The “VW-shaped” Recovery

The UK, home of John Maynard Keynes, has added a new term to the lexicon of descriptions of possible recovery patterns that could end the current global recession. It is  the”VW-shaped” recession, and, unlike the German car company, it is as vicious, lengthy, and brutal as any recovery could be. And, UK economists make a good case for it.

The Ernst and Young Item Club recently said that the UK economy will not move back to normal long-term growth rates, until 2012 which leaves almost three more years of misery for consumers, the unemployed, and many businesses. There theory is grounded in the belief that there will  a number of damaging setbacks and some temporary periods of short economic relief.

The E&Y forecast seems extremely gloomy when put next to other forecasts like those from the Fed, and the Adminstration, and government leaders of most of the other developed nations. They do not, however, have great defenses for their optimism.

It needs to be recognized that GDP probably grew modestly in most of the “wealthy nation” economies as it did in rapidly developing large nations, especially China and India. One quarter does not a recovery make, however. The real first test of whether the expansion will be robust is whether the consumer will be out in force for the upcoming holiday season. The economy could rapidly slip back into recession or a period of stagnation if he is not. A relatively modest improvement in corporate profits does not make up for a consumer who is in full financial retreat, and businesses will eventually be the victims of crippled consumer spending.

Those who have offered optimistic assessment of economic growth in 2010 and 2011 do not have the banking system on their side. Lending institutions are still not offering loans. They will not face the risk of another credit crisis by piling more potential bad debt on their balance sheets. The last year may not have taught them anything else, but it has  forced them to understand this danger.

The lender of last resort and the network of last support for credit hungry businesses and consumers and those who are out of work remains the treasuries and central banks of the largest nations. These treasuries and central banks are under more economic pressure than they have been in modern history due to borrowing to create stimulus packages. It is not even clear that those packages are working either because they are too small or misdirected.

The most popular theory about the economic recovery at this point is that it will be “V-shaped” which means that it will roar back to 5% or 6% GDP growth within a year from now. Employment will rise and companies will need companies to hire more people to keep up with demand for goods and services. This will force the industrial and financial sectors, stimulated by government capital, to become the leaders of the economic recovery.

Economic theories work until they don’t. Businesses have learned the lesson that they always learn in all horribly sharp downturns, which is that they can do with fewer resources, including employees, for a long. long time. It is better to be understaffed than to take on people who will be an immediate cost burden. The future is too tenuous to convince most enterprises to do that.

If business will not lead the recovery, then who will? The only answer is the consumer, and that is not a plausible answer at all. There is nothing that will stop unemployment from going over 10% early next year and under-employment from going to 16%. There is no precedent that allows for forecasting the effects of such a deep economic wound. To say that the likely outcome will be robust consumer spending is simply foolish.

This winter is going to be long and cold, not just as the temperature falls and many people are without work, support, or, in some cases adequate shelter. The economy is likely to become frozen again. 2010 will not be as good as advertised.

Douglas A. McIntyre