Archive for August 12th, 2011

A Bit of Optimism

It is now August 2011 panic grips the financial sector.   Despite budget cuts and new austerity, Italian bond yields rise and investors flee.    Will southern Europe take down the Euro?   Can and should the wealthy European states bail them out?  In the US politicians fight over simply approving the borrowing of money to pay bills that need paying; and bring the world’s largest economy on the edge of default, and to a credit downgrade.  The Dow gyrates at a pace not seen such the crisis began in 2008 as panic sets in on fears of further downgrades and a ‘double dip recession.’

Given my continual bearishness on the global economy, you might expect an “I told you so, now its really going to hit the fan.”    Yet I’m starting to think that the worst may be over.    Job growth was up in July, especially in the private sector.   New unemployment claims came in lower than expected in the last two weeks, under 400,000.   Corporations are starting to report plans to hire and that they are seeing an uptick in business.

Governments have recognized the seriousness of this crisis world wide and have proven remarkably capable of compromising and acting to try to change policies and turn the global economy around.   The idea that this is ‘just another recession’ has given way to the recognition that it is a ‘depression like crisis’ with no quick and easy answer.  Realism is trumping ideology in most of Europe, and I suspect it’s about to do so in the US.   Average people are making better choices too.  They are saving, planning, and adapting to new conditions in a very practical and sensible way.  Hyper-consumerism, rather than being a cultural depravity set to bring down the West, may have simply been a fad that blossomed due to the bubble years.

To core cause of this crisis is crystal clear and easy to understand.    We are in a recession that is a natural part of the business cycle.   However, this recession coincides with the fact that the accumulated debt of the industrialized West — public and private — has become unsustainable.     This debt helped avoid the recessionary corrections necessary in 1991 and 2001, but increases the scope and intensity of the one we are now experiencing.   Think of high debt as steroids — we’ve got a recession on steroids!

Originally, people thought the recession was simply another downturn and that much like the ones in 1991 and 2001; a strong stimulus along with cheap credit would again put us back on track.   This led to a belief that a stimulus alongside expansionary federal reserve policies would catapult the economy back into overdrive.   That didn’t work.   Debt had become unsustainable and counter-productive.

Others, mostly on the right, focused on debt as the sole cause of the problem, not recognizing the reality of a deep recession (correcting imbalances that began at the end of the last true recession in 1983) and the fact that spending cuts could spiral us down into depression.  To them the solution was to cut spending and get the budget in order.     They don’t get that alongside fiscal discipline there is a need for government to actively combat the recession and invest in the country.   Even though tax increases harm the economy less than spending cuts, ideology pushes them to demand only the latter, making it more difficult to reach political agreement.

In other words, many have very clearly seen half the problem, but ignore or deny the other half.  That’s starting to change.   The President embraced a strong and I believe relatively well designed stimulus program which has paid dividends.    The country was bleeding jobs in the early months of 2009, now it has gone to creating them.

And compare it with this longer term view:

(See these graphs came from this site, which also had an interesting discussion: Reflections of a Rational Republican.)

A couple of things stand out.   First, job growth late in the Bush Presidency (before the recession) was about the same as job growth after we came out o f the recession.   The recovery may be weak, but it’s symmetrical.  The decrease in job loses was swift in 2009 when the stimulus took effect.   With the good numbers for July and new unemployment claims dipping below 400,000 two weeks in a row, the economy is perking up.

Now, if you want it to grow faster you could say “add more stimulus” and expect the numbers to rise.   However, that ignores the debt issue, part two of this crisis.   There would be no down grades, no fear of defaults, and no difficulty in addding stimulus if the debt to GDP ratio was considerably lower.   That means that stimulus is not the answer to the second step of solving this crisis.   The budget must be restructured.

I expect job growth to continue into 2012, mostly because cuts will not take affect before then and the stimulus is starting to take hold.   Despite the fear and uncertainty on Wall Street, we have reached a point of capitulation where the markets stop reacting out of panic and start truly assessing the state of the world economy.

If the US passes a mixture of tax increases and budget cuts that promise a significant dent in debt, not only will the AAA rating be restored, but private investors will be more comfortable taking risks in the economy.   If the Europeans stabilize the Eurozone (or, less likely, make it smaller), countries like Germany, the Netherlands, Sweden and Norway — all of whom are handling the recession relatively well — can help motor Europe forward.   Lost in the whole controversy is that the unhealthy European economies are the minority, dragging the majority down.   As a continent, Europe is actually in better shape than the US.

However, the result will be continued slow growth as the global economy rebalances.   More power and wealth will shift to countries like China, Brazil and others.   Globalization will limit the impact of domestic policies — does a tax cut in the US stimulate the American economy, or does it stimulate the Chinese economy if the money is used to be Chinese consumables?   We won’t be partying like we did in 1999 (or 2006) when growth appeared permanent — bubbles create wild illusions!  That economy was a house of cards built on sand.   But a slow restructuring with jobs dribbling rather than surging back could mean the development by the end of the decade of a strong, restructured stable US and world economy.

Anyone who has read my blog for the last three plus years knows I’ve been pretty bearish on the economy.  I was a contrarian back in the heady days of 2006 when people believed that deregulation of financial markets and American innovation had heralded in a new economy.   It was debt, the current account deficit and hyper consumerism that caused that view.   Now the current account is back to just over 3% of GDP — too high, but tolerable.  Consumerism has given way to saving and paying off debt.   Both parties are serious about debt reduction.   In Europe and the US illusions of this being “just another recession” have given way to recognition that this is a time of systemic transition rivaling the 30s.

It’s always darkest before the dawn.  It may well be that August 2011 is remembered as the turning point in restructuring the global economy.   We won’t get the rah-rah consumerism and bubble games of the 00s, but we might get a sustainable economy and even learn that community trumps consumption.

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