The global economy is awash with talk that the bottom may have been reached. Fiscal stimulus packages have taken effect, while there is the prospect of a recovery based on restocking next year. However, David Leggett argues, the underlying causes of the downturn have not gone away – and could lead to a W-shaped recession.
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International economic institutions such as the IMF, World Bank and OECD are more or less united in the suggestion that the current situation for the world’s economy, while not a happy one, could be worse and that the bottom may have been reached in mid-2009.
However, there is also a consensus that stabilisation is uneven and that the recovery may be a slow and fragile one. Financial systems remain impaired, support from public policies will gradually diminish, and households in countries that suffered asset price busts will tend to rebuild savings rather than embark on a spending spree.
The advanced economies as a group are still projected not to show a sustained pick up in activity until the second half of 2010.
The decline to world industrial production in this recession is actually sharper than that which occurred during late 1929 and 1930. Those countries – like China and Russia – whose economies were growing strongly last year have not been able to escape the recession, either through reduced exports or through financial linkages which have reduced credit pretty well everywhere.
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By GlobalDataTo make things worse, risk aversion and liquidity demand have led to the withdrawal of funds from emerging markets. As business confidence globally has waned, so firms everywhere are moving to cut costs and conserve cash in the same way as banks did earlier in the downturn.
‘Deleveraging’ will keep things weak. Asset prices are set to stay low. Households are not in the mood to spend and won’t be for some time. Unemployment – a lagging variable – will be climbing well into next year.
While major progress has been made in restoring bank solvency, it is not yet sufficient to stop the deleveraging.
On the plus side, the authorities have acted swiftly to lower interest rates and initiate fiscal stimulus packages. And commodity prices have fallen back sharply since the highs of last year.
After the sheer depth of the contraction to the world economy this year, an apparent recovery based on restocking could actually be pretty fast to get going in 2010. It will be led by the US economy and when it comes it may even look like a sharp rebound, too. It could be more than a little misleading. The underlying problems that have caused this recession will not have gone away, giving rise to the risk of a deeper or more prolonged downturn. Credit remains in short supply, with the banks far from ‘fixed’. Other dangers include the risk of price deflation and growing protectionism that could hit world trade. Past experience also suggests that banks are slow to resume lending after banking crises.
The IMF says that US economic activity this year is expected to fall 2.6%. Growth in 2010 is now forecast at 0.8%.
The OECD sees a positive development in a recovery that ‘already appears to be in motion in most large non-OECD countries’. This is particularly so in China, it says, against the background of substantial monetary and especially fiscal stimuli. At the same time, these countries do not suffer from the kind of balance-sheet damage that afflicts many OECD countries, the organisation notes.
It also says that signs have multiplied that US activity could bottom out in the course of the second half of this year. Signs of impending recovery in the euro area are not yet as clearly visible, reflecting country-specific combinations of bursting housing bubbles, export set-backs and damage to financial sectors. The eventual recovery may also be slow in this region, including because rising unemployment makes consumers more reluctant to spend.
Concern has been expressed about potential inflationary impacts of central bank injections of liquidity. That could be a risk that will grow as the economic recovery gains greater traction in the US and Europe in the second half of 2010, alongside an apparent normalisation of financial markets.
‘W-shaped’ recession coming?
Robin Bew, the highly respected Economist Intelligence Unit’s (EIU) Editorial Director and Chief Economist, sums up the international situation succinctly as he warns on the outlook beyond 2009 and the possibility of a ‘W-shaped’ recession.
“There’s a lot of green shoots around, not just in America but elsewhere. And that does represent a genuine improvement. We do see a bit more activity. And so while clearly there’s still a lot of hardship around and some businesses are still doing very badly, we do see a bit more demand. But there is a couple of things driving that. One is this turnaround in the inventory cycle.
“But perhaps the most important thing is what’s happening in policy, because the policy stimulus measures that we’re seeing put in place – in a whole lot of markets, but America is clearly an important one – are feeding through into a slightly better economic picture.
“But for us the question is, how long can that be sustained? At the moment, much of the policy stimulus is scheduled to be removed or at least watered down a bit when we get to the end of this year or into 2010. At that point, we’d expect to see growth drop back. So that gets you the second leg down of the W-shaped recession.
“And then what happens after that is whether there’s a sustained private-sector recovery or whether the government actually has to step back up to the plate and inject yet more stimulus in.
“Now, if you look to Japan in the 1990s, you saw not a W, but a series of Ws, one after the other, because the government would inject funds; then they’d stop and the economy dropped back into recession. There’s a bit of a risk of that.
“But certainly I think we need to expect this upwards swing that we’re seeing at the moment to be followed by something a bit more negative during 2010.”
There is, therefore, a need for caution when looking at economic prospects beyond the short-term uptick from a low base being driven by the inventory cycle. And governments may need to do more to both support economic activity and encourage more lending by the recapitalised banks.
