The Realist Trumps the Optimist on the Subject of Global Recovery

by Inya Ivkovic, MA

There is such a thing as too much optimism, particularly when it is unfounded. True, there are signs, albeit weak ones, that the rate at which the global economy is retracting is actually slowing down. However, weak signs of recovery should not be equated with ringing endorsements sounding the “all clear.”

Why? Well, the U.S. economy is still struggling with rising unemployment, with falling retail sales, with suffocating industrial production and with a sinking housing market. Europe’s GDP numbers for the first quarter were simply appalling. Japan’s economy is still unconscious. And China, while probably the only economy in the world that has entered the recovery stage, is still not exporting anywhere near its pre-recession levels. So, talking about the global recovery now is, at best, premature and, at worst, downright irresponsible.

When Lehman Brothers collapsed in September of last year, global financial systems were probably mere hours from crashing and burning. Choosing not to salvage Lehman Brothers and letting others stand may have terrified the collective psyche of global policymakers into creating a new “religion,” defined by traditional and unorthodox fiscal and monetary policy easing, pumping of trillions of dollars into global financial systems, offering government-backed insurance policies to take a bite out of the credit and liquidity crunch, etc. Just in the past two months, policymakers around the world have passed over 150 policy decisions, all intended to fix whatever has gone so terribly wrong with our world in the past year and a half.

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The focus on recovery has been so intense that somehow one crucial tree became lost in the woods. It has never been just the question of if and when the global economy would bottom out, because its cyclical nature cannot be denied. However, what appears lost in the recent optimism is not so much the “when” question, but what kind of recovery may follow up — healthy, strong and fast-paced or weak, anemic and snail-paced? Unfortunately, there are more arguments for the latter.

First, unemployment is still falling dangerously fast in nearly every corner of the world. Indeed, most developed economies will likely experience unemployment rates of over 10% by 2010. That cannot be good news for consumer spending — the main driving force of any economic recovery.

Second, although liquidity issues have been the focus of policymakers in the past year and a half, solvency and deleveraging issues haven’t been tackled at all. Personal and corporate debt hasn’t been reduced, but rather absorbed in a very socialist, non-capitalistic manner by governments’ balance sheets. But shifting leverage from one balance sheet to another does not make it disappear. Actually, this lack of focus on deleveraging will keep on curbing banks’ ability to lend and consumers’ ability to spend and invest.

Third, global financial systems are severely damaged. It seems to matter little how much money had been or will be pumped into them, because banks are still saddled with massive losses on loans and securitized vehicles that are still badly underfunded. That cannot be helpful in easing the credit crunch.

Finally, as government debt keeps on rising, real interest rates will eventually have to go up, which is bound to crowd out consumer spending and adversely impact refinancing of sovereign debts. And, while fighting the global economic and financial crises with fiscal deficit is not inflationary in the near term, weak output and labor markets could mean either massive inflation or the creation of another asset/credit bubble — or both. For example, recent rallies in stock and commodity markets have been largely liquidity-driven, not real-value-driven.

So, regardless of how much I may wish the Optimist to beat the
Realist, wishful thinking and mirages are not what will get us out of this mess. Unless some or all of these structural weaknesses are addressed in time, we could be in for a long, slowly asphyxiating ride towards weak and disappointing recovery, well below recent peaks.