Is the Recession Over

28^th August 2009

The Malta Independent - Friday Wisdom

History books will show that this was the most violent recession since the War, distinguishable by the speed and the depth of the decline in economic growth in the last two quarters of 2008 and the first quarter of 2009.

Normally recessions set in more gradually and arrive with a degree of predictability. This one was deep and sudden. Normally recessions are the result of the normal cyclicality of economic activity. During recessions the banking sector remains strong and acts as a catalyst, through the supply of cheaper and easier credit, to pull the economy out of its lethargy by stimulating investment leading to sustainable economic growth. This recession is different because it was the banking crisis, especially following the Lehman collapse on 14 September 2008 that led the general economy into a recession. This time round the banking system is still very fragile to offer much support to the general economy.

So all prognoses is that this recession will be harsh and prolonged and recovery will be gradual and fragile with considerable risks of relapse. The argument was that growth before the collapse was fuelled by cheap and easy consumer credit, especially in the Anglo Saxon countries where domestic savings was negative as households spent more than they earned by borrowing second and third mortgages to cash in for consumption the rising values of their residential properties.

Now that the recession forced property values to collapse many households in the Anglo Saxon world are left with negative equity on their residences and consumers have to shift from negative savings to substantial positive savings in order to rebalance their finances. This is good, indeed necessary, for building future growth on sustainable foundations but in the short term it does not help a speedy recovery. In western economies consumer spending is a major part of the economy and if the consumer has to go slow it is likely that the whole economy will have to go slow. Unless....!

Unless the absence of growth in retail consumption in the Anglo Saxon economies is compensated by foreign demand from countries like China, India, Germany and Japan where traditionally the consumer has been more conservative and has capacity to increase consumption without incurring unsustainable debt.

The problem is that these countries are traditionally exporting countries and their economic growth has for decades been built on competitive export industries to meet foreign demand rather than on vibrant domestic consumption. So changing their economic model from export led growth to domestic demand growth, though crucially necessary for sustainable global recovery, necessitates a culture change that cannot be engineered just like flipping a switch.

So by all logic the recovery will be slow. The improvement in the financial asset prices since last March is mainly because last March the markets were pricing the end of the world. Now that governments’ intervention has stabilised financial markets markets can merely price a recession. So whilst the financial markets have shown great improvement since last March going forward to the peak levels of October 2007 will take much longer.

Given this scenario how does the news that Germany and France have seen economic growth in the second quarter for 2009 and are now technically out of the recession, fit into this big picture? Strange as it may seem it does!

Germany and France have not suffered a collapse in their property markets like the economies of the US, UK, Ireland and Spain. Their consumers have always maintained healthy savings ratios. So their consumers have much more capacity to increase consumption if they get incentivised to do so like for example through incentives to accelerate the changeover to more fuel-efficient cars.

But what is particularly relevant is that the growth registered in the second quarter was very minimal, some 0.1 per cent or 0.2 per cent and follows two quarters of sharp contraction.

So when it is said that Germany and France are out of recession it does not mean, as many seem to have understood, that their economy is back to pre-recession levels. It means that following two quarters of contraction their economy has started growing again but from a very low base.

Especially following two quarters of sharp contraction in growth as experienced between September 2008 and March 2009 re-establishment of small growth between April and June 2009 could possibly mean that manufacturing economies like France and Germany, who in the previous six months had suffered lack of orders as retailers and wholesalers run down their stock levels, have seen an influx of orders as stock levels were rebuilt.

Welcome as the news that Germany and France are technically out of recession is, reality does not change much as their economies are still knocking along a low bottom. But at least they are no longer in freefall and it helps to improve the psychology of the consumer. After all the recovery has to start from there!