Tuesday, March 3, 2009

Charting the course of misery

March 3, 2009

LAST week, United States Federal Reserve chairman Ben Bernanke predicted that 2010 'will be a year of recovery'. When will the misery end? Here are the guesses of three experts.

Risk of L-shaped near-depression

LAST year, some argued that the recession would be V-shaped - only about eight months long, like those in 1990 to 1991 and in 2001. Others like me argued that it would last at least three times as long and be three times as deep.

Today, as we enter the fifteenth month, it is obvious that we are in a U-shaped recession that has become global and will last at least until the end of the year - 24 months, the longest since the Great Depression.

Even if the US gross domestic product grows next year, it is likely to be no higher than 1 per cent. And at that rate, with the unemployment rate rising towards 10 per cent, the US will still be substantially in a recession.

Even if appropriate aggressive policy actions were undertaken, the growth rate would not rise closer to 2 per cent until 2011. So this recession may last 36 months. And things could get worse.

We now face a one in three chance that, if appropriate policies are not put in place, this ugly U-shaped recession may turn into a more virulent L-shaped near-depression or stag-deflation (a deadly combination of economic stagnation and price deflation) like the one Japan experienced in the 1990s after its real estate and equity bubbles burst.

Professor Nouriel Roubini, who teaches economics at New York University's Stern School of Business

Coordinated govt action needed

THE short answer is not soon. The recession is global: Exports, production and consumption are in high-speed descent. The headwinds are powerful because of excessive leverage, damaged balance sheets and the resulting tight credit.

Major financial institutions may be insolvent; their books are hard to assess. European banks have American-style problems with toxic assets and are also struggling because of their exposure to financial turmoil in eastern Europe. Eastern Europeans borrowed in euros and Swiss francs. Capital exodus and depreciating currencies have caused these debts to rise. And the shadow banking system through which a substantial amount of credit had been provided is no longer working.

Global growth is approaching zero, and all the advanced economies are likely to shrink this year. The prices of stocks and real estate continue to fall, and thus it will take more time for consumers and companies to pay off debt.

These factors have led to, first, reduced consumption and then declining investment and employment. This has lowered sales, profits, credit quality and, completing the loop, asset values. This interacting spiral is what makes this recession exceptional.

Governments and central banks are the only major sources of credit, liquidity and incremental demand - private capital and sovereign wealth funds, having experienced losses, are largely sidelined. If governments are quick and clear in their intentions and intervene in a coordinated way in both the real economy and the financial sector, we will probably have an unusually long and deep global recession through next year. If they don't, it is likely to be worse than that.

Professor Michael Spence, Nobel laureate in economics in 2001

Stop the bailouts

THE fundamental causes of this recession were mortgage defaults and the consequent insolvency of major financial firms. These insolvencies, and especially the fear of them, damaged normal credit mechanisms.

The self-correcting nature of markets will ultimately prevail. We should not underestimate the power of monetary policy; with the sharp increase in America's money stock starting in September, monetary policy is now extraordinarily expansionary. I believe, though without great confidence, that the recession will end in the second half of this year.

The US government's policy is damaging the economy's prospects. It fails to provide the needed tax incentives for investment in factories and equipment - incentives that were central to efforts to revive the economy during the Kennedy-Johnson era and under Ronald Reagan. But government spending can't lead the way to sustained recovery, because its stimulating effect will be offset by anticipated higher taxes and the need to finance the deficit.

Heavy-handed federal intervention into the management of companies from banks to carmakers will also delay recovery. And misguided efforts to help distressed home owners by permitting courts to rewrite the terms of mortgages will cause banks to limit mortgage lending, which will prevent housing from contributing to the recovery.

The unrelenting anger across the country over bailouts of corporations and households that made unwise and even irresponsible financial decisions is influencing federal policy. Punitive measures, like forcing companies receiving federal dollars to cancel employee events, will increase uncertainty over where the government will strike next in its effort to deflect public outrage. Instead of more bailouts, we need a clear path to fundamental reform of the US financial system.

Mr William Poole, president and chief executive of the Federal Reserve Bank of St Louis from 1998 to 2008


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