TEA WITH THE ECONOMIST

The Next Bubble Is Here. Have You Bought In?

by Gary North

I have identified the next bubble. It has already begun. It is in full swing.

Investors want to identify the next big bubble. Some investors want to buy in now, maybe using borrowed money (margin loans) to make a killing. They are confident that they will sell out near the top. They won't. Other investors just want to avoid getting trapped. They prefer to let the first group bear the uncertainty of profiting from a bubble sector.

The trouble with investment bubbles is that nobody seems to recognize them when they are making investors rich. Alan Greenspan denied that it is possible for central bankers to identify a bubble. He gave a speech in 2002, before his easy money policies had created the final stage of the worldwide housing bubble. He insisted on the following:

We at the Federal Reserve considered a number of issues related to asset bubbles – that is, surges in prices of assets to unsustainable levels. As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact – that is, when its bursting confirmed its existence.

Moreover, it was far from obvious that bubbles, even if identified early, could be preempted short of the central bank inducing a substantial contraction in economic activity – the very outcome we would be seeking to avoid.

First, he was blind to what the FED's policies had done in the second half of the 1990's to create the dot-com bubble. Second, he was equally blind to what these same expansionist policies were doing to the housing market – policies adopted in mid-2000, in response to the bursting of the dot-com bubble.

He was incorrect. Some of us did see that the dot-com bubble was a bubble. I told my subscribers in February and March of 2000 that the NASDAQ was a bubble at a price-earnings ratio of 206. The NASDAQ burst the week my second warning arrived in the mail.

With respect to the housing bubble, in late 2005, I wrote an article on "Surreal Estate on the San Andreas Fault," which warned against the coming bursting of the real estate bubble. It was clear to me what Greenspan had done to the economy.

If you remember the S&L crisis of the mid-1980s, you have some indication of what is coming. The S&L crisis in Texas put a squeeze on the economy in Texas. Banks got nasty. They stopped making new loans. Yet the S&Ls were legally not banks. They were a second capital market. Today, the banks have become S&Ls. They have tied their loan portfolios to the housing market.

I think a squeeze is coming that will affect the entire banking system. The madness of bankers has become unprecedented. They have forgotten about loan diversification. They have been caught up in Greenspan's counter-cyclical policy of lowering the federal funds rate. Now this policy is being reversed. Rates are climbing. This will contract the loan market. Banks will wind up sitting on top of bad loans of all kinds because the American economy is now housing-sale driven.

You may think that you are shielded. But your banker is not shielded. You may not deal with bankers. But your employer does.

If I saw it coming, why didn't Greenspan? Why didn't the pundits on CNBC? Why didn't the entire investment community? The real estate market still boomed through the first half of 2006. Then it began to falter. We all know what happened next.

It is not that no one can perceive a bubble while it is in progress. The problem is that investors who do not understand Ludwig von Mises' theory of the business cycle can't. They don't believe that central bank inflation causes the bubbles, and that these bubbles burst when the banks reverse their policies of monetary inflation. So, they and the advisors who cheer them on desperately want to believe the assurances by government officials and Federal Reserve Chairmen that no bubble is in progress, that there will be no regression to the mean.

The best way to identify a bubble is to look for investors who are rushing into an asset market and driving prices up to ludicrous ratios.

You can get 4.5% on a 30-year Treasury bond today. You pay $100 to get a guaranteed $4.50 a year in return: real money in your bank account (before income taxes). Meanwhile, the P/E ratio of the Standard & Poor's 500 index is at 120, if as-reported earnings are used instead of expected earnings. See the chart here.

At a P/E of 120, you pay $120 to get a hoped-for dollar of earnings (profits) for the latest reporting period. These profits are not dividends, just corporate profits.

This is a replay of 1999.

TODAY'S BUBBLE

Two words: "consumer confidence."

