A manager at the world's largest bond fund, PIMCO, has laid-out in unambiguous terms the problem facing the global economy in the quarters ahead: The U.S. and global recession will worsen -- with a "second wave" of turmoil -- unless governments increase fiscal stimulus and spending plans.

"The economic setback is still in its early stages," Koyo Ozeki, head of Asia-Pacific credit research at Pimco's Tokyo office, wrote in a report published on PIMCO's web site. "Any further decline in housing prices could accelerate the downturn, intensifying the pernicious feedback loop and possibly leading to a second wave in the financial crisis in the next six to 12 months."

Ozeki said in order to overcome that second wave "governments worldwide would have to spend vast quantities." Ozeki added that investors may wish to delay buying Japanese corporate debt until yields increase to reflect the full extent of the slump.

Emerging markets must act, too

Economist Richard Felson told DailyFinance Thursday PIMCO's latest macroeconomic analysis is in-line with the majority of economists.

"China has done a good job regarding fiscal stimulus, but the U.S., E.U. and Japan have so far come up a bit short, relative to the size of their economies," Felson said. "China has increased fiscal spending by about $800 billion, which is about double the U.S.'s so far, in purchasing power parity terms (ppp). Of course, China has the advantage of being able to deploy fiscal spending much quicker, by decree, than the U.S., Europe, or Japan, but that does not blot-out the undeniable economic reality that more stimulus will be needed for the global economy to get out of this slump."

The International Monetary Fund expects the global economy to slow to a crawl in 2009, growing just 0.5%. Any global GDP increase under 1.7-2.0% is considered recessionary, due to the higher growth capacity rate for emerging market economies.

Regarding those emerging markets, Felson said they, too, will need to increase fiscal spending to reverse negative trends plaguing international commerce. Felson recommended the following additional or second stage fiscal stimulus packages for emerging market states: India: $200 billion; Russia, $200 billion, Brazil, $250 billion; Mexico, $150 billion; Argentina, $75 billion; and the Middle East region, $200 billion.

Felson would also like to see the E.U. approve an additional stimulus package totaling $300 billion; Japan, $125 billion.

And the United States, which is fresh off a protracted fight in the U.S. Congress for its roughly $800 billion package?

"More than likely, we're going to need at least another $400 billion in stimulus, so I would err on the upside. During severe recessions it's better to overshoot than undershoot, so I would pass another package totaling about $500 billion, comprised primarily of infrastructure projects (50%), aid to states (20%), unemployment compensation extension (20%), and education grants (10%)," Felson said. "All of the above would feed directly into the economy, increasing demand, lifting GDP, and give us a decent chance at a recession bottom by the end of 2009."

Economic Analysis: For investors, an increase in government spending typically is not a good sign, but under current circumstances, it is. Demand is declining all over, domestically, abroad, in large economies and among younger and niche players. Governments must do everything within their power to reverse the 'negative cycle' that has taken hold in the international economy, and that means more fiscal stimulus. Further, while economic conservatives, market absolutists and others will decry the 'large spending totals,' investors should view that as a ruse: compared to the decline in U.S. and global GDP output and asset destruction from declining prices, the fiscal stimulus approved so far has been small.

Hence, as PIMCO noted, the view from here argues that if policy makers think small, the recession will get worse; think big, and we will likely pull out of this severe slump in the 12-month period ahead.

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