Monday, April 20, 2009

Weak Economic Recovery

At times of gloom we tend to fasten on to glimmers of hope with an over eagerness. For example, data showing a small recovery in the housing market may prove to be a temporary blip in a more protracted downturn. Yes, there was a slight rise in mortgage lending in March, but, it was from a depressingly low level. If the economy does manage to recover this year, then it is likely to be a weak and fragile recovery.

The Recovery will be weak because:
  • There is no pent up demand. In the last recession, 1991, interest rates rose very high reducing spending. Therefore when interest rates were cut, people could spend more. Now, in 2009, interest rates are close to 0%, they can only go up. Also after a decade of borrowing, consumers are likely to try and increase their saving rates for a substantial time.
  • Housing Market could continue to depress demand. I would anticipate house prices to continue to fall for at least 12 months. Hopefully the pace of decline may slow, but, price to earnings are still high, and banks still reluctant to lend.
  • Balance Sheets. The primary cause of the recession is bad balance sheets at banks leading to a contraction in bank lending. The recession, with the inevitable repossessions and bankruptcies has added to their problems. It will take a long time for banks to improve their balance sheets and gain the confidence to return to normal lending criteria.
  • Government Debt. The government has been forced to increase borrowing sharply to finance bank bailouts, fiscal expansion + automatic stabilisers of recession. In 2010, 2011, the government will have no room for further fiscal expansion and may have to increase taxes sooner than economic conditions would warrant.
  • Prospect of Deflation. Deflation would definitely depress consumer spending for a long time. I would anticipate the UK and US would avoid deflation due to their policies of increasing money supply, but, it might be an issue for the EU.
  • Global Downturn. The recession has been global in its impact leading to a sharp reduction in world trade
The economic recovery will be slow, and there is even a chance of a double dip recession. But, at the moment I think many would just take any kind of recovery.

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