We are told that consumer confidence has bounced back from its February 2009 low. It moved from 22 in February to 55 in May. This was a big jump. A spokesperson for the Conference Board, one of the main sources for this monthly survey, put it this way:

After two months of significant improvements, the Consumer Confidence Index is now at its highest level in eight months (Sept. 2008, 61.4). Continued gains in the Present Situation Index indicate that current conditions have moderately improved, and growth in the second quarter is likely to be less negative than in the first. Looking ahead, consumers are considerably less pessimistic than they were earlier this year, and expectations are that business conditions, the labor market and incomes will improve in the coming months. While confidence is still weak by historical standards, as far as consumers are concerned, the worst is now behind us.

Consumers listen to news reports. News reports speak of green shoots, parroting Ben Bernanke's pet phrase. That phrase has been picked up by the media, the same way that Greenspan's "irrational exuberance" was picked up when Greenspan used it in late 1996. Note: We should not ignore the context of Greenspan's remarks. It applies quite well to Bernanke's green shoots. Greenspan said this:

But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.

Balance sheets are crucial, he said. The #1 balance sheet in the American economy is the Federal Reserve's. It has doubled since last September. The Federal Reserve's economists did not see in August 2008 what a few weeks later Bernanke and Treasury Secretary Paulson described to senior members of Congress as a looming collapse of America's financial markets. They ignored the fact that the world's capital markets had seized up a year earlier, in August 2007. They did not see that a recession had begun in December 2007. They were caught flat-footed.

Today, Bernanke faces what Greenspan called "the complexity of the interactions of asset markets and the economy." His two-part policy has been to double the monetary base and to swap liquid Treasury debt for toxic assets held by the banks. He has allowed the banks to keep these borrowed assets on the banks' books at face value, as if they belonged to the banks. He has not challenged the Financial Accounting Standards Board reversal of its mark-to-market rule (FAS 157) in the week it would have gone into effect: April 1, 2009.

Consumers have not understood this FED-sanctioned policy of keeping bad assets on the books at Treasury debt prices. Bernanke has said that banks must be more transparent. Meanwhile, the FED has covered the entire banking industry with a security blanket that keeps economic reality from intruding.

Consumers are therefore confident. For now.

UNDERMINING CONFIDENCE

California's unemployment rate in May hit 11.5%. The state will go technically bankrupt on July 1. It is about to have its bonds downgraded to junk status. There are no green shoots in California. There is the equivalent of dead brush in forest fire season. No one seems to care.

The World Bank estimates that the world economy will sink by 2.9% in 2009. How scientific! Not 3% – exactly 2.9%. This, from an outfit that predicted with equal scientific rigor in March that the world economy would fall by 1.7%. Last November, it predicted that the world economy would grow by .9% – not 1%.

Regular gasoline is selling for about $2.70 around the country, up from $1.95 in February. The cost of getting from here to there is rising rapidly.

Yet the consumer says he is confident. "No problem!"

The summer will bring more news about rising unemployment. There will be more foreclosures. The real estate market will continue to decline. By how much? No one knows.

But aren't there statistics on foreclosures? Yes, but nobody knows if they are accurate. The U.S. government relies on a private firm, RealtyTrac, for its information. States use different ways to assess foreclosures. In April, the number of foreclosures reported for Atlanta by the national press was half of what the published local legal notices said.

The Case-Shiller index of 20 cities will show that housing prices are still falling. Commercial real estate prices will fall as vacancies rise. There will be more closed banks. The FDIC's assets will go below $12 billion. Then $11 billion. Then . . . ?

All of this is obvious. The public ignores it. This is why consumer confidence is a bubble. It keeps rising, yet it is not supported by the facts that count, which are data on the state of the real estate industry in relation to the solvency of the banks.

Doug French is a former banker. It was his warning at a conference in November 2005 that persuaded me that the real estate market and the banks were jointly entwined and headed for a disaster. His recent article, "Dead Banks Walking," appeared on June 16. His assessment indicates that we are nowhere near the bottom for either real estate or the banking crisis.

