Thursday, 11 June 2009

Now What? The W-Shaped scenario

Is this really the end of the recession?

Perhaps, there is reason to be sceptical about last month’s fashion of optimism.

The new, global economics framework for modelling the world economy in a post transition-phase state is still missing. The models we use still have major systemic errors in them, we obviously still have the same valuation problems and mis-specification of the policy mix. Despite some calling for the New Thinking, there is little new that has been put forward in reality.

Much of the problem in valuations is still here. Others argue that while the visible part of the sub-prime mess is mostly cleaned up, a lot of the less visible, but rather sizeable side-effects of it are still on the books, without ‘proper’ valuation. I would add my own observation, that the way the markets approached emerging markets has not really changed much, differentiation is still not really the name of the game. If the capital markets asked for the a realistic risk premium, some emerging market treasuries would have gone into default, whatever the urgent ambulance package was. In any case, we would see a much wider performance range from emerging markets than was the case the past months.

Plus, the policy response has been mostly inadequate. The global economy has gone through a transition phase the past ten years, making national level policy responses unlikely to do the job. The problem is that to tackle the kind of global crisis that is at hand, one would need to have enforceable monetary and fiscal policy in place, on a global level, and that is clearly not there. What has been there instead, after an initial bout of panic, is a set of protectionist measures, and a happen-to-be-at-more-or-less-the-same-time fiscal stimuli around the world that kind of works as harmonised global stimulus.

Yet, the current stimuli take most governments way-way beyond known territories: deficits are up to levels unimaginable before, and debt as well as debt projections are through the roof. For the majority of the governments the current stimulus it is a one-off action. This one really needs to work.

Which takes us to the really bad news: most of the ‘green shoots’ seem to be directly dependent on the fiscal stimuli. There is hardly anything else. Scratch any bit of ‘end of recession’ data around, independent whether the US, China, Germany, or Australia. Although there is some actual money in the pockets, it is not that much. The biggest across the board factor is the change of confidence. In other words, the governments are inducing a new bubble, and we lay all our hopes on it.

This might work. Yet, there is a significant momentum towards further slowing in the global economy. The multiplying effect of the initial hit is just taking shape. The main survival strategy in sectors hit only indirectly by the crisis has been to cut back spending as much as possible, and try to bridge over the shortage of revenues from reserves and bank loans. Banks are still hesitant to lend (even if they are ordered to by their respective governments, as we have seen many examples around the world), which means that the bridging exercise is mostly from own reserves. And there signs that reserves are running out.

If the global confidence boom will not be sustained, and there is plenty of reason why it should not be, then the coming fall might turn out to be even bigger than the one allegedly bottoming. The W-shape scenario might see a deeper, and longer, second trough.


  1. I agree. The end of recession tales are on par with Santa's adventures. Anyone who thinks that the moment has arrived for the bull to return will burn themselves badly.

    There is only one disagreement: I don't think there will be any 'w' here. Just a temporary stop for breath before the final collapse.

    Abyss is the next stop?

  2. Tamas ,

    I am keenly awaiting your second scenario, for this has not got much credibility. You are the last one to call for the end of recession. And in any case, unlike the graph of NIESR suggests, the slow down started in 2007 not 2008.

  3. dragon tamer, even if you were right about everyone thinking the same about the end of recession, it would still not follow that they were all right

    look at the bubble before the crisis. how some people, including tamas, incidentally, were drumming the danger signals, with the majority ignoring them

    it is just not an argument. unless of course you are saying that the mkts are going to rally because everyone expects that. in which case, of course, you are saying the same as this argument here, but still nothing about the fundamentals

    there not being a good overall framework to put all of this in seems to be the right way to put it actually

  4. Just because you are a paranoiac, it does not mean that you are not followed. That is, just because you, or Tamas, or anyone else, voiced their dissenting opinion in the past, and they might have got it right once, does not mean that you get it right next time, too.

  5. and vice versa. dragon tamer, you just have annulled your own argument above

  6. @dragon_tamer: You are right about the start of the crisis being end of 2007, not 2008. In fact, using GDP as the statistics here is probably quite inappropriate, for it does not capture the essence of the crisis.

  7. You argue that the fiscal stimulus is a weak source of renewed economic activity as its size necessarily make it one-off for most governments. This does not quite square with the fact that as it is difficult to find the adequate paths to channel government money to the economy, it takes a long time arrive there. There will be real stimulus effect a long time after the package is announced.

    Perhaps, you are right about business confidence being boosted by the announcement of the fiscal spending, but there will be more reaching the economy. This will, hopefully keep up the confidence momentum. If that happens everywhere at the same time, then the recession is indeed over.

  8. @ anonymous: This is a very good point. I would think, however, that no amount of treasury money would be able to do the kind of confidence bridge that you describe here, as the rational economic actors do already compensate with (a) extra savings to shield themselves from the long term tax impact; and (b) will move out to lower tax regimes. Thus the confidence can only be kept up as an indirect, and not a direct consequence of the fiscal stimulus. In other words, the economy needs to believe in the efficiency of the government action. I cannot see this. The credibility of both monetary and fiscal policy institutions, and toolbox, weakened significantly since September 2008. There is no reason why this should or would change dramatically. And thus the only way to keep up the boost is to keep coming up with newer and newer packages, which is impossible, given the state of the treasuries are already in.

  9. Here is an example for the problem. Everything we know about emerging markets should suggest that the government originated infra projects will not be able to generate enough and lasting domestic demand in the Chinese economy. The experience from other, albeit smaller countries, is unequivocal: this is way-way to early to take China as a mature economy and expect to react as such.

  10. it seems that the markets are suddenly back to the ground...

  11. or not

    we are seeing the most beautiful bubbles being piled on top of each other, that we would have to mop up in the years to come

    The truth is nobody has any idea what is going on, just look at the end of summer forecast revisions from -- well -- anyone. The good thing is that ignorance is matched with robust self-confidence ...