Stock markets have been strong in recent weeks – in anticipation of an Obama fiscal-led recovery - and many financial analysts are predicting the end of the panic and a reversal toward economic normality. That is a false perspective – the US, Chinese and European economies are in free fall. As with the Great Depression the dramatically low interest rates are not doing the trick and there are inevitable political difficulties in getting an effective fiscal stimulus package to work.
US job losses in 2008 are the worst since the end of WW2 – 2.4 million Americans lost their job in 2008 and yet the severe financial jolts occurred late in the year. Clearly the worst is yet to come as deleveraging throughout the economy occurs to offset decades of excessive borrowing.
Paul Krugman has come out and said it plainly* – this looks like a ‘second’ Great Depression. Janet Yellen has described the downturn as likely to be the longest and most severe since the Great Depression.
I am a pessimist and view the current stock market mini recovery not as a leading indicator of future prosperity but as a false dawn. The real effects of the disastrous financial crisis are only beginning to be felt.
* Excerpts of Krugman's views:
" Let’s not mince words: This looks an awful lot like the beginning of a second Great Depression.
... We weren’t supposed to find ourselves in this situation. For many years most economists believed that preventing another Great Depression would be easy. In 2003, Robert Lucas ... in his presidential address to the American Economic Association, declared that the “central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.”
Milton Friedman, in particular, persuaded many economists that the Federal Reserve could have stopped the Depression in its tracks simply by providing banks with more liquidity, which would have prevented a sharp fall in the money supply. Ben Bernanke, the Federal Reserve chairman, famously apologized to Friedman on his institution’s behalf: “You’re right. We did it. We’re very sorry. But thanks to you, we won’t do it again.”
...Yet credit remains scarce, and the economy is still in free fall.
Friedman’s claim that monetary policy could have prevented the Great Depression was an attempt to refute the analysis of John Maynard Keynes (but) The failure of monetary policy in the current crisis shows that Keynes had it right the first time. And Keynesian thinking lies behind Mr. Obama’s plans....
But these plans may turn out to be a hard sell. News reports say that Democrats hope to pass an economic plan with broad bipartisan support. Good luck with that.
In reality, the political posturing has already started, with Republican leaders setting up roadblocks to stimulus legislation while posing as the champions of careful Congressional deliberation — which is pretty rich considering their party’s behavior over the past eight years.
More broadly, after decades of declaring that government is the problem, not the solution, not to mention reviling both Keynesian economics and the New Deal, most Republicans aren’t going to accept the need for a big-spending, F.D.R.-type solution to the economic crisis.
The biggest problem facing the Obama plan, however, is likely to be the demand of many politicians for proof that the benefits of the proposed public spending justify its costs — a burden of proof never imposed on proposals for tax cuts.
This is a problem with which Keynes was familiar: giving money away, he pointed out, tends to be met with fewer objections than plans for public investment “which, because they are not wholly wasteful, tend to be judged on strict ‘business’ principles.” What gets lost in such discussions is the key argument for economic stimulus — namely, that under current conditions, a surge in public spending would employ Americans who would otherwise be unemployed and money that would otherwise be sitting idle, and put both to work producing something useful.
All of this leaves me concerned about the prospects for the Obama plan. I’m sure that Congress will pass a stimulus plan, but I worry that the plan may be delayed and/or downsized. And Mr. Obama is right: We really do need swift, bold action.
Here’s my nightmare scenario: It takes Congress months to pass a stimulus plan, and the legislation that actually emerges is too cautious. As a result, the economy plunges for most of 2009, and when the plan finally starts to kick in, it’s only enough to slow the descent, not stop it. Meanwhile, deflation is setting in, while businesses and consumers start to base their spending plans on the expectation of a permanently depressed economy — well, you can see where this is going.
So this is our moment of truth. Will we in fact do what’s necessary to prevent Great Depression II?"
Update: earlier views that the recovery of US employment reflected spurious seasonal effects are confirmed. In December US unemployment jumped by 525,000 to 7.2% of the workforce. This is a 16 year high. 2.6 million Americans lost their jobs in 2008. In total 11 million Americans are unemployed. My earlier forecast that US unemployment will hit 10% looks close to the mark - official forecasts are around 9% by end of 2009. The US economy is in freefall.