Bankers, pressured to earn returns for shareholders and protected from bank runs by FDIC insurance, have over time lent not only more of their deposits but advanced the money for riskier projects. James Grant in a recent Grant's Interest Rate Observer reminisced about National City Bank, which back in 1954 had only lent out 41 percent of its deposits, with less than one percent of the portfolio being real-estate loans.

By the end of last year, the total loan-to-deposit ratio for all US banks and thrifts was 87 percent, and 60 percent of all loans were classified as real-estate secured.

The public has never heard of the loan-to-deposit ratio. That does not change the fact that the ratio is historically high, and way too much of it is tied up in real estate.

I keep thinking on Mr. T's threat, 27 years ago: "You're going down!" The question is this: Is Ben Bernanke Apollo Creed or Rocky Balboa?

CONCLUSION

Optimism is as optimism does.

The American consumer may be less pessimistic today than in March, but he has less money to spend. His outlook has not been confirmed by the labor market. Unemployment is rising.

Then which market will confirm his optimism? Housing? No. Auto sales? In the second half of the worst year in decades? People are going to rush out to buy a new car, when the new models are due in October? We'll see in October. But the industry needs sales now.

Where will the hoped-for deliverance come from? Not from private industry. Private industry must compete for capital with the Federal government. Lenders must supply the Treasury with about $85 billion in loans each week to roll over the existing debt and pay for this year's deficit. From China? China is spending money on commodities and domestic bailouts. From Japan? With trade down, its surplus is down. From Europe? It is in recession. Then where?

There is no economic recovery yet. There is only a reduction in the decline of the economy. Earnings are still falling. Mortgage rates have risen. There is no end in sight for the real estate contraction. The banks will be squeezed. State budgets are running large deficits. They do not have money to offer more unemployment benefits. They are facing over $120 billion in red ink in the fiscal year beginning on July 1.

Tax revenues are down. Expenditures are up. Debt is rising. Interest rates will follow. State and local bonds will be downgraded.

So, consumer confidence is a bubble market. Stay out of it.

The Faith of Entrepreneurs

by Llewellyn H. Rockwell, Jr.

This originally appeared in the December 2005 issue of The Free Market

Ludwig von Mises didn’t like references to the "miracle" of the marketplace or the "magic" of production or other terms that suggest that economic systems depend on some force that is beyond human comprehension. In his view, we are better off coming to a rational understanding of why markets are responsible for astounding levels of productivity that can support exponential increases in population and ever higher living standards.

There was no German miracle after World War II, he used to say; the glorious recovery was a result of economic logic working itself out through market forces. Once we understand the relationship between property rights, market prices, the time structure of production, and the division of labor, the mystery evaporates and we observe the science of human action making great things happen.

He is right that understanding economics does not require faith, but there are actions undertaken by market actors themselves that require faith (and Mises would not disagree with this) – immense faith, faith that moves mountains and raises up civilizations. If we accept the interesting description of faith by St. Paul ("evidence of things unseen") we can understand entrepreneurship and capitalist investment as acts of faith.

Everyone who is in business understands this. It requires a thousand daily acts of seeing the unseen future to be in business. The reality of the marketplace is that the consuming public can shut you down tomorrow. All they need to do is to fail to show up and buy.

This is true for the smallest business to the largest. There is no certainty in any business. Nothing is a sure thing. Every business in a market economy is only a short step from bankruptcy. No business possesses the power to make people buy what they do not want. All success is potentially fleeting.

Success does yield a profit, but that provides no comfort. Every bit of profit you take for yourself comes out of what might otherwise be an investment in the development of the business. But neither is this investment a sure thing. Today’s smash hit could be tomorrow’s flop. What you perceive to be a solid investment could turn out to be a short-term craze. What you see, based on past sales, as having a potential mass appeal could actually be a market segment that was quickly saturated.

Emperors can rest on their laurels but capitalists never can.

Sales history provides nothing but a look backwards. The future is never seen with clarity but only through a glass, darkly. Past performance is not only not a guarantee of future success; it is no more or less than a data set of history that can tell us nothing about the future. If the future turns out to look like the past, the probabilities still do not change, any more than the probability of the next coin toss landing on heads increases because it happened previously five times in a row.

