Signalling Cycles & Present Financial Crisis

1. Signalling Cycles & Present Financial Crisis Perspectives on a Financial Crisis Patrick McNutt www.patrickmcnutt.com

2. The storybook…… • The world economy is now enduring a signalling cycle that probably began in the US on March 12th 2007 and it will continue to oscillate until either a market equilibrium (= continued recession) or a co-ordinated equilibrium is reached. The latter could be achieved initially at the G-20 Summits if a managed exchange rate regime was on the agenda and a loud unambiguous signal transmitted to the international investment and financial community, with escape clauses, of a managed regime 2009 to 2011. It’s the best we can do given the uncertainty in the world markets.

3. Why signalling? • Financial and economic variables create cyclical patterns (CTL) • Government policy is necessary but not sufficient • Economic policy depends on policymaker’s commitment (PLT) • Signalling recognises that our economic system is dynamic

4. Post 2003 China Japan Surplus $ Middle East Property Boom Asset Bubble 2001 -2007 April 2nd 2007 March 12th 2007 New Century file for bankruptcy New Century Financial Corp: Shares Suspended Nasdaq Crash2001 Invest in US T-Bills US Interest Rates Low Banks Serving Global Products US$, ¥en, YUAN, EURO Sub-Prime and Ninja Loans Panic Actions Observed Only Financial Crisis

5. Old view……….

6. Signals in 2009/2010 • World of transient economies • EMs and ASLEEP v Anglo-Saxon • Moving from non-technology to technology sectors Signals to observe: • Corporate: Output ►demand ►income • China and Inflation • Correlation Shanghai Composite and S&P 500

7. Paradigm Shift occuring……….

8. Less emphasis on a national market (crowding-out): More emphasis on a global market (crowding-in): GDP = C + X + Corporate Investment => Focus on global growth Emphasis products & services with global reach => Focus on global companies: geography and industry Emphasis on Emerging markets in Asia, Latin America and Eastern Europe & Pacific Rim (ASLEEP) ASLEEP economies to account for at least 50% of global growth, 30% of world exports by 2010

9. Belief and Actions:More signals • All price variables are signals..interest rates, exchange rates, inflation • Biology of signals.. belief…action • Noise: Think x but do y

10. ‘Shoe-shine’ boy dilemma • Rational ignorance as investors react to noise and not to information • Paper wealth effect US$50trillion loss may reduce global GDP by 4% • Idiosyncratic noise: shoe-shine boy gives share tips • surplus nations ►nations in debt

11. ‘Credible threat’ signalling language used…….. a) Debt-deflation trade-off Beggar-my-neighbour deflation, devaluing currency to increase export competitiveness b) ‘Credible threat’ policy formulation Trichet at Jackson Hole, Wyoming, August 2005 uses ‘credible alertness’ to signal inflation concerns in the EU It’s ‘a safe banking system, a sound system’ Paulson July 20 2008 Reluctance to use D-word, R-word or is it a cycle? ’

12. Critical Timeline: US and China 23 Mar 2009 22 June 2009 7 July 2009 17 August 2009 28 July 2009 15 July 2009 22 Sept 2009 8 July 2009 2 April 2009 5 July 2009 31 July 2009

13. Commitment to exchange rate targets 2009-2011 with escape clauses ….why? • Global growth will depend on world exports as domestic demand falls • Corporate earnings declining in Q1:3 2009 • EMs and ASLEEP economies will substitute export-led growth for more G • Beggar-my-neighbour policies emerge • China limited on interest rates moves due to capital inflows

15. Managed exchange rates • Managed exchange rates to assist corporate earnings, Chinese inflation,international trade • Defines the degree of uncertainty • Export-led growth v Domestic demand • China, Japan, ASLEEP surpluses v US indebtedness

16. Thank you for participating……… Sapere aude ‘That which one can know, one should dare to know’