Reasons to be cheerful about a recovery
ECONOMIC VIEW BY ANATOLE KALETSKY (the Times [London])
THE SUMMER is over and those of us who managed to get away for a long holiday return with a depressing sense of déjà vu. Financial markets and the world economy seem to be wandering aimlessly through the same no man’s land between depression and recovery where we left them in July.
Industrial indicators still point to recession, while consumer indicators point just as clearly towards steady economic growth. There has never before been anything like this extreme divergence between consumption and production.
Meanwhile, the signals from financial markets remain as depressing and confusing as they were before the summer. Equities have fallen back to their April troughs and bond yields are at or near record lows, suggesting that bond investors all over the world are now expecting a long and deep recession. The Federal Reserve Board and the Bank of England are both still clearly worried, while the European Central Bank continues to do too little too late. As for Japan, Argentina and many Asian countries, things are going from bad to worse.
So is the world economy in even worse shape today than it was before the summer holidays? For pessimists, the main difference between the situation today and in early summer is that two more months have gone by without any evidence of the long-awaited economic improvement — and with each week that passes, the pressures intensify for businesses to announce further big layoffs and for banks to call in their loans. Optimists can reply, however, that two more months have passed without the world economy sinking into the long-dreaded recession — and with each week that passes, inventories get leaner and the impact of monetary easing and tax cuts can be expected to grow.
The key question about the world economy is therefore the same as it was in July. Will the deflationary forces from the production side of the economy overwhelm the power of consumer spending? Or will the continuing growth of consumption, housebuilding and government spending force gloomy businesses to rebuild their depleted inventories and start increasing production? I remain confident that consumers, rather than producers, will win this tug-of-war.
Throughout this year, I have sided firmly with the optimists, for two main reasons: because consumption is more important than production in shaping the economic cycle; and because monetary policy has invariably succeeded in stimulating demand in all Western economies since the Second World War. Both of these observations are strongly supported by postwar experience and by economic theory. But economics is a game of probabilities, not an exact science. I have to admit, however, that nothing in economics is ever certain. The best I can do, therefore, is to continue assessing the evidence and guess how the probabilities have changed in the past two months.
My conclusion is that the short-term outlook has got worse, but not as disastrously as the markets seem to be suggesting. Instead of the robust recovery which I expected to start in America during the spring or early summer, we are now likely to see at least one more quarter of very slow growth. Moreover, there could be a new wave of layoffs in the next few weeks, as businessmen return from their summer holidays and find that their order books have not improved. A quantum leap in unemployment would probably trigger a renewed fall in consumer confidence and could produce a full-scale recession, not only in America but also Europe. But such a disaster is still not very likely, partly because of the effects of monetary easing and partly because inventories and industrial production have already been so drastically cut. In fact, the unusual divergence between consumer spending on the one hand and production and inventories on the other suggests that the recovery, when it does come, could be surprisingly rapid. This may be specially true in America and (to a slightly lesser extent) in Britain, the two economies in which the gaps between strong consumption and weak production have been widest.
Conventional wisdom maintains that the protracted nature of the present slowdown implies a slow, very gradual recovery. The doom-mongers also maintain that the length of the downturn demonstrates the seriousness of the long-term “structural’’ imbalances that will act as a drag on global economic growth for many years ahead.
This is obviously true of Japan, and in Europe, too, there can be little hope of rapid recovery until some of the key structural problems are overcome. The most important of these structural impediments to growth is undoubtedly the policy of the European Central Bank, or more precisely the ECB statutes laid down in the Maastricht treaty, which allow and even encourage the central bank to pursue a flat-earth monetary policy which bears the same relationship to the advances in modern macroeconomics as did the Roman Inquisition’s cosmology to the discoveries of Galileo.
Ironically, however, America and Britain, rather than Europe, are usually singled out these days as the economies suffering from long-term structural weakness. The severity of the present slowdown is cited as the evidence that America — and to a lesser extent Britain — are suffering from deep-seated imbalances which will result in years, if not decades, of substandard economic growth. Nothing could be further from the truth. The willingness of British and American consumers to go on spending money, despite the collapse of stock market prices, suggests that the Anglo-Saxon countries’ savings and debt levels remain at comfortable levels. The strength of their currencies throughout the current slowdown also suggests that their trade deficits and their dependence on inflows of “hot money’’ from short-term investors are both less serious problems than generally believed.
Far from implying a weak recovery, the present exceptional divergence between consumption and production suggests that the economic recovery, when it finally does arrive, could be very strong, at least in the US and Britain. The reduction of inventories in the past nine months has been among the sharpest on record. Yet final demand has remained much stronger than in any previous slowdown and there has been a surge in monetary growth. This suggests that either we will soon see one of the fastest declines in consumption on record or that manufacturers and retailers will find themselves very short of finished goods. The implication is that when demand does start to pick up, either as a result of the effects of lower interest rates or because of a simple turn in the inventory cycle, the required increase in production could be surprisingly big.
Finally, a word about the long-term outlook. Again, the protracted nature of this slowdown could prove unexpectedly benign. This slowdown, because of its depth and duration, will largely eliminate the inflationary pressures which have gradually been building up in the US economy since the late 1990s.
Until recently it seemed as if the present slowdown would be neither long enough nor deep enough to have much impact on US inflationary pressures. Many commentators (myself included) believed that the Fed and the Bank of England might end up over-stimulating their economies and facing a serious inflation problem by next year. But now it looks almost certain that this protracted period of economic weakness will create enough surplus capacity and unemployment to suppress inflation for several more years. If this happens, then the next expansion phase of the business cycle should prove more sustainable than anyone expected a few months ago.
The protracted slowdown has also diminished the threat to American economic stability posed by the US current account deficit and the expensive dollar. If the dollar had fallen significantly in the early stages of the present slowdown, this currency weakness would have aggravated inflation and created a difficult dilemma for the Fed. But the US economy is now so weak that inflation is not going to be a threat for at least the next 12 to 18 months. As a result, the US and the Fed would have nothing to worry about even if the dollar fell abruptly (which I still do not expect).
In retrospect, this year’s grim economic news may be seen as another blessing in disguise for the US, similar to the Asian and Russian alarms of 1997-98. Like those financial panics, this year’s hysteria about recession could give a new lease of life to the US economic expansion — and to Alan Greenspan’s reputation.
thetimes.co.uk |
