Many analysts are not too worried about a double-dip recession. They are, after all, rare: the slide in the US economy in the early 1980s shortly after a recovery is cited as the only recent example. The trouble is, however, that the type of recession we are going through is also very rare.
As Paul Kasriel of Northern Trust points out,this is the first time in the post-war era that bank lending to the private sector has actually fallen. Usually it just grows less quickly when overall activity dips. Banks have suffered their biggest losses since the war. So, with plenty of dodgy commercial real-estate loans still on their books and tougher accounting standards looming, they are hoarding capital.
In short, the “transmission mechanism” between the US Federal Reserve and the private sector is “malfunctioning”. After a typical recession, banks respond quickly to lower rates, passing along cheaper credit. But this time they’ve been so badly damaged that, even though the Fed is “revving up the monetary engine” (through rock-bottom interest rates and money printing), lending is shrinking and the economy is sputtering. As far as a double-dip goes, “this time it might be
different”. And not in a good way.
The last major examples of a damaged banking sector hampering the economy were in 1930s America and 1990s/2000s Japan. The latter has seen constant growth setbacks and has essentially flatlined for 15 years. “Broken banks make for a broken economy,” says Tim Price of PFP Wealth Management.
Bank lending in Britain has slipped into negative territory as battered banks hoard cash. Meanwhile, eurozone money-supply growth has also turned negative year-on-year. A falling money supply is deflationary, as Price points out: it puts downward pressure on prices. Once inflation slips into negative territory, debt piles rise in real terms. And just as inflation erodes debt, deflation adds to it.
Once deflation kicks in there is the danger of a vicious cycle as bad debts rise. That triggers bankruptcies and fire-sales of assets, further lowering economic activity and prices and causing more bad debts and bankruptcies. The danger of such a scenario “has never been higher in our lifetimes”, says Price. And as 1930s America and Japan post-1990 show, this is bad news for equity markets. All the more reason to stick with the defensives we highlight regularly in MoneyWeek.