It's something you heard for a while and even after some uptick in job creation, it hasn't died down. For many, it doesn't really feel like a recovery at all, but the one way to make sure is to simply look at the figures. So what do the figures say?
Luckily, we have Jim Reid from Deutsche Bank putting it all together:
click to enlarge
Indeed, the recovery from the 2008/9 recession is the weakest of them all, barring the one from 1927, but that ran into the stock market crash in 1929, so perhaps it's not the fairest of comparisons. But the real surprising thing is that it still seems to surprise many people. By now, it should be no secret that this isn't your garden variety recession.
After the second World War, recessions were typically brought about by the Fed, jacking up interest rates in order to cool the economy when inflation was threatening to accelerate (or already had, like in 1980). This isn't at all what happened this time around (and to a lesser extent, in 2001).
Balance sheet recession
The 2008/9 recession was another beast altogether, where a speculative bubble had exploded some asset prices, and these came crashing down, destroying many a balance sheet in the private sector and financial sector alike. Nine trillion dollars (nearly 40%) of wealth of American home owners has been wiped off their balance sheets.
Balance sheet recessions have unfortunate consequences:
- Damaged balance sheet holders become preoccupied with repairing their balance sheets, increasing savings, reducing spending.
- Credit demand really falls as a result.
- Because credit demand falls rather significantly, interest rates plunge and monetary policy becomes quite powerless.
This is a very different situation from a traditional recession. The dangers are threefold:
- The reduction in private spending creates a downward spiral, as spending by one is income for another party
- Inflation drops below zero (deflation), increasing the real value of debt and setting off a debt-deflationary spiral first described by Irving Fisher in the 1930s. This could very well reinforce the first negative spiral.
- Banks, faced with too many bad performing loans, restrict credit supply and tighten credit conditions, and might even go under because of the bad debt.
The US has been quite successful in stabilizing the banking system through rather unprecedented Fed interventions and bailouts. The fear that the large increases in money creation would be inflationary are misplaced and made by those not fully understanding the nature of a balance sheet recession.
Since monetary policy is quite powerless, much of the burden of keeping the economy afloat relies on fiscal policy. We had some success with this, but things could have been a lot better. Once again, those expecting runaway interest rates on public debt because of the large deficits and debts do not fully grasp the nature of a balance sheet recession. There simply is enough savings to finance the debt rather effortlessly and indeed, the US can borrow at record low interest rates despite having large deficits and debts.
Savings is what goes up in a balance sheet recession, making credit demand weak, hence, monetary policy ineffective, and producing enough savings to finance budget deficits at record low interest rates. Deficits that are an unfortunate necessity, as higher savings also means lower demand. A balance sheet recession is in one sense rather traditional; it manifests itself as insufficient aggregate demand and lots of idle resources.
What happens next?
The good news is the deleveraging of the private sector (that is, households, as most companies had rather healthy balance sheets) has gone some way in the US, much more so compared to many other nations. According to a McKinsey study, there is a market reduction in private sector debt in the US.
Well, that's the good news. The bad news is that according to Shiller, housing will remain depressed for years to come. So we muddle through.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.