2009 is turning into a record-breaking year – and we’re only just into February.
We’re facing the worst recession since the Second World War and now we’ve been landed with the heaviest snowfall since the last recession in 1991.
But the good thing about the snow is that it will pass pretty quickly – and some people might even enjoy it while it’s here.
You can’t say the same for the recession…
This recession will last much longer than the snow
The snowfall and our usual chronic unpreparedness for it has given us all a good excuse to beat ourselves up about something else. And it is ridiculous that we can have known this was coming for so long (and in any case, snow in Britain in winter is hardly a novelty), and still have the entire transport system in the South just give up.
But the snow will go away, and we’ll all forget about it. And it’s taken the wind out of the ‘wildcat’ strikers’ sails somewhat – when half the population can’t get to work, picket lines suddenly don’t seem that big a deal.
The recession will take a while longer to clear up unfortunately. And it won’t be so easily forgotten.
In the Wall Street Journal today, Carmen M. Reinhart and Kenneth S. Rogoff compare the current crisis with ones in the past. (If you recognise the names, that’ll be because these two are the banking experts of the moment – they’ve put out several useful papers covering past financial crises). They focus on the US, but their comments are pretty applicable to the UK – and the rest of the world – too.
The good news, they say, is that “financial crises, even very deep ones, do not last forever. Really.” That’s about the extent of the good news though.
The average financial crisis wipes 36% off house prices over five to six years. So in the US, the bottom is unlikely to come until 2010 at least. And Britain would be further behind than that, as our slump started later.
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As for stocks, they “bottom out somewhat more quickly”. But it still takes three and a half years from peak to trough. There’s an average fall of 55% in real terms, which some markets, including the S&P 500, have already seen. But “given that most stock indices peaked only around mid-2007, equity prices could still take a couple more years for a sustained rebound.”
Unemployment is of course a big worry – it’s one of the few areas where problems tend to be worse in rich countries than in poor ones. But the real eye-opener is the massive surge typically seen in government debt. This isn’t just down to bail-outs – in fact, it’s mostly down to normal recession effects, such as unemployment payouts rising while tax revenues slump.
Reinhart and Rogoff argue that “a near doubling of the US national debt suggests that the endgame to this crisis is going to eventually bring much higher interest rates [as investors demand higher yields in return for buying US government debt] and a collapse in today’s bond-market bubble.” The high level of debt will also mean “stunted US growth for at least five to seven more years”.
The big difference between this crisis and the average one
But there’s a big difference between today’s crisis and the average one in the past. Usually, a crisis hits just one country or one region. That means the affected area can simply devalue its currency and export its way out of trouble.
But that requires there to be someone in the world who actually still wants to buy stuff. However, countries that are willing to play buyer of last resort are now thin on the ground. To a great extent, the US has been in that role for the past decade or so.
The trouble is, the roles can’t just flip around. If you built your economy – like China for example – on making cheap exports for the West, then if the West stops consuming, you go out of business.
The flood of cheap money has encouraged a great deal of what Austrian economists (see www.mises.org if you want to learn more about this school of thought) would call “malinvestment”.
A great example of malinvestment is all the blocks of buy-to-let flats built in, say Manchester. The wide availability of cheap money encouraged people to speculate on property prices. This in turn encouraged builders to construct flats specifically targeted at speculators, rather than genuine demand for homes.
When the cheap money vanished, the practically worthless nature of these flats was revealed. And now builders are starting to go out of business.
Nearly the whole world has been fooled by cheap money
At a broader level, almost every country in the world has been fooled by cheap money into going down an unsustainable path of economic development. And now all those malinvestments have to be unwound. That will take a long time, and it’ll involve a lot of pain – particularly as our governments are keen to stand in the way of the adjustment process.
As for house prices – still an abiding preoccupation in Britain, though perhaps not for much longer – our regular contributor, Pali chief strategist James Ferguson gives us his view on when they’ll bottom out on both sides of the Atlantic in this week’s issue of MoneyWeek, out on Friday. If you’re not already a subscriber, or you know someone who you think would like the magazine, you can get one issue completely free for you or a friend, for a limited time, by filling in your details here.
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More bad news to come for the markets
Stock markets may seem like fair value at the moment. But they’re only fair value if you think all of the bad news has been priced in. And that’s unlikely – so we could see them fall a fair way yet.