A double-dip recession is coming: here are three reasons why
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MoneyWeek Editor
John Stepek Sep 15, 2009
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It's going to be miserable for a while yet
The papers are still full of the anniversary of the Lehman Brothers collapse. Pundits are cogitating, mulling over, and pronouncing their views on the crisis and what should happen next.
Do yourself a favour – ignore it. It's a waste of your time. Seldom have so many column inches been squandered on so much pointless speculation. It's almost as pointless as all the columns devoted to Labour's pathetic refusal to use the word "cuts" when referring to public spending.
For a start, the credit crisis didn't start with the Lehman collapse – it had its roots far earlier than that. And for another thing, nothing that any of the pundits say will make a difference. Everyone's still vaguely rumbling on about the need for banking reform. But any concrete, genuinely useful reform ideas are being lost amid the pointless mud-slinging over bonuses. And the truth is that politicians are now too scared to do anything that might derail the relief rally.
So, is it back to business as usual then? Well, not quite...
There's still plenty of dodgy debt on the banks' balance sheets
There are at least three good reasons to be concerned that this economic rebound won't last. For one thing, all that dodgy debt that was on the banks' balance sheets hasn't gone away. Plenty of it is still sitting with the banks themselves. That's one of the main reasons that – despite all the money pumping by the central banks – the money supply is plunging in the US.
As Ambrose Evans-Pritchard notes in The Telegraph this morning, US bank lending fell at an annual rate of around 14% in the three months to August. Professor Tim Congdon of International Monetary Research tells him: "There has been nothing like this in the USA since the 1930s." And we all know what happened then.
Banks are scared that a) regulators will force them to hold more capital (in other words, to have more of a cushion against future losses) and b) that rising bad debts will put them back in a position where they have to return to shareholders or governments for more handouts. Therefore, quite sensibly, they're not as keen to lend as they once were.
When credit availability is shrinking, debt-dependent economies have a hard time growing. Now, we'd argue that sometimes economies that have overstretched themselves need to take the time out to lick their wounds, heal their balance sheets, and unravel all the bad investments that were made during the boom times. But that involves a fair bit of pain, something which governments in particular want to avoid, as voters don't like it.
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Governments can't really afford to take on banks' debts
That's why governments stepped in to take some of the banks' debt onto their own shoulders. And that's the second reason to be fearful. The trouble is that Western governments can't really afford to do this. They were profligate during the good times, and they're being even more profligate now. So although they may have declared war on deflation, they don't have as much leeway as they might think to act.
The massive budget deficit in the US leaves it vulnerable to foreign buyers of its debt deciding not to prop it up anymore (the same goes for the UK). So any spending or money-printing plans have to be tempered by the understanding that any hint that the government is trying to inflate its way out of debt could drive up borrowing costs rapidly.
That's not to say that the Federal Reserve wouldn't rather err on the side of inflation. But while it looks as though the stock market is recovering and property prices are bottoming, they'll probably hold off, perhaps hoping that they've done enough.
They probably haven't. As Bill Bonner puts it in the current issue of MoneyWeek, "it would take a miracle for central bankers to find exactly the rate the market needs when it needs it most." Of course, when they realise that it's not enough, and that the economy is heading for a double-dip, we can expect another wave of stimulus. "Central banks, ignoring the futility of their hot money programme so far, will add more hot money." But not quite yet. (If you're not already a subscriber to MoneyWeek magazine, claim your first three issues free here.)
A nasty reminder from the 1930s: protectionism
Thirdly, there's protectionism, another nasty reminder from the 1930s. Fears over this problem had drifted away somewhat, but the US government's decision to impose tariffs on Chinese tyre imports has brought them back to the surface.
President Barack Obama imposed hefty duties on Chinese tyre imports at the weekend, saying that such imports had resulted in the loss of more than 5,000 US jobs. We're not sure where he got that figure, particularly as the Chinese reckon that their tyre exports to the US actually fell in the first half of 2009. In any case, our immediate reaction would be that the solution is not to make Chinese tyres more expensive, but for US tyre-makers to become more efficient and provide better value for money.
But no. The solution – as with everything else these days – is to make things more expensive. Just as the government is trying to push up falling property and share prices with cheap money, so it seems that manufactured products are too cheap for comfort as well.
The Chinese of course aren't taking this lying down, and are taking the US to the World Trade Organisation. They're also retaliating by conducting investigations into imports of US car parts and chicken meat.
It's a small spat for now, but stories of deflation and protectionism all have uncomfortable echoes of the 1930s. The pundits might be asking now if the 'Great Recession' was really all that 'Great', but I suspect they'll be in for a nasty shock before long.
My colleague Cris Sholto Heaton explained in yesterday's MoneyWeek Asia email why for now, it's a good idea for cautious investors to err on the side of deflation rather than inflation when investing. And he has a quality, cheap Asian stock which fits the bill. If you haven't already done so, sign up for MoneyWeek Asia here.
Our recommended article for today
The price of gold has quadrupled in the last ten years. But - oddly - many people still think gold is a bad investment. Merryn Somerset Webb explains why they're wrong.
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