Goldman Sachs warns of spreading economic turmoil


Goldman Sachs has abandoned its ultra-bullish view of the world economy, warning of a likely recession in Japan and mounting risks that US property slump could spread to parts of Europe.

In a new report, “The Global Economy Hits a Crunch”, the US investment bank said it was no longer sure that Asia and Europe would be able to pick up the growth baton as America stumbled. It fears that turmoil is spreading beyond the debt markets to the factory floor. “Much has changed since mid-July, when we wrote that ‘the global economy continues to enjoy one of the strongest sustained expansion in modern history’. The mood in financial markets is clearly darker, and the economic data in the developed world is showing signs of wear,” it said.

“Japan’s recovery is tottering, with the chance of an outright recession having risen to nearly two in three,” said the report, authored by chief economist Jim O’Neill. It is an abrupt change of tack for the bank known as the “cheer leader” of the global boom. Until now Goldman has insisted that Asia and the developing world are strong enough to shrug off an American slowdown, allowing world growth to keep racing ahead without missing a step -- despite subprime woes. Often overlooked, Japan remains the world’s second biggest economy and top creditor with some $3,000 billion in net foreign assets. Output had already contracted an annual rate of 1.2% in the Q2 before the credit crisis hit. There has since been a surge in the yen as speculators unwind carry trade positions, leaving Japan’s margin-trading housewives and grannies nursing big losses. Wages have fallen for the last eight months in a row. They are now down 1.9% from a year ago, threatening to pull the country back into deflation.

Goldman Sachs feared it was now “inevitable” that consumers would batten down the hatches for a while. The bank said Europe is now so weak after a clutch of dire confidence surveys in Germany, Italy, France, and The Netherlands that any further rate rises by the European Central Bank are “off the table”. It expects the euro to fall back to $1.35 against the dollar over the next year, and sterling to tumble to $1.88 as the Bank of England pushes through three rate cuts.
The one bright spot is the ‘BRIC’ quartet of Brazil, Russia, India, and China, all still firing on four cylinders, if slowing slightly. In a separate report, “Rising Risks to the Global Housing Market,” it said that much of global system had succumbed to a property boom that is in some ways more stretched than in the US, with real (inflation-adjusted) house price rises of over 100% in France, 60% in Italy, 55% in Canada, and 72% in Australia since the late 1990s. The bubbles in Spain and Ireland have been more extreme. “Such a widespread housing boom has little precedent in modern history.
In those markets where prices have run up the most, and rental yields have fallen dramatically, the risks of a housing correction are likely to have increased materially,” said the note, by Peter Berezin. “The wealth effect for housing is about twice as large as for equities, with consumption falling by about two cents in the short run for every $1 decline in home prices,” he said. He expects US house prices to drop 7% in 2007 and another 7% in 2008, as mortgage lenders shut off credit to chunks of the market. “The US is often a leading indicator for what happens in the rest of the world”.

Berezin said construction booms usually lead to housing busts lasting several years. Residential construction in the US reached 6.3% of GDP at the peak of the bubble, the highest since the baby boom in the early 1950s. In Spain, it has been even higher, averaging 8.7% of GDP since 2003, and in Ireland it has exploded to 14.2%, leaving an overhang of unsold property. House prices are already falling in Spain, where 98% of mortgages are on floating rates that have roughly doubled since late 2005. Property prices have dropped for the last four months in a row in Ireland. Berezin said the Goldman’s “decoupling” thesis was based on the assumption that the US housing slump was a “country-specific-shock” that would not spill over into other economies. This was now in doubt. “The spread of global credit risks has introduced a new potential transmission mechanism. If home prices in the key economies begin to fall, this will have an adverse effect on global growth,” he said. (

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