Market Fear in High Gear

October 16, 2008

The headlines blame falling equities on mounting expectation of a U.S. and global recession.  That is hardly the whole story.  Recessions are too commonplace, however, to justify the kind of escalating panic seen over the past month.  The United States experienced eleven recessions in the second half of the 19th century, nine more last century prior to the Great Depression, and another dozen since World War II including the one at present.  Counting the 1930’s depression as two downturns, that adds up to 34 recessions in 158 years or a setback every 4.65 years.

Not all recessions are equal.  The last two were milder than average and considerably milder than those in the 1970’s and 1980’s, which were associated with spikes in inflation.  Financial sector-triggered recessions tend to be severe, and downturns are generally worse when global business cycles are synchronized.  The current recession carries each of these dangers.  Market concern is magnified when uncertainty is high, and central bankers have been underscoring the tremendously high amount of uncertainty since the onset of this crisis in 3Q07. Investor confidence also suffers disproportionately if informed voices of reason are not trusted.  Political leaders have low approval ratings throughout the G-7.  The piecemeal approach until recently to the banking system problems has been exposed to have been very misconceived.  Even now, governments are acting in unilateral fashion, even as officials share ideas, and the $700 billion U.S. government banking plan looks like a conspicuously low share of the $3.2 trillion of global emergency measures thus far committed.

The credibility gap is not limited to politicians and their appointed central bankers.  Forecasts still look too optimistic like the one just released by the International Monetary Fund.  The IMF anticipates that world GDP growth will slow less than a percentage point from 3.9% in 2008 to 3.0% in 2009.  Its projected global growth rate next year exceeds the 2.9% per annum pace of the 1990’s and the 2.5% per annum pace over the consecutive years 2001-02.  Weak growth in 2009 of 0.1% in the United States, 0.2% in Euroland, 0.5% in Japan, and 1.2%  in Canada is expected to be counter-balanced by resilient emerging markets, whose collective growth forecast is penciled in at 6.1%.  Developing Asia will supposedly expand 7.7% (9.3% in China and 6.9% in India).  Middle Eastern growth is projected at 5.9% despite the halving of oil prices since July.  Africa is to grow 6%, and even developing economies in the Western Hemisphere are to advance 3.2% despite their proximity to the United States. Declines since September 10th of roughly 20% each in the South Korean won and Mexican peso and the cascade of equity wealth destruction shared by emerging as well as developed economies suggest that the former will be much less insulated from the current downturn than assumed by many forecasters.

Economic data, and not just financial market developments, have meanwhile turned truly ugly.  On back-to-back days, the U.S. reported drops of 1.2% in retail sales and 2.8% in industrial production (the worst since December 1974).  At a seasonally adjusted annual rate, industrial production fell 6.0% last quarter in the United States and was below the 2Q level in July-August by 4.8% in Japan and 1.6% in Euroland.  Forecasts of the next cyclical peak in U.S. unemployment run generally around 7-8%, but a climb to 9% or worse is quantitatively more consistent with assertions that this is the worst financial/economic disaster since the Great Depression. 

People do not fear the present so much as the future.  When expert opinion doesn’t parallel observed facts and after a series of discredited reassurances and reversals by officials, market players are left to fill in the blanks.  The rumor mill (e.g., speculative reports of massive hedge fund liquidations) and the imagination take over.  Moreover, the current economic crisis has surfaced in a landscape already loaded with major dangers and unpopular challenges.  Some are causes of the crisis such as excessive personal, corporate and government debt and the mushrooming costs for health care and other impacts related to aging populations.  The solutions to other threats like global warming, world terrorism, bloated public finances, and the debt-service burden on future generations appear much more daunting, especially if we are merely in the early stages of an L-shaped period of prolonged and substantial sub-trend growth. In one very important respect, we are much less prepared for an economic disaster than in 1929, and that is the considerably smaller population shares that make a living from farming.  Little scope now exists for reverting to a subsistence existence if that becomes necessary.  Pervasive, even irrational, fear may be the greatest threat of all as Roosevelt warned 75-1/2 years ago, but it will not dissipate spontaneously.



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