Short Run Prospects

This is the first of a number of comments on the economy.

Green shoots notwithstanding–"rough winds (may yet) shake the darling buds of May" (and kill the shoots)–there is no assurance that the economic decline is ending or that it will end shortly–this summer or the fall. Even a devastating relapse should not be ruled out. May of 2009 may in the years to come be compared to the spring of 1930, the beginning of the Great Depression, although even a worse case scenario should not quite lead to what we had in the thirties.

Will May of 2009 be comparable to the summer of 1982? We were then in a severe recession but it was one that ended in the fall of that year. That recession may end up being the worst recession since WW II, if the recovery comes soon, but this present recession is the most dangerous, in that it harbors the possibility of degenerating into a real depression. This was not really true of the recession of 1981-82. That recession was brought on by tight money to stop inflation and ended by easy money. This recession was not brought on by tight money and easy money has not brought us out of it. But assuming the green shoots people are right and the end of the recession is near, what about the recovery?

Using the lettering system developed in the last decade, I think we can say with assurance, we will not have a V, a bottom followed by a strong recovery, although Roubini says V simply stands for a short recession. A U is weaker, but the letter I just typed looks to me to be overly optimistic–a bottoming out, then a pause, followed by a rise to economic heaven. But a third alternative, an L, seems more appropriate, especially the L on my keyboard, since the economy would first level off and then there is an ever-so-slight rise (take out your magnifying glass). Roubini thinks an L is a depression, but I suspect his keyboard has letters with slightly different shapes.

Both the short-run and longer-run prospects seem to me to be dreadful. Let me deal, here, only with the short run. Those who have taken a traditional course in economics (or taught it) probably remember the equation and letters for the gross domestic product–the overall measure of output: GDP = C (consumption) + I (investment) + G (government) + [X (exports) - M (imports)] (Imports are subtracted, obviously, since goods sold here but made in China, are part of China’s GDP, apart from what is done here, which is counted–unloading the ships, trucking the goods to Walmart and then the work of paid, er, underpaid employees selling the stuff.

Given the devastation of an increasingly catastrophic world-wide recession, increases in exports will be limited, at best, undercutting one recovery constituent. More important are the negatives on what is key–investment. Housing construction has properly been put in this category by economic statisticians, even if one might alternatively consider it part of consumption. Usually, in a recession, the Fed lowers interest rates and this helps bring down mortgage rates and this in turn leads to greater housing purchases. And while most of these purchases are of existing housing, there is also a significant growth in housing construction.

But, given the glut of foreclosed houses in this recession, construction is not only dead now, but it clearly will show little life for a long time to come. Thus a very important part of the recovery syndrome is undermined. (And in passing, while there are areas where buyers are stepping in, most reports expect housing prices to continue falling some and mortgage defaults to continue to rise, even if the worst is over.)

But yet another part of a normal recovery is undermined–increased business investment. While most banks may have passed, more or less, the "stress test," banks in general are still very stressed. Even if the worst is avoided--a resumption of major bank defaults (or major outlays to prevent these defaults)–it is clear that it will take quite a while before banks will be able to make the loans to businesses they typically make during a recovery. In other words, investment will be far weaker than it usually is during a recovery.

Consumption is also likely to be more stunted than usual. First, people are fearful and, understandably, because of this, they are being more cautious. (The front page article in the Times yesterday, May 10, entitled "Shift From Spending to Saving May Be Slump’s Lasting Impact" spells out this argument.) Many, who have kept their jobs, are "saving" more by paying off their debts. And while saving is a wonderful activity, and as individuals we should all do it during most periods of our lives, it is the opposite of what is needed during a recession (or during a recovery). The wonderful Keynesian "paradox of thrift," in which attempts to save lead to less actual saving since postponing consumption leads to goods not being sold, and workers being laid off, is as alive and well as it was when originally put forth by Keynes in the thirties.

Consumption is also being hit by two other sources. People can’t spend by borrowing on the increased value of their houses, since their houses have decreased in value. And banks at this point won’t lend many potential borrowers the money even if the value is there. The other negative is that credit card companies are being forced to be more careful. Moreover, they are increasing their rates, which not only discourages borrowing directly but indirectly allows for less consumption, rather than more, since more must be spent on payments of interest.

We are left, therefore, with one hope, and one hope only, if the recovery is to be stronger than what it appears it will be, whenever it begins to take place–the last letter in the equation above, G (government). The stimulus will help, but unfortunately, big as it is, it is too small. Moreover, too much of it is going to tax cuts, much of which will not be spent, but saved–the paradox of thrift again. The President’s attempt to be bi-partisan, whether induced by belief (and/or temperament) or caused by political considerations, has led to a lower stimulus than what we needed, with too much of it perversely directed into tax cuts, instead of spending projects.

I thought Obama could have achieved immediate results–countering the argument that spending takes too long to go into effect–if the federal government had given the money to the states, and to their universities, and to cities, enabling the states and cities to reduce their cutbacks in education, libraries, infrastructure and everything else that is being cut. And almost all of this kind of spending is considered socially useful, and appropriate, by all who are not clones of Ron Paul.

Given all this, what do I think will happen in the short run? While a recovery of sorts could possibly be around the corner, to use the (unfortunate) phrase Herbert Hoover employed in the early 30's, the greater likelihood is that it will not take place until later in the year. Or worse, it may even be delayed until 2010 when the effects of the stimulus kick in enough to reverse the decline, although other factors such as the rebuilding of inventory may cause GDP to increase slightly at an earlier point. But, like the situation after the recession of 2001, an end to the recession can be determined and announced by the official arbiters of the dating process (of recessions), the National Bureau of Economic Research, but I fear that most persons will be unable to distinguish the recession from the recovery. Nevertheless, the optimistic part of all this is that barring a disastrous set-back in the financial sphere, we are probably near the bottom.

Unemployment is now 8.9 %. But a more appropriate measure of unemployment, one which includes those too discouraged to look for a job and those working part time who would like to work full time, is about 16 %. The official rate is likely, as I predicted a few months ago, to reach double digits this summer. If not, it will surely come close. This level of unemployment, while nowhere near the level reached in 1933, is nonetheless dismaying. But even more daunting is the fact that a weak recovery almost ensures that the level of unemployment will keep on rising, even after a recovery begins. This is usually the case, but this time it will likely rise more than it does on average, and rise longer than it usually does, since the recovery is almost guaranteed to be an anemic one.