Baffled? It’s hardly surprising. On the one hand, euphoric stock markets, up more than 20 percent in two months, proclaim the recession is nearly over. On the other, dark stories circulate about the chiefs of the Bank of England worrying that the banking crisis is intensifying. One banker says the banks are back; another that there is no sign of light. One businessman says he can see green shoots; another that recession is deepening. Whom and what to believe?
The answer is that the situation remains very serious, very fragile, beset by risks. Recovery, when it comes, may not bring much in terms of new jobs and rising production. The threat of a Great Depression may be receding, but this is hardly reassuring — the new prospect being a worldwide Great Recession. After all, in London shares were valued more cheaply two months ago than in October 1940 when there were fears of a German invasion. Now stock markets think the threat has receded, but only to a state of mass unemployment and protracted economic stagnation. Some relief, but hardly an occasion for wild celebration.
On the plus side, markets have been reassured that governments will underwrite their stricken banking systems, a commitment made at the G20 summit in London. Interbank markets worldwide are less stressed. Some of the sickening drops in production in Japan and elsewhere at the turn of the year were because retailers and distributors around the world were meeting lower demand from their stocks. That period of destocking is coming to a close; orders are beginning to be placed at factories again. That is reflected in less pessimistic surveys of business confidence and reports that the pace of decline is easing.
On top of this, as I have written a number of times, it would be very extraordinary if the British economy did not stabilize given the scale of the stimulus it is receiving. Interest rates at 0.5 percent, a deep devaluation of the pound, a budget deficit of 12 percent of GDP, along with the Bank of England printing £75 billion (US$114.4 billion), injecting it into the financial system (called quantitative easing) and announcing plans to print a further £50 billion last week, is about as much as can be done to stimulate an economy in recession. We know from other bad recessions — 1929-1931, 1979-1981 — that after 12 to 15 months the worst of the fall begins to ease. That is likely now.
But that is about all one can say with any confidence. The scale of the British stimulus is an acknowledgement of the scale of the unprecedented economic catastrophe. I doubt that the Bank of England embarked on its second round of quantitative easing because it thinks a second British banking crisis is imminent, as some reports on Saturday said: There would be storm warnings in the interbank markets if it were. Rather, it is acutely concerned, as it should be, that the British financial system is short of hard cash and lending capacity. The risk is that further problems in US or European banks may bring fresh contagion here.
The US government is opting for what Nobel Prize-winning economist Paul Krugman dismisses as a policy of “muddling through,” largely because President Barack Obama knows that winning more cash as “welfare” for bankers will be almost impossible to get through Congress. The compromise deal announced last week in Washington over how much money US banks had to raise to stay solvent was the barest minimum. Everybody has to hope it is enough.
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