Breaking Views

The worst may be yet to come

Just because a few signs point to an economic recovery doesn't mean we're out of the woods yet.

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By Edward Hadas, breakingviews.com

(breakingviews.com) -- Is the worst over? Investors seem to think it is. Confidence that the crisis is winding down has been mounting. But the right answer to the question depends on what "worst" is meant. Appropriate replies include: probably, yes but so what, not yet, probably not, and let's hope so.

The worst of the credit squeeze is probably over. True, loan losses are still increasing. But the official aid is massive: minimal policy interest rates, ample liquidity supplies, capital injections and implicit loan guarantees.

The aid from above has helped push dollar interbank borrowing rates down in the last six weeks. The cost of insuring against corporate failure in the credit default swap market has also fallen by 0.5-0.7 percentage points to about 1.9 and 1.6% annually for the main U.S. and European investment grade CDS indexes. Improving bank credit has contributed to this trend. Better credit all round means more loans will be refinanced, so fewer companies will go under than would otherwise be the case.

The big official liquidity push also gives investors more cash to put into the markets. The additional buying power may account for some of the sharp increase in oil and equity prices. There have also been tentative signs of revival in the junk bond and IPO markets. To some extent, the mood is following the money.

It may be due to government help or it may just be the passage of time, but another worst that has probably passed is in the pace of economic decline. The huge sudden drop in activity after the collapse of Lehman Brothers last September has already become something of a business legend. If the decline had continued at that pace, economies would be back to the Stone Age in a few decades.

It's not going to be that bad. Globally, exports are down 30% since last July, according to Lombard Street Research. But the pace of decline is moderating. Similarly, U.S. housing starts, which have declined by 75% since the 2006 peak, may have reached their low.

The balance of indicators still suggests GDP is falling in most developed economies, but at a much less dramatic rate than a few months ago. When the economy is only declining at a moderate pace, some measures typically suggest that growth is returning - the much talked-about "green shoots" - but more show further decline. That seems to the case now.

Inventories complicate the picture. A sharp decline in global demand led to an even sharper reduction of inventories as retailers and manufacturers cut back. As the inventories are rebuilt, production will most likely pick up faster than consumption.

So yes, all in all the economy isn't shrinking as rapidly as it was. But so what? It's still shrinking. On that yardstick, therefore, the worst isn't yet over.

Now look at another measure of "worst": unemployment. Even when growth does return, recovery is likely to be anemic. It will take time to absorb the excesses built up during the credit boom, from houses in the U.S. to too many Chinese factories making cheap goods.

What's more, it's not as if all that private-sector debt has gone away. The rise in savings rates in the U.S. and elsewhere isn't going to be a one-quarter wonder. This means that the peak in unemployment could easily be two years away.

And will that then be the end of the pain? Probably not. The crisis will leave government balance sheets shot to pieces. The best case scenario is that the authorities manage to suck all their fiscal and monetary stimulus out of the economy safely once economic growth has bottomed out. Then all that the world will suffer is high taxes and slow growth.

But there is a risk that this outcome proves too unpopular and that the authorities instead take the current fad for "quantitative easing" to the extreme - and just print money to finance their deficits. The outcome would then be inflation.

An inflationary outburst might even lead to another sort of financial crisis - a loss of confidence in key currencies. That could be worse than anything seen up to now.

Can such a dire outcome be avoided? Let's hope so. To top of page

Company Price Change % Change
Ford Motor Co 8.29 0.05 0.61%
Advanced Micro Devic... 54.59 0.70 1.30%
Cisco Systems Inc 47.49 -2.44 -4.89%
General Electric Co 13.00 -0.16 -1.22%
Kraft Heinz Co 27.84 -2.20 -7.32%
Data as of 2:44pm ET
Index Last Change % Change
Dow 32,627.97 -234.33 -0.71%
Nasdaq 13,215.24 99.07 0.76%
S&P 500 3,913.10 -2.36 -0.06%
Treasuries 1.73 0.00 0.12%
Data as of 6:29am ET
More Galleries
10 of the most luxurious airline amenity kits When it comes to in-flight pampering, the amenity kits offered by these 10 airlines are the ultimate in luxury More
7 startups that want to improve your mental health From a text therapy platform to apps that push you reminders to breathe, these self-care startups offer help on a daily basis or in times of need. More
5 radical technologies that will change how you get to work From Uber's flying cars to the Hyperloop, these are some of the neatest transportation concepts in the works today. More
Sponsors
Worry about the hackers you don't know 
Crime syndicates and government organizations pose a much greater cyber threat than renegade hacker groups like Anonymous. Play
GE CEO: Bringing jobs back to the U.S. 
Jeff Immelt says the U.S. is a cost competitive market for advanced manufacturing and that GE is bringing jobs back from Mexico. Play
Hamster wheel and wedgie-powered transit 
Red Bull Creation challenges hackers and engineers to invent new modes of transportation. Play

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.