Despite the utter absence of a road map, the entrepreneur-investor must act as if some future is mapped out. He or she must still hire employees and pay them long before the products of their labor come to market, and even longer before those marketable products are sold and turn a profit. The equipment must be purchased, upgraded, serviced, and replaced, which means that the entrepreneur must think about today’s costs and tomorrow’s and the next day’s saecula saeculorum.

Especially now, the costs can be mind-boggling. A retailer must consider an amazing array of options concerning suppliers and web services. There must be some means of alerting the world to your existence, and despite a century of attempts to employ scientific methods for finding out what makes the consumer tick, advertising remains high art, not positive science. But it is also art with high expense. Are you throwing money down a rathole or really getting the message out? There is no way to know in advance.

The heck of it too is that there are no testable causes of success because there is no way to perfectly control for all important factors. Sometimes not even the most successful business is clued into what it is, precisely, what makes its products sell more as compared with its competitors. Is it price, quality, status, geography, promotion, psychological associations people make with the product, or what?

Back into the 1980s, for example, Coca Cola decided to change its formula and advertise it as New Coke. The result was a catastrophe as consumers fled, even though the taste tests said that people liked the new better than the old.

	$29 $25

If the historical data are so difficult to interpret, think how much more difficult it is to discern probable outcomes in the future. You can hire accountants, marketing agencies, financial wizards, and designers. They are technicians, but there are no such things as reliable experts in overcoming uncertainty. An analogy might be a man in a pitch-black room who hires people to help him put one foot in front of the other. His steps can be steady and sure but neither he nor his helpers can know for sure what is in front of him.

"What distinguishes the successful entrepreneur and promoter from other people," writes Mises, "is precisely the fact that he does not let himself be guided by what was and is, but arranges his affairs on the ground of his opinion about the future. He sees the past and the present as other people do; but he judges the future in a different way."

It is for this reason that entrepreneurial habit of mind cannot be implanted through training or education. It is something possessed and cultivated by an individual. There are no entrepreneurial committees, much less entrepreneurial planning boards.

The inability of governments to engage in the entrepreneurial act of faith is one of many reasons why socialism cannot work. Even if a bureaucrat can look at history and claim that his agency could have made a car, dry wall, or a microchip, that same person is at a loss to figure out how innovations in the future can take place. His only guide is technology: he can speculate about what might work better than what is presently available. But that is not the economic issue: the real issue concerns what is the best means given all the alternative uses of resources to satisfy the most urgent wants of consumers in light of an infinity of possible wants.

This is impossible for governments to do.

There are thousands of reasons why entrepreneurship should never take place but only one good one for why it does: these individuals have superior speculative judgment and are willing to take the leap of faith that is required to test their speculation against the facts of an uncertain future. And yet it is this leap of faith that drives forward our standards of living and improves life for millions and billions of people. We are surrounded by faith. Growing economies are infused with it.

Mises forgive me: this is a miracle.

TEA WITH THE ECONOMIST

Banks' profits

Red and black ink

Banks with the biggest profits and losses last year

THE balance sheets of many banks took a pounding last year. Royal Bank of Scotland, which received a government bail-out of $3 billion, posted the largest loss of $59.3 billion, according to an annual review of the world's leading banks by The Banker magazine. Citigroup and Wells Fargo also fell into the red by over $45 billion. But all three are still counted among the 12 biggest banks in the world by tier-one capital, albeit at a lower rank than in 2007. Not all was doom and gloom. ICBC turned a $21.3 billion profit, one of four Chinese banks to make the top ten. HSBC and Barclays, British banks that showed better risk management than RBS, also saw a decent profit.

