It’s now clear that the Great Recession is not (was not) the Great Depression 2.0. A deeper crisis appears to have been averted. That’s not to say that all's well. But given the dire expectations of late-2008 and early 2009, the view from early April 2010 looks like a gift from heaven. The question is whether this is a free lunch? Or, as we expect, there's a price to pay, even if the price isn't obvious yet, in either the details or magnitude.
Of course, we know that there'll be lots of debt to deal with. We've known that for some time. But it seems as though the market, so far, has accepted this price. In fact, the market doesn't appear extraordinarily upset, to the extent that we can glean such sentiments from things like bond prices and the associated yields.
Given what we know so far, the global economy has made a remarkable rebound over the past 18 months or so. Remarkable relative to what was expected not so long ago. Using global industrial production as a proxy for world economic activity, economists Barry Eichengreen and Kevin O’Rourke attribute the recovery to proactive monetary and fiscal policy responses that flooded the economic system with liquidity. This is in direct contrast to the early stages of the Great Depression in the 1930s, they advise.
"Global industrial production now shows clear signs of recovering," Eichengreen and Kevin O’Rourke report last month. They go on to write:
There's one more reason for thinking positively in anticipating that demand will eventually catch up with supply: Last week's encouraging update on nonfarm payrolls for the U.S. The government advised that last month witnessed the biggest net creation of jobs since the Great Recession began.
This is a sharp divergence from experience in the Great Depression, when the decline in industrial production continued fully for three years. The question now is whether final demand for this increased production will materialize or whether consumer spending, especially in the US, will remain weak, causing the increase in production to go into inventories, leading firms to cut back subsequently, and resulting in a double dip recession.
The global economy (the U.S. in particular) is still a long way from the halcyon days of, say, 2006, when all seemed right with the world. But it's obvious that there's reason to be hopeful. Does the business cycle always tell us so?
The financial journalist and historian James Grant made a case for answering "yes" last September, when the outlook was quite a bit less optimistic compared with the vantage of April 2010. As Grant reminded, "it has been a generation since a business cycle downturn exacted the collective pain that this one has done. Knocked for a loop, we forget a truism. With regard to the recession that precedes the recovery, worse is subsequently better. The deeper the slump, the zippier the recovery."
Grant went on to cite a bit of U.S. cyclical history:
But if there's a stronger case for expecting a "zippier" recovery these days, that happy outlook is not yet the consensus view. Just a few weeks ago, Lee McPheters, economics professor at the W. P. Carey School of Business, observed:
Growth snapped back following the depressions of 1893-94, 1907-08, 1920-21 and 1929-33. If ugly downturns made for torpid recoveries, as today's economists suggest, the economic history of this country would have to be rewritten. Amity Shlaes, in her "The Forgotten Man," a history of the Depression, shows what the New Deal failed to achieve in the way of long-term economic stimulus. However, in the first full year of the administration of Franklin D. Roosevelt (and the first full year of recovery from the Great Depression), inflation-adjusted gross national product spurted by 17.3%. Many were caught short. Among his first acts in office, Roosevelt had closed the banks. He had excoriated the bankers, devalued the dollar, called in the people's gold and instituted, through the National Industrial Recovery Act, a program of coerced reflation.
"At the business trough in 1933," Mr. [Michael] Darda [chief economist of MKM Parnters] points out, "the unemployment rate stood at 25% (if there had been a 'U6' version of labor underutilization then, it likely would have been about 44% vs. 16.8% today. . . ). At the same time, the consumption share of GDP was above 80% in 1933 and the household savings rate was negative. Yet, in the four years that followed, the economy expanded at a 9.5% annual average rate while the unemployment rate dropped 10.6 percentage points." Not even this mighty leap restored the 27% of 1929 GNP that the Depression had devoured. But the economy's lurch to the upside in the politically inhospitable mid-1930s should serve to blunt the force of the line of argument that the 2009-10 recovery is doomed because private enterprise is no longer practiced in the 50 states.
Since 1948, the average growth in real output following a year of decline in GDP is 5.6 percent. But it seems unlikely there will be a corresponding Great Recovery following the Great Recession of 2008-2009.Declaring final truisms about the business cycle is always subject to the economic report du jour. Indeed, the only thing for sure in economics is what appears valid today, which is hopelessly bound up with the last batch of numbers in front of us. The world economy shifts and shakes based on, well, everything and anything. Depending on the day, it appears that we've isolated the key drivers. And to some extent we have...until it's no longer relevant.
The prevailing view among economy watchers is that the recovery will be "u" shaped rather than "v" shaped, meaning that real growth of Gross Domestic Product will be modest compared to past upturns and unemployment will remain as a persistent problem.
The March revision of the W. P. Carey economic forecast reflects this somber assessment. While 3.0 percent growth of real GDP for this year and next is not a "gloom and doom" outlook, it is consistent with expectations that consumers will remain cautious, business will be slow to expand plant, equipment and hiring in the face of excess capacity, and state and local governments will remain strapped for funds.
But surely we've learned a few things over the decades. We know, for instance, that raising interest rates and letting banks fall like dominoes is something less than intelligent during an international financial crisis. It's the course of action after the worst of the danger has passed that's the central challenge.
The larger topic of debate is whether there's a cost to all our efforts at managing the business cycle. Have we simply traded the acute for the chronic in the last round of prescriptions? Some analysts warn that we're facing the problem of managing hefty debts and rising inflation in the years ahead with no easy solutions. Does that mean we're fated for stagflation? Or can we avoid this trap even as we sidestep the risk of Great Depression 2.0? So far, it looks like we've dodged a bullet. Then again, we're only halfway through this process. Perhaps the biggest risk is hubris at this point. It ain't over till it's over.
Or until the labor market starts expanding again on a sustained basis. "I personally put lots of emphasis on employment," Robert Hall, who leads National Bureau of Economic Research’s Business Cycle Dating Committee, told Bloomberg News last week. "“I think the odds favor a continuing expansion in employment, but I don’t have great confidence."
This article has been republished from James Picerno's blog, The Capital Spectator.