After nine harrowing months on the brink, it appears the U.S. economy can be taken off life support and moved out of intensive care. All concerned can breathe a deep sigh of relief. Disaster has been averted.
Which might explain the recent improvement in consumer confidence despite still-rising unemployment and yet another seemingly inexplicable spike in gasoline prices. In this case, just surviving is sufficient cause for celebration.
But for all the talk of economic green shoots, the road to actual recovery will be long and arduous. Governments worldwide have moved forcefully across an unprecedented number of monetary and fiscal fronts in a desperate attempt to prevent financial Armageddon. And to their credit, they’ve succeeded.
Yet a return to normal economic conditions will take more time than people are accustomed to following a recession. As Warren Buffett noted, “You cannot produce a baby in one month by getting nine women pregnant.”
At 19 months and counting, the current recession is the longest since the 43-month contraction from August 1929 to March 1933. Even under a best-case scenario, the downturn will end this fall and be followed by a leveling off in unemployment at around 10% and economic growth of about 2% in 2010.
Such a tepid recovery would not be entirely consistent with past experience. The worst downturns are usually followed by the most explosive rebounds. After the severe 1981-’82 recession, the economy grew by an average of 5.5% over the next two years in a classic V-shaped recovery.
But there are reasons to think this time will be different.
Economies recover fastest from recessions caused by monetary tightening. In those instances, there is plenty of scope to lower interest rates when the rationale for the tightening – usually inflation – is no longer a threat. The steep plunge in the price of money stimulates big-ticket sectors such as housing and autos, and the recovery builds up momentum from there.
This time, rates already are near rock bottom. Yet consumers are in no mood to borrow, and banks are even less eager to take on risk. Both sides are hunkered down in balance-sheet repair mode.
That’s not unusual following a banking crisis brought on by the demise of an asset bubble. Almost without exception, countries experiencing the greatest damage to their financial systems suffered from an extended period of subpar growth and a massive buildup in public-sector debt.
An exhaustive study of major banking crises by Kenneth Rogoff of Harvard University and Carmen Reinhart of the University of Maryland concluded that “if the United States does not experience a significant and protracted growth slowdown, it either should be considered very lucky or even more ‘special’ than most optimistic theories suggest.”
Exit strategy
With attention already turning to the Federal Reserve’s “end game,” or how and when the central bank will remove the monetary punchbowl from which financial institutions have been imbibing since last fall, there’s a risk that government policy will turn restrictive too soon.
That’s why 1937 has been on the minds of economists lately.
The American economy had grown at the robust rate of 9.2% a year between 1934 and 1936, and unemployment had dropped by 11 percentage points from its peak in 1933. But the Fed was worried about the inflationary and speculative implications of the massive bank reserves it had created to stoke recovery. Fiscal policy also was tightened to address a widening budget deficit.
The esteemed economist Milton Friedman argued that the premature tightening of monetary policy played a key role in pushing the economy back underwater for another 13 months beginning in May 1937.
Japan made a similar mistake several years into its own Depression in the 1990s and is still suffering the consequences.
A keen student of history, Fed Chairman Ben Bernanke seems determined to avoid those errors. But government policy is caught between bond market vigilantes rightfully concerned about large structural budget deficits and shell-shocked households that have lost 20% of their net worth over the last two years.
So, yes, the economy can be moved out of intensive care. Long years of rehabilitation lie ahead, however, and the prognosis remains guarded.
By Tom Saler – jsonline.com
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