Is Real Recovery Coming This Fall?



We've suffered a great trauma over the past two years, and though we seem to be on the mend, the aftershocks linger.

Eyeing nervously the recent 50 percent rise in the market, we wonder whether it will continue, or if we will be disappointed once again. Is this the proverbial "sucker's rally"? Will the autumnal months of September and October live up to their reputation for down markets, or is the worst behind us, and the recovery begun?

Uncertain about the future, we can look to the letters of the alphabet for reassurance. Will the recovery be "V"-shaped (unlikely at this point); "U"-shaped (possible); "W"-shaped (the current worry); or "L"-shaped?

Reducing the mind-numbing complexity of the world economy to a series of English letters is necessary to get any kind of handle on today's events, and it provides us with some sort of psychological comfort (for instance, even if it's "W"-shaped, at least we know what's coming).

However, when the dust finally clears, the recovery, in hindsight, may not look like a letter we recognize at all.

Can studying the past help tell us what the shape of the recovery will be? Studying the past is necessary, but of limited usefulness in divining the future.

There were phantom recoveries during the 1930s, and the early 1980s saw a "W"-like recession, but 2009 is not 1932 or 1982. What we saw in 1929 was plenty of leverage and speculation, but no mortgage-backed securities; a less experienced Federal Reserve; a market that had lost 80 percent of its value; and a federal government that raised taxes in the midst of a Depression.

In 1982?

What followed was a period of double-digit inflation, oil shocks and high interest rates, purposefully jacked up by the Federal Reserve. Today's period followed "The Great Moderation" of low unemployment and low inflation. Every period has its own characteristics.

There are many challenges to be faced, both short- and long-term. In the short-term, we still have to confront the toxic assets on the balance sheets of the banks. Commercial mortgages could be the next shoe to drop. If you don't shop at the mall, then the Gap can't pay its rent, and the mall can't pay the interest it owes on the money it borrowed, which means the bank doesn't get paid back or the pension plan doesn't get one of the revenue streams backing the securitized mortgage it holds.

Unemployment remains high, although it will probably not get much higher; it should slowly move back to 4 or 5 percent.

In the long-term, the Fed will have to remove delicately all the liquidity it pumped into the system, or risk a damaging inflation. Doing this in the right way and at the right time is an unprecedented challenge.

In It for the Long Term

At the same time, the United States will have to confront our long-term fiscal situation or risk actually defaulting on our debt. Everyone's seen the same numbers about unfunded pension and Medicare liabilities reaching into the trillions. The question is whether we will have the will — and our politicians the courage — to confront the unsustainable path we're now on.

Of course, the recent market rally may have been a reaction to the stalled health-care plan, which the markets saw as being funded by future tax increases.

Closely related to the fiscal situation is the effect of these deficits on the dollar. If we as a country spend more than we take in, we have to borrow from either foreigners or from our own citizens to cover the shortfall.

If the Chinese get tired of buying our debt, we can cut spending or raise taxes. However, since we as citizens want all our benefits without having to pay for it, and since politicians love to tell us that we can have this fairy tale, cutting spending or raising taxes is unlikely.

One other option: Print money to cover the shortfall, which reduces the value of the dollar.

What will prevail is a complex interweaving of events and economic factors whose interactions will produce an outcome that no one can precisely predict, but which many are saying will result in a recovery that is tepid, prolonged and slow, a prediction that is becoming known as the "New Normal" — an era of slower growth, more government regulation, higher inflation and less risk-taking.

Nevertheless, even if it's slower growth, it's still growth, and for that, we should be thankful.


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