x Abu Dhabi, UAEMonday 22 January 2018

The Insider: will the economy make L, V, U or W?

The rune of this recession is not yet decided, but it's possible to examine the four letters and find out whether there is another.

The economist Paul Krugman cautions against loose monetary policy flowing through into inflation.
The economist Paul Krugman cautions against loose monetary policy flowing through into inflation.

Tumultuous events rightly excite the masses. Experts examine and present initial thoughts in a digestible form best represented by the soup de jour: economic alphabet soup. Deep diagnostics will provide funding for (much) academic review of what has passed, with the resulting hectares of academic tomes serving as a paper wilderness for tomorrow's students to orienteer through.

The rune of this recession is not yet decided, but let's examine the four contenders and ask: is there another?

"L" is today associated with the solipsist of pessimists.

Japan's lost decades, still counting, is the finest example of one. The severest of recessions caused by the pricking of a gas giant asset bubble has stymied growth there since 1990. By the time the government began serious attempts to refloat the economy, confidence had collapsed. A country with an already high propensity to save began to get serious about saving.

The vertical line of the "L" represents the downturn; the horizontal line the recovery that isn't. Follow that principle for all letters. This global recession is not an "L" recession thanks to swift reaction by global central banks to refloat the banking system through quantitative easing. This injected an adrenaline shot into the material parts of the world economy.

It was timely that Ben Bernanke, the chairman of the US Federal Reserve, happened to be academically obsessed with the Great Depression of 1929, ensuring that those particular mistakes would not be repeated. Further, he has written a great deal about it in the past.

The vast majority believes and hopes - based on experience - that this is just another "U" recession. They have good reason. Recessions in non-addled memory, within a reasonable margin of error on the downward and upward slope, have been of this variety. It's akin to getting a seemingly unshakeable malady that seems to not want to clear, although typically it does after one to two years.

Given the time that has passed so far, it is the homely soapbox of the global optimist, who, clutching at the most minor piece of good data, without any sense of perspective, declares recovery in our time.

The dreary 1970s were rescued by deregulation in the 1980s with the success of supply-side policies. The recession of the early 1990s was overcome thanks to the IT revolution. Something has always come along to alleviate a downturn. Why should this time be different?

The "V" view was taken by those who believed in a soft landing. Only the self-interested subscribed to this: the type of person who doesn't open the mail for fear of the nature of the correspondence.

It is worth pausing in the present to look at the only valid defence of the denial disseminators, if only because they have been governments. Freedom of information or speech is tempered by the generally accepted maxim that you don't shout fire in a crowded auditorium. A panic needed to be avoided and a gradual descent into the bowels of the truth was required to prevent a calamitous collapse in general economic confidence.

The risible reaction to Eric Cantona, the French football legend who called for his countrymen to withdraw all their holdings from banks, bears witness to the steadying of the ship by a national government.

"W" is the new "V". Economists of a sinister bent prescribed titanic injections of monetary intervention, the net effect being a one-off transfer of debt by government away from financial institutions to individuals and their children, in some cases to the generation to come. Not since ostrich futures were de rigueur has so much been asked of the unborn.

Quantitative easing will shortly need to begin the process of withdrawal, driven primarily by two factors.

Firstly, public spending crowds out private investment and no recovery is possible until the private sector re-engages with the wider economy. Secondly, loose monetary policy is beginning to flow through into inflation.

Gentle zephyrs of protest, arguably led intellectually by Paul Krugman, the Nobel Prize-winning economist, have warned against doing this for fear it will choke recovery when it appears to be working, thus risking a double-dip recession, or a "W". Surely the continued printing of money is Zimbabwean economic policy and will lead to ruin?

I have believed for some time that this was going to be a "W". We have lived beyond our means at an unprecedented scale and this debt must be paid off. The only question I have is regarding the slope on the upturn on the "W". It is likely to be very horizontal and lengthy.

At the beginning, I posed the question about whether there was another letter in the wings. With apologies to Sesame Street, this recession is potentially going to be brought to you by the letters "V" and "L" joined together and appearing like a wretched form of "W".


David Daly is the chief financial officer of The Sifico Group.