MacroScan - The Signs of a Global Recovery

Finance Ministers of the G8 meeting at Lecce in Italy during the latter part of week ending June 14, were cautiously optimistic. The final communiqué noted that in the aftermath of efforts at financial stabilisation and fiscal stimulation ''there are signs of stabilization in our economies, including a recovery of stock markets, a decline in interest rate spreads, (and) improved business and consumer confidence''. But, the ministers cautioned ''the situation remains uncertain and significant risks remain to economic and financial stability''.

There were two elements of the communiqué that pointed to a compromise between the differing perceptions of the US and UK, on the one hand, and Germany and France, on the other, regarding the principal problems and tasks at hand. The first of these elements was the reference to the persistence of ''significant risks'' which was not there in the original draft of the communiqué, and was ostensibly inserted by those countries (UK and US) who feel that it is not yet time to decide that the recovery is here and the stimulus provided thus far has been adequate. Moreover, the mention of ''encouraging figures in the manufacturing sector'' that figured in the draft was dropped, since it went against the evidence that industrial production in the eurozone area had fallen by 21 per cent in April, relative to the corresponding month of the previous year.
Chart 1 >>

The second element of the communiqué of interest is that it pushes for going beyond thinking of recovery and formulating national level ''exit strategies'' ''for unwinding the extraordinary policy measures taken to respond to the crisis.'' The reference here is to the huge budget deficits and high levels of public debt that many countries, especially the US, have accumulated in the wake of the bail-outs and the stimulus packages they have been put in place. Though the US and UK have played down this aspect of the discussions, there is clearly a difference in emphasis among the leading powers on where the world economy stands and what is the immediate priority in terms of action.

The difference hinges, quite clearly, on the extent to which different sections believe that the worst is over. The reason for uncertainty regarding a potential recovery is that the figures are yet to point to a definitive revival. As of May 2009, nearly two years since the financial crisis broke and a year-and-a-half after the onset of the global recession, the economic scenario remains uncertain, if not bleak. The rate of unemployment in the US, which stood at less than 5 per cent in the first quarter of 2008, had risen to 8.1 per cent in the first quarter of 2009 (Chart 1) and is estimated to have touched 9.4 per cent in May 2009—its highest rate for the last 26 years. This possibly explains US pessimism. It is true that the unemployment rate in the European Union had also risen from 6.8 to 8.1 per cent between the first quarters of 2008 and 2009. But the higher base level may be making the problem appear less alarming to ruling governments there than in the US, influencing their perceptions.

Output growth too gives no cause for optimism. Quarter-on-quarter growth rates of US GDP (as measured relative to the corresponding quarter of the previous year) had declined sharply in the last quarter of 2008 and first quarter of 2009 across the G7. This decline was even sharper in the UK and the EU, than the US (Chart 2). The crisis had clearly not gone away by the beginning of April, despite signs of recovery in the stock market. The disconcerting element is that this situation prevails despite huge infusion of funds by G7 governments. According to one estimate, the US Federal Reserve had by April 2009 offered about $12.7 trillion in guarantees and commitments to the US financial sector, and spent a little over $4 trillion in combating the crisis. As a result the federal deficit has risen to more than 12 per cent of GDP, frightening fiscal conservatives who predict the onset of stagflation. The big thrust seems to be over and the recovery is still not in sight. What it has possibly done, and even that is not certain, is prevent the recession from turning into a depression.
Chart 2 >>

Despite this evidence relating to the period till the last full quarter for which numbers are available, speculation that the downturn has bottomed out and the developed world is on the verge of recovery proliferates. This optimism is based on still tenuous evidence, including evidence that the rate of decline of economies is slowing. The most important of these is that the monthly decline in employment in the US is down sharply. In May 2009 nonfarm payroll employment fell by 345,000, which is around half the average monthly decline over the previous six months and well below the close to 750,000 fall in January this year. Associated with this fall in monthly employment declines is a fall in new unemployment claims. Economist Robert Gordon of Northwestern University in the US, a respected analyst of growth and productivity trends in the US, has found that past recessions came to an end four to six week after new unemployment claims peaked, which they have now done. So he conjectures that the business cycle will find its trough in May or June (Financial Times, June 3, 2009). While these developments are reassuring, we should view them in the light of the fact that the unemployment rate is at record levels and new unemployment claims are still above the figures they touched in the worst months of the last recession.
Chart 3 >>

A second cause for optimism is that US producers may be reaching the phase of their inventory cycle where an increase in production is inevitable. By April, wholesale inventories had fallen for the eighth month running as firms cut back production to clear the excess inventories generated by falling demand. Having made those adjustments, it is argued, firms are now in a position where they would have to step up production, especially if demand begins to stabilise. In other words, the argument is that since things are so bad, they can only get better. But the figures do not support even this position. Thus, after seven months of decline, inventories in April fell 1.4 per cent relative to the year before and 6.4 per cent relative to the corresponding month of the previous year. That was because sales fell by 0.4 per cent in April, led by automobiles and parts. Sales of durable goods too were down 1.9 per cent during the month and 23.4 per cent over the year.

The third potential cause for comfort is the sign that relative to previous months, the decline in production is slowing. As Chart 3 shows, the decline in GDP relative to the immediately preceding quarter, which was rising till the first quarter of 2009, seems to have bottomed out in the US and to a lesser extent in the EU. What is more, this trend seems to be reflected even in the month-on-month annual growth rates of industrial production, with the rate of decline in April 2009 relative to the corresponding month of the previous year showing signs of reversing its hitherto continuous increase in the US, UK and EU (Chart 4).
Chart 4 >>

While this third factor may be adequate reason for optimism for some, there are two reasons why we should not read too much into this data. To start with, even if the downturn is touching bottom in terms of the stabilisation of the rate of decline, the decline could persist and the economy could ''bounce along the bottom'' as some analysts reportedly speculate. That is, there is no ''statistical'' reason why a stable rate of decline should automatically lead to lower rates of decline and positive rates of growth in the coming months or quarters.

Further, it is unclear whether there would be adequate alternative stimuli to sustain the recovery when the effects of the already implemented fiscal stimulus wane. Governments could hold back on providing any fresh stimulus because of arguments of the kind espoused by conservative economists, representatives of the financial sector and even some European governments, which emphasise the dangers of inflation. If that happens, recovery would depend on the return of the consumer to the market.

But here too the prognosis is not all too happy. Fears generated by the recession and rising unemployment and the increased desire to save to make up for the decline in the values of accumulated housing and financial assets is encouraging savings even in the US. According to a recent estimate of the Federal Reserve, the net worth of US households had fallen 2.5 per cent or by $1,300 billion in just the first three months of 2009. This comes on top of the 18 per cent fall in the previous year which was the worst since the Fed began estimating household wealth in 1946. The net result is that household savings rates in the US are rising and consumer spending was falling in March and April this year.

In the event many still remain sceptical. The Financial Times quotes Martin Feldstein as saying that ''it is possible but unlikely'' that the recession is over. ''I think it is a more likely scenario that we are seeing the favourable effects of the fiscal stimulus,'' he reportedly said. ''That, for a while, will offset the general diminished trend we have seen over the past two quarters, but it is a one-shot thing.'' Put otherwise, there could be more bad news ahead.