World Economy: The (Dangerous) Audacity of (Too Much) Hope

[br]

[br]

There is much still to be done to save the global economy, and a false sense of security won’t help us to do it

Chicago, 4 May 2009. Presidential Candidate Barak Obama came to power in the US on the back of 2 themes, ‘A Change we can Believe in’, and ‘the Audacity of Hope’. Once in power, however, President Obama changed tack a little. He was then criticised for fear-mongering in the lead up to the passing of his Economic Stimulus bill, when the chattering classes called for a bit more of his campaign trail optimism and hope.

In recent weeks, President Obama has seemed to heed that criticism and has been talking up the ‘glimmers of hope’ he sees in the economy. Chairman of the Federal Reserve Ben Bernanke has added his belief that there are ‘green shoots of recovery.’ Everyone seems happier, thanks in part to the run up in the stock markets. But is there a danger in this new found optimism?

According to many – but not all – economists, and the Economist in a lead article, the answer is ‘yes’, a clear and present danger. If we believe that things are getting better, we are likely to take our eyes of the ball, our foot off the gas, and to leave some difficult decisions to someone else to make. All of that could prolong the pain being felt throughout the world economy by years.

Panic has been the traditional cause of runs on banks, and as it was magnified by the global financial system it led to trillions of dollars being taken out of stocks, funds and credit markets. Confidence is vital to the orderly running of all these markets, and that confidence needs the optimism of visionary leaders to flourish. Wall St and the economic team at the White House both felt that this was a vital step in recovery.

Unfortunately there is not much to support this optimism. Nobel Laureate Paul Krugman says that the only green shoots of recovery are that “things are getting worse more slowly.” For example, US home prices in February 2009 were 18.6 per cent worse than a year earlier. That is a massive drop by any standard. So how could that be seen as good news? For the first time in 16 months, the decline did not set a new record. Things are getting worse, (barely) more slowly. Don’t be surprised if that number ticks up a bit before a solid trend of slower declines is established.[br]

Although some leading indicators such as stock market prices might already be trending upwards, the consumer market still has a lot of pain to come in the form of all-round deleveraging and unemployment. Consumers are tightening their belts around the developing world, and the expansion of spending in the BRIC countries won’t happen soon enough to cushion the fall. “There are [only] three areas where consumer spending is increasing: guns, alcohol and condoms”, jokes Diane Swonk of Mesirow Financial.

Even though the stock market is a leading indicator, it does not always call the economic bottom correctly. Between 1929 and 1932, there were 4 rallies with more than 20 per cent gains, all of which came to nothing. It took years before any sustained bull market out of the Great Depression could be achieved.

There is a very real possibility right now that policies that will become increasingly unpopular are not carried through. Governments and central banks around the world must continue to prop up their economies with stimulus plans, low interest rates and unconventional actions like quantitative easing (printing money). This will lead to bigger and scarier deficits and a rising concern and demands to reduce those ballooning debts – but if taxes are raising or social benefits cut, the recession could be brought right back in.

They will need to manage both the immediate risks of deflation, which will make debts bigger and bigger, and the longer term challenge of inflation once credit starts moving properly again, which could leave any recovery too weak to flourish.

Law-makers need to make difficult calls to tackle regulatory reform. The words ‘too big to fail’ need to be removed from our dictionary, so that no financial institution is able to hold the world economy to ransom in the future. Some financial products are so complex that even their inventors don’t fully comprehend them – this kind of financial engineering needs to be tightly regulated, but get it wrong and the unintended consequences could bring new crises down the line.

And this is perhaps the best example of the big picture challenge we are all facing together. Some of the threats we are dealing with, and some of the policy responses taken, are completely new. We are in uncharted territory, floating on a sea of debt, with storms that can buffet us near instantly in the age of Twitter and instant Internet news.

We agree with the economists, and the Economist, in saying that it is far too soon for optimism. It is a time for caution, analysis and hard work, to get us out of this mess without creating an even bigger one for our children to deal with.

Hosni Afleck, EconomyWatch.com