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Last Updated: Wednesday, 23 January 2008, 13:51 GMT
Warning about US economic slump
By Tim Weber
Business editor, BBC News website, in Davos

Delegates walking through the snow in Davos
The global economy is going through some unsettled times
The US economy is set for a long recession, a panel of economists at the World Economic Forum has warned.

The US mortgage crisis will spread to consumer and company loans, and push up defaults sharply, warned New York University economist Nouriel Roubini.

A year ago, Mr Roubini had been one of the few economists to predict correctly a slump in the US housing market and subsequent crunch in credit markets.

China and Europe will be hit, though India less so, the panel forecast.

This time round the US suffers a protracted pneumonia, and we can only guess what happens in the rest of the world
New York University economist Nouriel Roubini

Discussion about global economic turmoil is the hottest topic at this year's World Economic Forum, and this session was packed, with many participants turned away at the doors of the large conference room.

'Severe recession'

After five years of strong global economic growth, it was now only a question how hard the landing of the US economy would be, said Mr Roubini, chairman of Roubini Global Economics.

Foreclosures are spreading to areas like Los Angeles, depressing prices
Housing worries are hitting US economic growth

He predicted a "severe recession" that could last for a whole 12 months.

The US Federal Reserve would probably keep cutting rates, and that in turn might "make the recession a bit more shallow", but it would not stop the downturn.

Mr Roubini was backed up by Stephen Roach, chairman of Morgan Stanley Asia, and a well-known "bear" or economic pessimist.

He said both the Federal Reserve and the US government were trying to solve the current crisis by "reaching back into the same playbook that created the mess in the first place".

Instead of tackling asset bubbles like inflated housing and stock markets head-on, they waited until the bubble had burst and then cleaned up afterwards.

"That's a dangerous way of running the economy," said Mr Roach.

The global fallout

All panellists agreed that there would be no global recession.

But there is an old economic saying: "When the US sneezes, the world catches a cold," and the panellists were divided about whether it still holds true.

Mr Roubini was the most pessimistic.

"This time round the US suffers a protracted pneumonia, and we can only guess what happens in the rest of the world."

He predicted a bursting of housing bubbles in the UK, Ireland, and Spain.

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In Eastern Europe, meanwhile, many people had taken out mortgages denominated in euros, not their own country's currency.

If those currencies started falling, "many homeowners will go belly-up," said Mr Roubini.

Mr Roach said Europe's economy was simply not dynamic enough to get "a dispensation from the global economic slowdown".

The region would be "lucky when it gets 2-3% [annual] growth".

Ferenc Gyurcsany, prime minister of Hungary, disagreed.

He EU growth rates would be hit, but not by much more than 0.8%.

China and India to the rescue?

But what about the emerging giants of the world economy, China and India?

A popular topic of debate here at the World Economic Forum is whether the fast-growing Asian economies are now "decoupled" from the US Economy.

Not so, argued Yu Yongding, director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences.

China's economy was growing rapidly, he said, but that was because every year it needed to create 24 million jobs just to keep up - and last year it had reached only the 10 million mark.

China's reliance on "external demand is enormous," he said.

India's commerce minister Kamal Nath was more optimistic. East Asia, he said, was not as dependent on the US economy anymore, not least because South-South trade was soaring.

India's economy itself, he said, was much more driven by domestic demand than foreign investment.

Who will buy?

Morgan Stanley's Stephen Roach, however, begged to differ.

He was very optimistic about Indian and Chinese consumers, he said, but only in the long-term.

US consumers bought goods and services worth $9.5 trillion every year, a demand that was currently running at 5% above historical levels.

The Chinese consumer market, in contrast, amounted to just $1 trillion, and India's to a mere $500bn. That was not large enough to take up the slack left by the US downturn.

Africa worries about food

And there were worries that Africa would be hit badly by the global economic turmoil.

The reforms and better economic governance of the past decade had been rewarded with strong growth during the past few years, said Ngozi Okonjo-Iweala, a managing director of the World Bank.

But she said there was uncertainty whether Africa's economies were robust enough to cope with a sharp downturn, especially if it resulted in China cutting back on importing raw materials.

Her biggest worry, though, was the recent rise in food prices.

Yes, it would help farmers in Africa and other developing nations.

But there were even more people in urban areas who would find it difficult to cope.

Mr Nath added that there were 25 million people in India who for the first time were able to afford not one but two meals a day. How would they be affected by a doubling of the price of wheat and other commodities?

With the trend for biofuels driving up demand, the panellists wondered whether the market could provide an answer.

Since the "green revolution" of the 1970s, agricultural productivity has been at a standstill in recent years, and as Stephen Roach pointed out, demand for food was "not optional".

Next year, predicted Ms Okonjo-Iweala, the Davos participants would hear much more about the devastating impact of the rising cost of food.

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