A Strange and Disappointing Recovery

by: Max Fraad Wolff
We have had a strange and disappointing recovery. The recovery was built on massive governmental intervention the world over. Vastly expensive support was uneven, massive in some areas and absent in many others. This left a pattern of growing imbalance.
As the free fall stopped and activity began to increase in 2009, we went into denial. Articles and conversations about challenges and issues became fewer and farther between. There were real improvements. There was never much in the way of deep or accurate exploration of the causes and contours of the decline. Many were tempted back to the same world view that produced the great swoons of 2008-2009. States became guarantors to industry as industry denounced the state. The public settled into theories that all economic problems were “Wall Street” caused or government generated. Both sets of explanation are shallow, simplistic, self-serving and inaccurate.
The 2008-2009 years exposed structural problems in the global economy and leading local economies. Developed and developing countries were treated to a painful, rapid and severe lesson in interdependence and imbalance. As soon as minimum stability returned, everyone got right back to doing what produced the crisis. The developed world substituted state balance sheets as households were in no position to spend. Corporations embarked on cost cutting obsession and built giant cash holdings. Global business re-focused on the less debt burdened and faster growing areas of the developing world. Banks were pressed to take fewer risks and hold more cash. They responded beyond expectation, cutting way back on lending and building large pools of cash and “safe” investments. Trillions in tax payer and borrowed monies flowed in to shore up and repair select commanding heights of national economies. China invested in its export machine and kept its currency cheap. America rebuilt select firms and industries. Europe struggled to keep spending up to support its way of life. In short, the world re-invested in the structural imbalances that created the crisis. The savers went back to saving and spenders went back to excess spending. The importers kept importing and the exporters redoubled efforts to export.
The US, eurozone and East Asia used state balance sheets to ride out tough times. Massive cyclical response to the crises obscured the structural nature of the problem, at least for a while. Cyclical refers to the business cycle. This is the “normal,” if painful and recurring, boom bust cycle that has defined growth and contraction in every capitalist market economy ever known. Structural crises are more vexing and significant. Structural recessions occur because the basic structures, rules/norms, of the economy are, or have become, unsustainable. In structural crisis traditional cyclical policies don’t work to repair the economy. They cost too much and don’t last too long. Sound familiar? It should. The developed world bolstered wealth and ignored wealth creation. Thus, the spending done only helped to rebuild the imbalances and structural problems that created vulnerability to decline.
In the U.S. economy this took a very bizarre form. Corporate profits were rebuilt. Household balance sheets were not rebuilt. Job growth and wage growth remain absent. Federal, state and local balance sheets were stressed. Tax revenues fell and stayed depressed. Spending soared to rebuild an economic structure that produced the last crisis. We can see this in the staggering cost of imbalance in our recovery. Corporate profits rebounded nicely. In the final quarter of 2010 corporate profits reached $1.7 trillion, a record level. Wages, employment, trade balance and government balances deteriorated dramatically. With significant support many companies were able to rebuild and this did improve the economy. This proceeded as the government guarantors all relied upon slid deeper and deeper into economic distress.
Asset prices moved nicely up on Federal Reserve policies including, but not limited to, multiple rounds of quantitative easing. Strong profits and corporate earnings with subdued tax rates and an implicit government guarantee buoyed spirits and asset prices. All the while GDP, job creation, wages and household balance sheets struggled. The markets got well ahead of the macro economy by the spring of 2011. We saw the doubling of major equity indexes from spring 2009 to spring 2011. The economy remained very weak. The divergence of corporate profits and asset prices from the economy was unsustainable. This is now being violently over-corrected as the government guarantor proves startlingly incompetent and fiscally challenged.
The national solvency struggles in the eurozone, around the U.S. debt ceiling and credit rating have slammed home this reality. Markets are reeling as they adjust to their excess and sliding fortunes of governments. The government has gone from plan B to a major drag. This has occurred violently and rapidly and is driving a global asset price slide that has trimmed over $10 trillion in wealth since July.
The slide in prices is overdone and has taken on a strong air of panic. The relative strength of corporate balance sheets and profits remains impressive. The boom struggled from structural issues of the highest order. However, this is neither new nor clearly over. Absent a political or economic shift, we still have the broken structure that gave us the boom. We do need to factor the loss of our guarantor and the new realities that this entails. Buying Treasuries and selling equities to de-risk portfolios is the kind of response that signals an absence of understanding.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.