Economic Recovery: The Shape of Things to Come

Cookie Monster and the Shape of the Recovery: Where's My 'V' Gone?

Vienna, Austria, 6 September 2009. Coffee shop talk among economists, investors and business people alike has increasingly turned to one topic; what shape will the recovery take. And the discussion sounds more like an episode of Sesame Street with each passing day.

The main streamview is that the global recession is ending now, but not everyone believes that it will stay away. These discussions normally revolve around the 'shape' that the recovery will take. The shape refers to what a graph of GDP growth looks like, and the shapes are normally described as letters. These conversations can generate so much passion for wonks and market wizards alike can be reminiscent of the Cookie Monster's excitement at see a particularly tasty looking letter.

The most tantalising letter is the 'V'. This shape signifies a dramatic contraction followed by an equally-dramatic recovery, getting you back to where you were before the crisis within a short time frame. So far we have had the dramatic decline, and we are seeing signs of dramatic recovery, particularly in Asian exporters such as China, Korea, Taiwan and Singapore. The OECD has recently raised its GDP forecasts (for all major countries except the UK), suggesting that 2009 will end on a strong note.

The question now is, will it last, or is it too good to be true? Many people don't think so. The more pessimistic view is of a 'U' shape, meaning that we will skid around in an economic trough for quite a while, with a real recovery not coming for years. The 'L' is an even gloomier version of the 'U', meaning that in effect we will flat line for years or decades. The 'S' is a more aracane slow growth slow decline slow growth theory that is starting to be heard.

An increasingly popular view, although probably still not the predominant one, is that we are in the middle of a 'W' or double-dip recovery. In this scenario, we are currently wobbling precariously on the small pointy bit in the middle, before we slide into the second dip recession.

The poster child for a more pessimistic view is the economist who has become famous for predicting the credit crisis, Dr. Doom himself - Professor Nouriel Roubini. He has said that although he believes that the recovery will be 'U' shaped, he believes the likelihood of a 'W' is rising.

He cites several reasons to support a 'U' hypothesis:

• Government stimulus money is providing much of the fuel for the current economic recovery. This is particularly the case in China - which requires re-balancing. What happens when the stimulus dollars stop pumping demand into the system? Consumers have to then take up the slack - but look at the problems they face
• Unemployment is still rising in the US - and indeed in most countries. The US has just hit 9.7 per cent unemployment, and will cross the 10 per cent threshold soon. Consumers who lose jobs are not going to keep spending
• There are still a lot of bad debts out there which have not been written off and wound down, and now that governments have bailed out banks and effectively taken on those debts, politics will dictate a delay in that necessary cleaning up process
• There is still so much deleveraging to go through as a result, and much of the shadow banking system has disappeared. There won't be as many loans to consumers and businesses who need credit to spend
• Businesses have managed to report mostly profitable second quarters, but this is due to cost-cutting. Revenues are down, and there is talk that even that downplays the full effects of the contraction, since many companies keep back revenues from bull years (such as 2008) for bad ones (such as 2009). Most if not all of that 'spare' revenue has been used up, and there is growing concern for third quarter results
• Global imbalances still need to be addressed. This means more saving in current account deficit (net importing) countries like the US and more spending in trade surplus (net exporting) countries like China. This process is likely to take years to play out

He also cites additional reasons for a 'W'. Massive fiscal and monetary intervention from governments and central banks worldwide has saved us in the short-term, but they are now trapped between a rock and a hard place. Try to cut back the unbelievable deficits being built up ($5 trillion of debt and counting), they risk killing recovery and kicking off a period of stagflation. But leaving deficits could push up borrowing rates, leading from inflation to stagflation. Growing prices of oil (the IEA says oil over $70 could kill recovery, which is where it is at now) and commodities such as sugar (see the sugar prices: the next bull market) also threaten recovery.

While we hope that Professor Roubini is wrong, his arguments are starting to sound increasingly persuasive.

Dr Hosni Afleck, EconomyWatch.com