BRICs, emerging markets and the world economy

Not just straw men

The biggest emerging economies are rebounding, even without recovery in the West

THE inaugural summit of the BRICs—Brazil, Russia, India, China—came and went in Yekaterinburg this week with more rhetoric than substance. Although Russia’s president, Dmitry Medvedev, called it “the epicentre of world politics”, this disparate quartet signally failed to rival the Group of Eight industrial countries as a forum for economic discussion.

But that should be no surprise: to realise how disparate they are, consider that Russia and Brazil are big commodity exporters, whereas China is a big commodity importer; China is a proponent of the Doha trade round, India a sceptic; India and China vie for influence in the Indian Ocean, Russia and China compete in Central Asia.

Instead, the really striking thing is that four countries first lumped together as a group by the chief economist of Goldman Sachs chose to convene at all, and in such a high-profile way. And that when they met, they discussed topics such as reforming the IMF; their demand for more say in global policy-making; and, in the case of China, Brazil and Russia, a plan to switch some of their foreign-currency reserves out of dollars and into IMF bonds.

All this reflects growing self-confidence. The largest emerging markets are recovering fast and starting to think the recession may mark another milestone in a worldwide shift of economic power away from the West. Estimates for their national incomes in the first quarter were better than expected. In the year to the end of March GDP rose by around 6% in China and India. The two accounted for no less than half the world’s increase in wireless-technology subscriptions in that period. In Brazil gdp fell slightly in the first quarter but it is growing faster than the Latin American average and most economists think growth will return to its pre-crisis level as early as next year. In contrast, output in most large industrial economies is still falling. The exception in the BRICs is the host: dragged down by plunging oil prices last year, Russia’s economy shrank by 9.5% in the first quarter, the worst performance in the G20 after Japan.

The fortunes of the others mark a sharp rebound since the turn of the year. Then, it seemed, the largest emerging markets faced being overwhelmed along with everyone else. Chinese exports in January were 18% lower than they had been a year earlier. Industrial growth fell by two-thirds in November and December. And around 20m migrant workers were wending their way back to their villages, jobless after the collapse of construction and export booms in coastal cities. The notion of “decoupling”—that emerging markets were no longer mere moons revolving around planet West—suffered a severe setback.

So what should one make of the turnaround? Might there be something to decoupling after all? Why are the BRICs recovering? And what are the implications for the rest of the world?

Decoupling means not simply that emerging markets tend to grow faster than rich industrial ones, although that is certainly true; it also implies that to some extent the two groups dance to different tunes, with emerging markets growing or shrinking autonomously, not just under the influence of rich ones. A study last year by Ayhan Kose of the IMF, Christopher Otrok of the University of Virginia and Eswar Prasad of Cornell University gave some support to this idea.

You would expect less decoupling as a result of globalisation. The cycles of output, consumption and investment should become more closely aligned in countries engaged in world trade. Yet when the authors looked at these indicators, they found something different. The cycles of output, consumption and investment did indeed become more closely aligned in rich countries. And the same thing happened in emerging markets. But when the authors compared the two groups, they found they were diverging. The business cycles of America and Europe converged. The business cycles of India and China converged. The business cycles of rich and emerging markets had decoupled.

When this study came out in mid-2008 the worldwide crash seemed to render it instantly obsolete. Yet the sheer size of the meltdown may temporarily have swamped deeper trends that are now reasserting themselves as the initial shock recedes. In 2000 developing countries accounted for 37% of world output (at purchasing power parities). Last year their share rose to 45%. The share of the BRICs leapt from 16% to 22%, a sharp rise in such a short period. Almost 60% of all the increase in world output that occurred in 2000-08 happened in developing countries; half of it took place in the BRICs alone (see chart).

If this pattern of growth were resuming, it would be good news: nearly half the world economy would be bouncing back. And there are one or two signs that the benefits of growth in the BRICs are being felt farther afield. Anecdotal evidence suggests “south-south” trade and investment by richer emerging markets in poorer ones continued to rise even as global capital and trade flows fell. One example of this is the “land grab” in which China and Gulf countries are buying millions of acres of farmland in Africa and South-East Asia. China overtook America to become Brazil’s largest export market in March and April; it is also now the largest exporter to India. China is using its $2 trillion of foreign reserves to invest in other emerging markets: for example, putting $10 billion into Petrobras, Brazil’s state-run oil company.

