The easy answer would be: nobody really knows. We are tentatively navigating through uncharted waters. No one knows what we should be comparing our current situation to, or the likely course back to normality.
Should we be comparing it to the Great Depression of the late 1920s and early 1930s? Or the situation that has existed in Japan for the last twenty years? Or Norway’s banking crisis of the last decade? Or are we all just being over cautious, and can assume that things will be back to normal soon?
The last scenario is the most unlikely. There have been many discussions about whether we are going to see a V-shaped recovery or a W-shaped recovery. If you’re like me, you’ll think this is economist speak for “we haven’t got a clue.” A V-shaped recovery would see things returning to normal sooner rather than later, while a W-shape maps a recovery where things get better, then worse, then better again. But given the extent of the financial crisis and the amount of money governments have had to invest to keep the financial system afloat, I don’t think the world can return to normal anytime soon. Each government is desperately trying to rebuild its own economy.
I suspect one of the other historical case studies is much more likely.
As we know Japan has not enjoyed the last twenty years. Sometimes it is difficult to understand why this is the case, given their all conquering ability to produce electronic goods that the world wants. However, they suffered the most enormous of bubbles twenty years ago, when property prices shot up to unbelievable levels and their stock market had a greater capitalisation than the US stock market. Since those halcyon days, property prices have crashed to between one and 10 percent of their bubble value, and the stock exchange continues to be in the doldrums. The banking system still has significant problems with bad loans, which seems to be a key factor in the problem dragging on. That is why we have had the talk about setting up bad banks so that the problem loans can be hived off – leaving the rest of the banks to get on with life as normal.
However, just when the Japanese economy finally seemed to be turning around, with inflation about to reappear, the problems in Europe and the US cut the Japanese recovery short. In fact, Japanese industrial production reduced to levels last seen roughly 20 years ago. Witnessing a generation’s growth taken away in a moment is truly frightening.
But the Norwegian scenario gives an interesting contrast. Here, the problem was that firstly, individuals and companies saved money and rebuilt their own balance sheet and secondly, the banks found it very difficult to lend as no one wanted their money. So in essence it took quite a while for a level of confidence to be reached whereby people began to spend rather than save, allowing businesses to grow and banks to increase the amount of their loans. But this wasn’t done in a few hundred days: it took many years to work through the pain and reach normality. Again, there are arguments that the Norwegian banks could have done more – but I do wonder if hindsight is 20/20 in this case.
The argument made regarding the Great Depression is that not enough was done by governments – especially in the US – to help liquidity and fund investment in the early stages. I think it is fair to say that this isn’t the case in the current situation as the liquidity supplied by the US, UK and European governments has been mind-boggling in its size.
So what do as I see as the most likely scenario? My feeling is that it is a very long road to recovery. The governments have hocked the future for the present and most people are saving as if their life depended on it. But it is the spare capacity that is going to be the hardest thing to overcome: production in some countries has been reduced by up to 20 percent, and with the resultant unemployment it is going to take a long time to reach last year’s levels of production. We also have exchange rates causing problems as the US dollar weakens against other currencies – meaning that these other countries’ exports become more expensive relative to the US’s. If we get back to where we were in the summer of 2008 within five years I would surprised. I wouldn’t bet against 10 years. I hope I am wrong.
Charles Purdy is a director at Smart Currency Exchange – international payment specialists.
