JDN - just for you buddy ... <g> ... Ken
The latest views of Morgan Stanley Economists
Steve Roach Weekly Commentary October 08, 2001
Global: From L to V
For some time, I have championed the "American-Style ‘L’." It was a scenario calling for three years of anemic growth in the US economy, averaging 1.5% to 2.0% over the 2001-03 interval (see my essay in the 9 May "Investment Perspectives"). More recently, I took the ‘L’ even further, arguing that the broader world economy was likely to be afflicted by a variation of the same disease -- a persistently chronic shortfall in global economic growth (see my 5 September essay, "The Global ‘L’"). In both of its forms, the "L" was largely a story of structural headwinds -- hinging on a purging of post-bubble excesses in the US economy and an American-led global economy that was now lacking a growth engine.
That was then. As Lord Keynes once said, "When the facts change, I change my mind. What do you do?" As I see it, there’s no getting around it -- The Shock does, indeed, qualify as a new set of circumstances that very much changes the macro call. That’s especially the case with respect to the likely contour of the near-term, or cyclical, outlook. For a US economy that we judged to have already been in mild recession before the events of 11 September -- an out-of-consensus view now supported by a slew of very negative pre-shock data -- the scales have tipped in favor of a deeper and longer recession than even we had expected.
That’s just it. The modern day history of the US business cycle makes it quite clear that deep recessions are invariably followed by vigorous upturns. America’s recessions of the mid-1970s and early 1980s -- heretofore the deepest downturns of the post-World War II era -- are cases in point. On average, the economy contacted by 3.2% in these recessions -- only to be followed by spectacular rebounds of 7% in the first year of recovery. Needless to say, that’s the silver lining of the glorious V-shaped business cycle.
The hows and whys of this time-honored cyclical magic are not hard to fathom. Deep recessions set in motion some very powerful self-correcting forces. The inventory dynamic is classic in that regard. Sharp production adjustments are required to take the inventory dynamic from accumulation to liquidation. The deeper the recession, the greater the de-stocking. As businesses succeed in cleaning out unsold goods, they must then raise production targets just to slow the rate of liquidation. That lifting of output then has positive implications for employment and income that boost aggregate demand. Pent-up demand is another key self-correcting feature of the business cycle. During recessions, consumers and businesses both put discretionary purchases on hold. Once the worst of a recession is perceived to be over -- a signal often flashed by a turn in the inventory cycle -- the release of pent-up demand can also provide a powerful stimulus to economic recovery.
In addition, psychological shocks have a self-correcting element to them. That’s because most of them stem from transitory events that disrupt economic activity for a finite period of time. As time goes by, the impact of even the most painful of shocks -- such as the terrorist attacks of 11 September -- fades with time. As that dulling of pain gives way to healing, consumer and business psychology will then improve. It’s all about feeling "less worse." However, there is little reason to believe that such healing is now at hand in America -- especially as the inevitable phase of US military retaliation now commences. The US economy is likely to be caught up in the midst of such a multiple-shock syndrome for some time to come. It is virtually impossible to speak about event risk with any degree of certainty under the current circumstances. But I do believe in the inherent adaptability of the human spirit. While US military action in Afghanistan underscores the risks of more shocks to come, it also adds clarity to the retaliatory wildcard. Once the unknown becomes known with greater certainty, it will then be possible to envision the healing that lies beyond these shocks as well.
The policy response is a final piece to the recovery puzzle. Here, as well, the deeper the recession, the greater the counter-cyclical stimulus of fiscal and monetary policy is likely to be. This current downturn is hardly an exception to this rule. The Fed has led the charge, with 100 bp of post-shock easing coming on top of 250 bp of cuts implemented earlier in the year. The fiscal authorities are now doing their fair share, adding a stimulus worth a little more than 1% of GDP on top of a previously enacted boost that was close to 0.75% of GDP; that puts the resulting 2% counter-cyclical stimulus very much in line with those of the past. A key question is whether these actions will work, or whether the authorities will end up pushing on that proverbial string. In our view, traction is the more likely of the two outcomes. The self-correcting features of this business cycle -- inventories, pent-up demand, and psychology -- should set up a classic cyclical turning point that will enable US policy makers to establish meaningful traction with the real economy by mid-2002. That, of course, pre-supposes the absence of further severe shocks along the way -- a critical assumption that admittedly may look tenuous now that the US military has embarked on its long-awaited retaliatory campaign.
I must confess that there is a certain mechanistic aspect to all this that troubles me. Perhaps, because this is all very broad-brush macro. By contrast, a careful look at the prognosis for the various sectors of the US economy is not particularly encouraging. Capital spending hardly seems poised for a rebound, policy stimulus or not. Homebuilding activity is at such a high level, it’s hard to envision much on the upside. Nor does a weakening global economy point to much support from exports. That, of course, leaves it all riding yet again on the American consumer. And with jobs and income under pressure, the case for a policy-assisted rebound in personal consumption is not without its downside risks either. There’s one other element of the cyclical call that I worry about: Our recession call may not be deep enough to trigger the recovery piece of the V. Currently, our baseline forecast calls for just a 0.9% drop in real GDP from peak to trough -- a contraction that would qualify as one of the two shallowest recessions of the post-World War II era. Rare is the mild recession that triggers a V-shaped recovery.
I want to stress that my conversion from L to V is purely cyclical and does not alter in any way whatsoever the structural endgame that I have long been stressing. Indeed, I have argued previously that The Shock may well usher in a period of lower longer-term growth norms (see "America’s New Norms" in the 3 October issue of Investment Perspectives). To the extent that the events of 11 September signal a turning point both for productivity and globalization, the long run outlook for the US economy looks very different than it did in the late 1990s. Moreover, The Shock does nothing to eradicate America’s post-bubble excesses -- a massive current account deficit, an outsized capacity overhang, anemic personal saving, and excessive household debt. A long overdue purging of those excesses should also inhibit economic growth for years to come.
The business cycle is best seen as an oscillation around a trend. This cycle -- like all those of the past -- will probably run its course in a relatively short period of time. To the extent the downside now looks deeper than it did before, there is good reason to suspect that it will be followed by a more vigorous rebound. Consequently, while I am now more comfortable with a cyclical V than I was before The Shock, I suspect that any such revival will be relatively short-lived before the US economy converges quickly on its new, and lower, growth norms. As I see it, there’s no turning back the clock to the Roaring Nineties. Here, again, Keynes probably has the final word -- the
facts have changed. |
