Ever wondered what can happen to an economy, known for taking cautious approach, within a year? Economics defines recession as a business cycle contraction that occurs due to a general slowdown in economic activity. Problems that occurred in the West found its arms stretched all over the world. Developing countries, which were chasing their dreams to globalise found themselves caught in the contagion. West’s spending more than it was earning and increased risk appetite at the highest level was a problem in itself.
Just a couple of weeks ago, the world was about to end. Now it’s blue skies ahead in the West .
So how did this happen? Are the dark days gone for investors? Or are they too optimistic now?
A Dow Jones sentiment indicator for the US suggests the latter more than the former.
ROLE SENTIMENT
Prior to late July 2011, it was a position that various structural forces pointed in the direction of a sustained, albeit slow, economic recovery. However, major sentiment shocks in Europe and the US have jeopardised the recovery dynamic.
As things stand right now, the economic slowdown caused by shocks to sentiment is still reversible. However, if the forces driving the deterioration persist – primarily uncertainty surrounding policy decisions in the US and Europe – the structural foundations of recovery will be jeopardised.
Consumer and business psychology is a critical factor in any economic recovery. The way people are feeling about the economic environment has an important impact on spending decisions – both quantity and timing. By the same token, the way business owners and managers are feeling about the business environment has a major impact on their decisions regarding investment and hiring.
Policy responses by the US Federal Reserve and Bank of England, as well as expectations that the European Central Bank will soon follow suit, have helped. So too is the view that China will be reversing its recent tightening policy as inflation there seems to be peaking and commentators start worrying about a hard landing.
One of the puzzles the Bank of England is wrestling with in the non-recovery is how much the British economy’s productive potential has been damaged by the financial crisis; and how much growth is likely to be held back by the debts that many households and firms are still carrying – despite David Cameron’s hastily rewritten scripture that people should pay their credit cards.
PENT UP DEMAND
This is the upside scenario for the US economy in the next few months. If policymakers can restore confidence in the US and Europe, pent-up demand could manifest, providing a considerable spark to the economy.
On the other hand, if confidence remains low and deteriorates further, decisions to postpone consumption and investment expenditure can go from being temporary to permanent. When this occurs, a “new normal” level of expenditure tends to be established at a lower level to match lowered expectations. This is how a recession manifests.
Sentiment has been declining clearly. It is roughly at a level that has marked off previous recessions, although the indicator’s recent pace of decline has not been quite fast enough to make it an incontrovertible call.
Maybe the Fed will have done enough to stave off recession. Perhaps the eurozone will sort out its banking crisis, helping lift the sentiment and prop up growth. But the trend hasn’t been a nice one and we’re now at levels on the ESI where people should be nervous.
People can get used to anything, and then start to take it for granted.When things are expected to carry on in a certain way, and don’t, they take a turn for the worse, there must always be a period of adjustment. America went through a long period of growth which came to an abrupt end, something people were not prepared for. It is just that people are feeling it more now, because they were living way beyond their means on credit, and credit was taken for granted. People were encouraged by credit card companys and mortgage lenders to take credit for granted. Then the rug was pulled. Consequently everyone fell hard, and now it hurts. The higher the fall the harder the landing.
It appears that the economic indicators are missing some portion of the US economy that is keeping it out of recession. Is it perhaps the underground economy in which goods and services are exchanged via cash or perhaps barter? Perhaps these transactions are not being picked up by the economic tracking numbers, because numbers like retails sales and unemployment indicate that we are not in a recession, and unless something changes this winter, we are not heading into a recession.
If Europe can some how stitch together a way to save itself from the debt collapse and China does not slow down too much, then many analysts believe they don’t see the impetus for a recession in the near term. One danger is a conflict with Iran that spikes oil prices, and then hits US consumers and reduces retail spending. If that happens, it could really hurt the US economy.
Source: Wall Street Journal ,Guardian,Seeking Alpha
Posted in Arabian Gazette on 16 October 2011
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