http://www.telegraph.co.uk/finance/c...-pitfalls.html
We could seek an answer in the common view, or in business opinion. But all along, people, both expert and ordinary, have failed to get the full measure of what has happened, continually looking on the bright side, first expecting only a mild downturn, and then an early recovery.
We could look to the economic forecasters for guidance. But bearing in mind their lamentable record in foreseeing what I call the Great Implosion, not to mention countless other major events, this would represent the triumph of hope over experience.
Alternatively, we could see what financial market valuations are implying. But that would be dangerous: stock markets have forecast 10 of the last three recoveries.
I think the best way of assessing what may happen is to take a sober look at the past. A reading of the historical evidence suggests that early recovery is unlikely, and the danger of a recovery petering out is considerable.
Of previous man-made shocks, what we have come to know as the Great Depression was far and away the biggest. As the crisis of 2007-09 deepened, the ghastly thought started to take root that what we face now is something like a repeat of the 1930s. Even if the current recovery does continue into 2010 and 2011, you would be ill-advised to put thoughts of the Great Depression aside. At the end of the 1930s, after a mild recovery, the US economy appeared to be slipping back into depression – until it was rescued by the demands of war.
Both the Great Depression and the Great Implosion had their roots in large asset price bubbles and both involved catastrophic problems in the banking sector. Moreover, like the Great Depression, the Great Implosion is truly global. And there must be a risk that the world will again succumb to protectionism, just as it did in the 1930s.
Thankfully, there are some significant differences. The greater size of the state has meant that there is now a larger chunk of the economy where expenditure is not automatically cut due to lack of finance or loss of confidence, and indeed there is more automatic cushioning of private-sector spending as the public deficit expands passively in response to lower tax payments and higher benefit spending.
Over and above these passive responses, policymakers have also been pro-active, using Keynesian-style expansionary fiscal policies. Moreover, central banks have slashed interest rates aggressively and have continued expansionary monetary policy once rates have hit near-zero, through quantitative easing. And policymakers have been quick to prevent banks from failing and depositors from losing their money.
So, on the basis of past experience, what are our prospects now? Could the gloomy and fatalistic consensus view have overdone the pessimism? With the world economy now apparently recovering, this looks a distinct possibility. Perhaps we will look back in a few years' time and wonder how we could all have been duped into exaggerated pessimism. Common opinion, both expert and popular, may be as bad at anticipating the recovery as it was in spotting the downturn in the first place.
Although I think this is possible, I do not think it is likely. The game has moved on. Recessions are like the plague. The Black Death that ravaged Europe in the 1340s did not hit every city simultaneously. While it was raging in Milan, across the Alps in Geneva people thought they were safe, but within a few weeks Geneva was consumed by it too. Meanwhile, in Paris things continued as usual – for a while. By the time the time the plague was raging in Paris, it was finished in Milan, but London was yet to fall. By the time London had succumbed, Geneva was clear.
It is quite possible that even after the huge government bailouts of the banks in 2008, yet more public money will need to be poured in. Moreover, with the exception of the American giant AIG, there have so far been no insurance company failures, although it is surely possible that a significant insurance company will yet go under.
It is clear that the Great Implosion is the worst downturn of the post-war period. Whether it turns out to be even worse than that will depend largely on the policymakers.
For my money, the aspect of the current situation that will present some of the most serious challenges, and over which the policymakers will be most liable to making a serious mistake, is something that played a major part in the events of the Great Depression of the 1930s, the Long Depression of the 19th century, and the Japanese Lost Decade in the 1990s – namely the threat of a progressive fall of the price level, which we know by the term deflation. The problem is now all the more intense, and the dangers all the greater, because at the time that the deflation threat is most pressing, most people and institutions fear its opposite: inflation. This will be the subject of my next extract.
We could seek an answer in the common view, or in business opinion. But all along, people, both expert and ordinary, have failed to get the full measure of what has happened, continually looking on the bright side, first expecting only a mild downturn, and then an early recovery.
We could look to the economic forecasters for guidance. But bearing in mind their lamentable record in foreseeing what I call the Great Implosion, not to mention countless other major events, this would represent the triumph of hope over experience.
Alternatively, we could see what financial market valuations are implying. But that would be dangerous: stock markets have forecast 10 of the last three recoveries.
I think the best way of assessing what may happen is to take a sober look at the past. A reading of the historical evidence suggests that early recovery is unlikely, and the danger of a recovery petering out is considerable.
Of previous man-made shocks, what we have come to know as the Great Depression was far and away the biggest. As the crisis of 2007-09 deepened, the ghastly thought started to take root that what we face now is something like a repeat of the 1930s. Even if the current recovery does continue into 2010 and 2011, you would be ill-advised to put thoughts of the Great Depression aside. At the end of the 1930s, after a mild recovery, the US economy appeared to be slipping back into depression – until it was rescued by the demands of war.
Both the Great Depression and the Great Implosion had their roots in large asset price bubbles and both involved catastrophic problems in the banking sector. Moreover, like the Great Depression, the Great Implosion is truly global. And there must be a risk that the world will again succumb to protectionism, just as it did in the 1930s.
Thankfully, there are some significant differences. The greater size of the state has meant that there is now a larger chunk of the economy where expenditure is not automatically cut due to lack of finance or loss of confidence, and indeed there is more automatic cushioning of private-sector spending as the public deficit expands passively in response to lower tax payments and higher benefit spending.
Over and above these passive responses, policymakers have also been pro-active, using Keynesian-style expansionary fiscal policies. Moreover, central banks have slashed interest rates aggressively and have continued expansionary monetary policy once rates have hit near-zero, through quantitative easing. And policymakers have been quick to prevent banks from failing and depositors from losing their money.
So, on the basis of past experience, what are our prospects now? Could the gloomy and fatalistic consensus view have overdone the pessimism? With the world economy now apparently recovering, this looks a distinct possibility. Perhaps we will look back in a few years' time and wonder how we could all have been duped into exaggerated pessimism. Common opinion, both expert and popular, may be as bad at anticipating the recovery as it was in spotting the downturn in the first place.
Although I think this is possible, I do not think it is likely. The game has moved on. Recessions are like the plague. The Black Death that ravaged Europe in the 1340s did not hit every city simultaneously. While it was raging in Milan, across the Alps in Geneva people thought they were safe, but within a few weeks Geneva was consumed by it too. Meanwhile, in Paris things continued as usual – for a while. By the time the time the plague was raging in Paris, it was finished in Milan, but London was yet to fall. By the time London had succumbed, Geneva was clear.
It is quite possible that even after the huge government bailouts of the banks in 2008, yet more public money will need to be poured in. Moreover, with the exception of the American giant AIG, there have so far been no insurance company failures, although it is surely possible that a significant insurance company will yet go under.
It is clear that the Great Implosion is the worst downturn of the post-war period. Whether it turns out to be even worse than that will depend largely on the policymakers.
For my money, the aspect of the current situation that will present some of the most serious challenges, and over which the policymakers will be most liable to making a serious mistake, is something that played a major part in the events of the Great Depression of the 1930s, the Long Depression of the 19th century, and the Japanese Lost Decade in the 1990s – namely the threat of a progressive fall of the price level, which we know by the term deflation. The problem is now all the more intense, and the dangers all the greater, because at the time that the deflation threat is most pressing, most people and institutions fear its opposite: inflation. This will be the subject of my next extract.