China’s appetite for raw materials to fuel resurgent growth probably explains the 36% rise in industrial raw-material prices since the start of this year, benefiting exporters of things like copper—though how long this will last is an open question. If it comes from the boom in Chinese investment spending, then the boom could continue. If China is merely filling its stores temporarily after a period of destocking, then prices could fall again.

But the resilience of China, India and Brazil cannot offset the dire state of the rest of the world economy. While the three giants recover, developing countries as a whole are mired in recession. The giants seem to be decoupling not only from the West but from many of their smaller emerging brethren, too.

A series of reports confirms how badly things are going there. A review of ten poor countries by the Overseas Development Institute, a think-tank in London, concludes that they were worse hit than anyone expected, with sharp declines in remittances, employment and revenues and widespread balance-of-payments problems. As the study’s author, Dirk Willem te Velde, points out, the differences are often striking. In some countries—Indonesia, Kenya, Bangladesh—foreign direct investment has held up reasonably well; others—Ghana, Nigeria and Zambia—are facing sharp declines. Cambodian textile exports have been hit harder than Bangladeshi ones. But because import demand, capital flows and the need for foreign workers declined precipitously in the West, almost all developing countries are suffering.

In its most recent assessment, the United Nations says at least 60 poor and emerging markets will this year suffer falls in income per person. The UN’s forecasts for eastern Europe and sub-Saharan Africa are especially dark. For eastern Europe, Russia and its neighbours, the body predicts a fall in output of 5%. Arvind Subramanian, an economist at the Peterson Institute for International Economics, a think-tank in Washington, DC, argues that the recession in eastern Europe sounds the death knell for one of the two main growth strategies of the past 20 years—capital-account liberalisation (growth through exports is the other). The east European countries threw their financial sectors open to the world. In 11 of the region’s countries, foreign banks account for over 60% of bank assets. The flood of foreign-currency borrowing destabilised their economies and left them vulnerable when Western banks reduced lending.

In Africa, the UN predicts, output will now fall by 0.9%. That might not sound too bad but only two months ago the IMF was forecasting a rise of 1.7% and at the start of the year the UN had projected a 4.8% increase. To return to pre-crisis growth, says the African Development Bank (AFDB), would require the continent to attract $50 billion of new money this year. Africa is nowhere near those levels because world capital flows are falling. The latest forecast by the Institute of International Finance says total net flows will collapse from $890 billion in 2007 to just $141 billion this year.

The AFDB fears that “a growth crisis” may be turning into a “development crisis”, leading to sharp increases in poverty and malnutrition. By the end of 2009, says the UN, there will be between 105m and 143m more people in poverty than if growth had continued at its pre-crisis levels (see article). The main exception is in smaller East Asian countries, where industrial output is rebounding and GDP growth is likely to resume in the second quarter.

At the moment, then, recovery in the BRICs is coinciding with recession in the developing world as a whole. If this does not point to any change in global economic conditions, what does it reflect?

Partly, that the BRICs depend less on exports than do many emerging markets. In Brazil and India exports are less than 15% of GDP. China, too, exports less than many people think. Though exports were 34% of GDP in 2008, these included “processing exports”—goods imported into China, processed and exported without much value having been added. All three were thus less affected by the slowdown in world trade than most.

The BRICs were cautious in liberalising their financial systems, so have been less affected than, say, eastern Europe, by the West’s financial heart attack. And their recoveries have been boosted by governments which have dramatically loosened monetary policy and increased government spending. But many other countries are relatively closed to trade and finance. Smaller ones like Chile and Taiwan have had a large fiscal stimulus. But few have done so well. Something more is needed to explain the recovery of the giants. A plausible explanation is size.

