What will be the shape of the recession?

Wednesday, 08 April 2009 08:02
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Inverse Square root signThe recovery will look like "an inverted square root sign," said billionaire investor George Soros said on Monday. Soros, speaking to Reuters Financial Television, said. "You hit bottom and you automatically rebound some, but then you don't come out of it in a V-shape recovery or anything like that. You settle down—step down... The healing of the banking system and housing markets is crucial to recovery... The banking system, as a whole, is basically insolvent".

Soros predicts that the U.S. economy is in for a "lasting slowdown" and could face a Japan-style period of relatively low growth coupled with high inflation. He also warned that rescuing U.S. banks could turn them into "zombies" that draw the lifeblood of the economy, prolonging the economic slowdown. "I don't expect the U.S. economy to recover in the third or fourth quarter so I think we are in for a pretty lasting slowdown", adding that in 2010 there might be "something" in terms of U.S. growth.

Soros's view contrasts with the majority of economists, who expect the U.S. economy to stop contracting in the third quarter and resume growing in the fourth quarter, according to the latest monthly poll of forecasts conducted by Reuters.

Green shoots nipped in bud

The inverse square root shape sounds convincing in the UK context. Whatever stimulus to the economy that the government's financial measures may achieve will be overshadowed by the need for huge tax rises to cover the debt that has been incurred in saving the banks from their toxic debt. And that is on top of the falling tax revenues due to declining economic activity, accompanied by the rising cost of welfare benefit as unemployment increases. Higher taxes on labour, goods and services have the effect of depressing economic activity. The green shoots of recovery will be nipped in the bud. We suspect that the government will use inflation to cover some of the gap, which will drag the UK into a 1970s-style "stagflation", only this time a much more intractable one. As HM The Queen said, the prospect is awful.

Yet if one considers what is happening, nothing makes sense. People are being put out of work. Productive capacity - physical capital - is standing idle. In the high streets of Britain, shops are standing empty with "To Let" signs in their windows. Yet there is no shortage of work waiting to be done. Public buildings need to be repaired. Britain's roads are potholed and the pavements broken and uneven. The railways are congested and chronically short of rolling stock. Many people are still living in poverty despite the long period of boom, and would gladly improve their living standards if they had the chance. As the old saying goes, everyone that comes into the world has a mouth to feed and has a pair of hands to feed it. If there is chronic want, then there must be a blockage in the system. We need to ask why things do not add up.

Blockage in economic system

Look again at all those empty premises. The fishmonger or fruiterer doesn't throw much stock away. They drop their prices until everything is sold. It is known as "allowing prices to fall to market-clearing levels". Yet it does not happen in the property market. Owners do not all drop their prices but let the property stand vacant. It may be in their interest to do so, rather then tie themselves into a contract with a tenant at a lower rent than they might have received a couple of years ago. It is their free choice. But there are two primary factors of production: Land and Labour. Wealth is created by the application of human labour to land. If land is held out of use, then wealth is not produced. There is the blockage.
 

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