Pessimism, the new realism

Robert Reich offers a pessimistic — i.e., realistic — view on the economy in his blog post “When Will The Recovery Begin? Never.”:

[T]he whole debate about when and how a recovery will begin is wrongly framed. On one side are the V-shapers who look back at prior recessions and conclude that the faster an economy drops, the faster it gets back on track. And because this economy fell off a cliff late last fall, they expect it to roar to life early next year. Hence the V shape.

Unfortunately, V-shapers are looking back at the wrong recessions. Focus on those that started with the bursting of a giant speculative bubble and you see slow recoveries. The reason is asset values at bottom are so low that investor confidence returns only gradually.

That’s where the more sober U-shapers come in. They predict a more gradual recovery, as investors slowly tiptoe back into the market.

Personally, I don’t buy into either camp. In a recession this deep, recovery doesn’t depend on investors. It depends on consumers who, after all, are 70 percent of the U.S. economy. And this time consumers got really whacked. Until consumers start spending again, you can forget any recovery, V or U shaped.

Problem is, consumers won’t start spending until they have money in their pockets and feel reasonably secure. But they don’t have the money, and it’s hard to see where it will come from. They can’t borrow. Their homes are worth a fraction of what they were before, so say goodbye to home equity loans and refinancings. One out of ten home owners is under water — owing more on their homes than their homes are worth. Unemployment continues to rise, and number of hours at work continues to drop. Those who can are saving….

This economy can’t get back on track because the track we were on for years — featuring flat or declining median wages, mounting consumer debt, and widening insecurity, not to mention increasing carbon in the atmosphere — simply cannot be sustained.

Economists expecting the current Great Recession to track past recessions are making the same mistake financial analysts who valued assets based on the past, say, ten years of financial data made. They’re failing to see how dramatically — “structurally,” to use the economics profession’s phrase — current economic and financial conditions have changed. Mean reversion applies only when the system isn’t too far from equilibrium. When the economy takes the kind of whack it’s taken in recent years, all bets are off.

Our economy has flown off the rails. Yet many economists think the train has just slowed down and is due to speed up again soon. Expecting the present to look like the past in the face of such massive structural change is plain dumb.

Posted by James on Friday, July 10, 2009