Five Years After Crisis, No Normal Recovery
Comment of the Day

April 03 2012

Commentary by David Fuller

Five Years After Crisis, No Normal Recovery

This is an informative article by Carmen Reinhart and Kenneth Rogoff for Bloomberg. Here is the opening:
With the U.S. economy yielding firmer data, some researchers are beginning to argue that recoveries from financial crises might not be as different from the aftermath of conventional recessions as our analysis suggests. Their case is unconvincing.

The point that all recoveries are the same -- whether preceded by a financial crisis or not -- is argued in a recent Federal Reserve working paper by Greg Howard, Robert Martin and Beth Anne Wilson. It was also discussed in a recent article in the Wall Street Journal.

It is mystifying that they can make this claim almost five years after the subprime mortgage crisis erupted in the summer of 2007 and against a backdrop of an 8.3 percent unemployment rate (compared with 4.4 percent at the outset of the financial crisis). Our research makes the point that the aftermaths of severe financial crises are characterized by long, deep recessions in which crucial indicators such as unemployment and housing prices take far longer to hit bottom than they would after a normal recession. And the bottom is much deeper. Studies by the International Monetary Fund concluded much the same.

Redefining Recovery

We have suggested that the concepts of recession and recovery need to take on new meaning. After a normal recession (which for the average post-World War II experience in the U.S. lasted less than a year), the economy quickly snaps back; within a year or two, it not only recovers lost ground but also returns to trend.

After systemic financial crises, however, economies of the postwar era have needed an average of four and half years just to reach the same per capita gross domestic product they had when the crisis started. We find that, on average, unemployment rates take a similar time frame to hit bottom and housing prices take even longer. With the Great Depression of the 1930s, economies on average needed more than a full decade to regain the initial per capita GDP.

"After the Fall," a 2010 paper written by one of the authors of this article and Vincent Reinhart, a former Fed official who is now chief U.S. economist at Morgan Stanley, added evidence that in 10 of 15 severe post-WWII financial crises, unemployment didn't return to pre-crisis levels even after a decade. It also showed that in seven of the 15 crises there were "double dips" in output.

David Fuller's view For the simple reason that it would be more fun to have a robust economic recovery sooner rather than later, many people predict a short convalescence even though they know that financial history suggests a very different outlook.

I have long maintained that it takes at least five to seven years for an economy to recover from a credit crisis recession. With a banking collapse, a property slump, household deleveraging and ballooning government debt, not to mention Europe's problems, it can take considerably longer.

Fortunately, there is no reason for investors to be despondent.

After all, we buy shares, not economies. Most Autonomies (sector-leading multinational companies leveraged to Asian-led growth) have very strong balance and rising profits. Many are also Dividend Aristocrats. The real crisis has been in the west, plus Japan's lengthy decline. Most of the growth economies have experienced no more than a somewhat lower rate of GDP expansion in recent years.

We also have a genuine technology boom, in contrast to the mirage of the late 1990s. We are witnessing an exponential increase in technical innovation which could last for a very long time, to the benefit of most other industries.

Yes, there are plenty of risks as is so often the case. The Eurozone's problems are far from resolved. However, the situation that concerns me the most, because of its global implications, is that we are in the second consecutive difficult decade in terms of tight energy supplies. Nevertheless, we can also see the US-led solution to this problem. Fullermoney maintains that the average cost of oil in the next decade will be lower than it is today in real terms. The cost of natural gas should also be lower in Europe and Asia as fracking technology is utilised by more countries.

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