Size matters when world trade is falling because large economies have millions of domestic consumers to turn to when foreign markets fail. China is the best example. Small economies need trade to specialise, but the pressure of selling into a big domestic market helps companies in large economies remain competitive even without a lot of competition from imports. Big economies also tend to be diversified. India, for example, exports not just garments and cheap electronics—characteristic of many countries with similar levels of income per head—but ships, petrochemicals, steel and business services. Being diversified means little when markets all fail at once. But it is a big advantage when recovery begins since you are more likely to be in a business in which demand is rising.

Size and variety may also help the economic stimulus programmes of China, India and Brazil. In general, one of the commonest problems of government reflation is that the benefits leak out beyond your borders because the programme sucks in imports. Giant economies do not face this problem so acutely because even when trade has been liberalised, imports naturally tend to be a lower share of GDP.

The other challenge is to ensure that government stimulus programmes are broadly based. This could be more difficult in small economies which specialise in relatively fewer sectors. A handful of big companies may be able to use political clout to grab the benefits of spending for themselves. In principle, giant countries such as India or China have more companies competing to manipulate the government for a share of the spoils. That is speculation, but the fact is that the stimulus programmes in the big emerging markets have been, mostly, large and effective.

China’s stimulus package was the earliest and best-known example of fiscal shock and awe. But it is only part of the story. The government is using the state-owned banks to pump out loans at astonishing rates. According to Josh Felman, of the IMF’s Asia research department, state banks and others issued 5.5 trillion yuan ($800 billion) of new loans in the first quarter—more than in the whole of 2008. This is producing a spending splurge on steroids. Excluding SUVs, almost as many cars are being sold in China as in America. In 2006 Americans bought twice as many.

Brazil and India are following suit, albeit more modestly. Brazil reduced reserve requirements and gave banks and its deposit-insurance fund incentives to buy up the loan portfolios of smaller banks. These measures injected 135 billion reais ($69 billion) into the domestic credit markets, according to Otaviano Canuto of the World Bank. Domestic credit rose sharply between September 2008 and January 2009 and consumer confidence is rebounding.

The source of India’s resilience, argues Mr Subramanian, was “goldilocks globalisation”: neither too dependent on foreign capital, like eastern Europe, nor too reliant on foreign customers, like parts of East Asia. Foreign capital dried up in the crisis, so India relied on domestic savings, which amounted to almost 38% of GDP in the year to March 2008. Companies thus turned for loans to India’s unfashionable state banks, which hold almost 70% of bank assets, rather than borrowing overseas or raising money on the stockmarket.

India’s growth was also shored up by government outlays, such as a generous pay rise for state employees, the cancellation of small farmers’ debts, and the expansion of its rural-workfare scheme. Announced before the crisis struck, this spending was fortuitous. It left the public finances deep in the red, even as it helped the government to a decisive election victory. So far, this political triumph has boosted confidence in India more than the budget deficit has dampened it.

State of triumph

The question is whether such splurges are efficient and how long can they last. Consider China’s investment (see article). According to the IMF’s Mr Felman, in early 2008 all the contribution of investment to growth came from non-state-owned enterprises, mostly the private sector; since December 2008, more than half has come from state-owned enterprises. Something similar is happening in Brazil. Between last September and this January credit from foreign-owned and domestic private banks rose by 3%; credit from public banks rose by 14%. The beneficiaries seem to be large firms, where loans are growing four times as quickly as at small ones.

It is not clear how far, in the long run, the BRICs will be affected by a big rise in the size of the government and large state-owned firms. But that rise is probably inevitable. China and, to a lesser extent, Brazil and India, benefited hugely from America’s appetite for imports in 2000-08. That appetite has fallen and is likely to remain low for years, as American consumers adjust their spending and savings habits. The rise may also be difficult to reverse: the experience of the West has been that the public sector expands relentlessly until it reaches between 40% and 50% of GDP. But if the BRICs cannot export their way out of recession, the expansion of government is the main alternative to the slump being endured in those other big capital exporters, Germany and Japan. It is part of the price China and others are paying to clamber out of recession before everyone else.