Global Economic Research
June 11, 2010
Same, But Different
Business cycles follow a typical pattern. Recessions, and the raredepressions, eventually trough, and recoveries ensue. At some point,output growth peaks, and the cycle re-plays. The confidence, earnings,and spending of consumers and businesses increases and thendecreases. Co-incidentally, a similar pattern emerges for prices, whereinflation pressures eventually build upon disinflation or even deflationtrends until macro-economic and policy conditions change. Public policy shifts from firming and tightening, to easing, and then back again. Investors typically lead the cycle shifts, selling as theeconomies turn down and then buying as the cycles turns up.This cycle is no different, but at the same time, it is. Although therecession was deep, and virtually every region was impacted to varyingdegrees, the economic toll was most evident in the developed world. TheUnited States was again a major drag on global economic activity, butwas joined by a number of European countries that also suffered fromdebt overload. But unlike past U.S. housing/real estate cycle busts which pulled down a bank — Franklin National, First Penn, Continental Illinois,and the myriad of S&L firms — this cycle was noteworthy because of thesimultaneous failure of a number of large financial institutions, not onlyin the United States, but throughout Europe as well. The resulting short-circuiting of credit flows internationally probably did as much, or evenmore, to drag the rest of the world down than just the trade-relatedconsolidation that would have normally occurred.Exaggerated policy responses — generational lows in short-terminterest rates and massive fiscal deficits — were needed to reverse thesevere economic and financial strains. And although the ensuingrebound has been comparatively more moderate than prior cyclicalrecoveries, the results have generally been in line with past performances. Countries that were least impacted by the implosion inreal estate and banking are the ones that are experiencing the strongestrecoveries in domestic demand, though external trade is beingconstrained by the deleveraging underway in the United States and inmany European nations that is dragging on these respective countries.An inventory restocking cycle has helped to generate the renewed andstronger momentum that is helping to revive the global economy. After
Past, Present & Prospects
a significant compression on costs and expenditures, profitable businesses are again moving to expandoutput, productive investments, and hiring. Andconsumers are again in a buying mood, takingadvantage of discounting, low borrowing costs, andan important stabilization in financial well-being.While most of these traditional factors should continueto support the expansion, one of the different aspects of this recovery is that the developing countries are playing a much greater role in the global economy’srevitalization. There has been a much greater focus inthese nations to promote domestically-generatedactivity that in turn has buoyed commodity prices andexpanded imports. Collectively, these large andheavily-populated developing nations can be expectedto remain the key drivers of global growth, especiallysince many of the developed nations must beef up their savings, investments, and exports. This ‘rebalancing’ — from surplus to deficit nations — is critical to themagnitude and sustainability of the recovery, and mustcontinue to be nurtured during the unprecedented period of deleveraging underway in the United States,the U.K., throughout Europe, and even Japan.In the same, but different category, are the policyresponses that the developed nations pursue torebalance their own economies. In the past, relativelysmall counter-cyclically induced fiscal imbalanceswere eventually reduced or eliminated by renewedgrowth. However, fiscal adjustments have taken on agreater sense of urgency in the wake of the sovereigndebt crisis that has enveloped Europe. Throughout theregion, the transition from fiscal stimulus toconsolidation is being brought forward, with spendingcuts and restraint supplemented with revenueenhancing measures. With inflation pressuresevaporating under the weight of slow growth andfiscal drag, normalizing ultra-low interest rates has been put on hold. Monetary policy favoursunconventional easing, and euro/sterling depreciationhas become a relief valve. Eventually, the UnitedStates will likely be forced to move accordingly, sincerepeated trillion dollar deficits may be on the verge of becoming counterproductive if consumers, businesses, and investors believe that a growing tax burden will overpower expenditure restraint.