Enough to drive an optimist to drink

It had seemed the American economy might be coming right, which meant the world economy could look forward to a recovery, which would be great news for the export-dependent New Zealand economy.

Ben Bernanke, at the Fed, was seeing green shoots; President Obama was seeing glimmers of hope; the stock market was exuding confidence – but Paul Krugman, the Nobel Prize winner who writes for the New York Times, isn’t ready to sound the all-clear.

Ordinarily, that would be enough for Alf to demand Krugman’s arrest, to be tossed into a tumbrel with other gloom-sayers, hauled through the streets of Wellington and be jeered by the populace, then thrown into the stocks for a couple of days.

In this case, extradition proceedings would be required.

More important, Alf concedes Krugman has given four reasons for caution. Maybe we should consider them.

First, things are still getting worse.

Industrial production just hit a 10-year low. Housing starts remain incredibly weak.

Foreclosures, which dipped as mortgage companies waited for details of the Obama administration¹s housing plans, are surging again.

The most you can say is that there are scattered signs that things are getting worse more slowly – that the economy isn’t plunging quite as fast as it was.

Second, some of the good news isn’t convincing.

The biggest positive news in recent days has come from banks, which have been announcing surprisingly good earnings. But some of those earnings reports look a little … funny.

Krugman cites aspects of Wells Fargo’s latest quarterly earnings (the best ever) and a huge jump in Goldman Sachs’ profit as examples.

I don’t want to go overboard here. Maybe the banks really have swung from deep losses to hefty profits in record time. But skepticism comes naturally in this age of Madoff.

Third, there may be other problem areas. Back in the Great Depression, there was a pause in the economic plunge about a year and a half in (roughly where the USA is now), but

then came a series of bank failures on both sides of the Atlantic, combined with some disastrous policy moves as countries tried to defend the dying gold standard, and the world economy fell off another cliff.

Can this happen again? Well, commercial real estate is coming apart at the seams, credit card losses are surging and nobody knows yet just how bad things will get in Japan or Eastern Europe. We probably won’t repeat the disaster of 1931, but it’s far from certain that the worst is over.

Fourth, even when it’s over, it won’t be over. We are reminded that the 2001 recession officially lasted only eight months, but unemployment kept rising for another year and a half. The same thing happened after the 1990-91 recession.

And there’s every reason to believe that it will happen this time too. Don’t be surprised if unemployment keeps rising right through 2010.

Why? “V-shaped” recoveries, in which employment comes roaring back, take place only when there’s a lot of pent-up demand. In 1982, for example, housing was crushed by high interest rates, so when the Fed eased up, home sales surged. That’s not what’s going on this time: today, the economy is depressed, loosely speaking, because we ran up too much debt and built too many shopping malls, and nobody is in the mood for a new burst of spending.

Employment will eventually recover – it always does. But it probably won’t happen fast.

Alf was depressed by this analysis and had to go down to the club to resurrect his spirits.

He sat back in his favourite chair with a stiff whisky and proceeded to read the rest of the column, where Krugman prescribes persistence.

History shows that one of the great policy dangers, in the face of a severe economic slump, is premature optimism. F.D.R. responded to signs of recovery by cutting the Works Progress Administration in half and raising taxes; the Great Depression promptly returned in full force. Japan slackened its efforts halfway through its lost decade, ensuring another five years of stagnation.

The Obama administration’s economists understand this. They say all the right things about staying the course. But there’s a real risk that all the talk of green shoots and glimmers will breed a dangerous complacency.

Alf is only too aware there are many who would challenge these recommendations. Fiscal stimulus is anathema to them (unless it takes the form of tax cuts).

But Krugman’s fundamental advice, to the public and policy makers alike, is: Don’t count your recoveries before they’re hatched.

2 Responses to Enough to drive an optimist to drink

  1. Pique Oil says:

    Alf, you are quite right to be very skeptical.
    An article from the Houston Chronicle by Loren Steffy is well worth a read.
    Changes to accounting rules and financial year dates can do wonderful things to a set of accounts. As can the way a previously worthless asset is suddenly unable to be valued and thus gets put in at nominal value, all in the name of fairness you understand.
    Personally I believe what I see in the mail and in our small training business around the country. I get a customer going out of business on average every fortnight and those that are still in business are spending very little.

  2. Alf Grumble says:

    Thanks for the steer. Loren Steffy’s piece was worth the visit and reinforces the doubts Krugman casts on the bank quarterly financial results. The final paragraph is worth repeating: “The economy may have slowed its slide, but to borrow Federal Reserve Chairman Ben Bernanke’s analogy, a few green shoots don’t make a forest.”

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