking about. Except that the IMF recommends that countries should start contingency planning. The worst is yet to come.

The uncertainly around the unravelling of credit and its impact brings to mind the famous 2002 statement by the then US secretary of defence, Donald Rumsfeld:

As we know,
There are known knowns.
There are things we know we know.
We also know
There are known unknowns.
That is to say
We know there are some things
We do not know.
But there are also unknown unknowns,
The ones we don't know
We don't know.

Gerry Gold
Economics editor
April 10, 2008



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