The Economist: Fear returns

On the cover of its latest issue, The Economist featured a shark sneaking underwater. Barely a month ago, its front page read "Hope, finally". How sentiments change so quickly in the wake of a recession is nothing less than remarkable. So what do we do to “avoid a double-dip recession"? Here I am going to borrow some ideas from the term paper I wrote for my macro analysis course last spring.

One thing for sure is that we have reasons to remain cautious and even pessimistic, though it's probably safe to say that the worst is behind us. To me the difficulty today is not a double-dip recession, but a sluggish recovery for years to come. It's unlikely that we would see another systemic default of the economy, given the decisive actions governments have carried out during the crisis. However when we examine one by one the four cartage (consumption, government purchases, investment, net exports) dragging the economy forward, it becomes really hard to believe that future is free of worries:


- Consumption, several factors make spending our way back to prosperity rather unrealistic:

1. unemployment.
2. less household wealth, diminished values of portfolios and houses
3. fear caused by the first two factors may as well transform the spending habits of the consumer. The average Joe is turning into, if never too much of a saver, less of a spendthrift.

- Government purchases:

1. A soaring deficit is highly undesirable during an economic recovery, for it could make financing costlier for both the public and private sectors, and politically weaken the administration’s control to do what is needed. And since technically we are not in recession any more, a Keynesian approach may fall out of the vote seeking politician's favor.

- Investment:

1. An optimistic stock market does not automatically signal the healing of the system, whereas a financial system that remains abnormal affects virtually every participant in the economy. For private companies, the premium they have to pay to attract capital is still very high as compared to earlier recoveries, signaling a lack of confidence in the bond markets. Since small businesses, employing 500 people or fewer, have traditionally accounted for 65 percent of all new jobs created. If these companies could not get money for their projects, they will not be in a position to hire people or make capital investment

- Exports:

1. Many economists agree that exporting our way back to prosperity is the optimal way to go. There is real hope here, but not certainty.
   
2. The U.S. is the dominant exporter of "knowledge oriented" goods, things that cannot be produced easily by a sweat-shop in China.
3. A combination of tight fiscal and loose monetary policy is likely to lower the exchange rate, and make U.S. goods more competitive abroad.
4. However, exchange rates cannot be firmly controlled, and the dollar tends to not behave in the way it is told.
5. Crisis abroad might cause capitals to flow into the dollar and make it appreciate.
   

All told, the road to recovery is a game of confidence. Until one of the horses dragging the cart wakes up and “ignites” the rest, things will remain sleepy as they are. This is not to say that over-confidence is golden; the economy is still in a feeble stage, and it will take exceptional vigilance and execution to lead it to where it needs to be. Perhaps we don't have to be pessimistic, but caution is indeed needed going forward.



Yi Gao
Research Analyst
Analyze Capital LLC

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