Global Economic Crisis – The Mirage of Economic Recovery

November 22, 2009 at 2:42 am (Economics)


By Adnan Khan

On the 60th anniversary of the Great depression the US Commerce Department Bureau of Economic Analysis released advance estimates that the US economy (GDP) had grown after four consecutive quarters of decline. If correct the US economy has posted economic growth for the first time in a year. America joins Japan, China, Germany and France as the world’s leading economies that appear to have emerged from recession and averted economic collapse. Some are arguing that this signals the end of the ‘great recession’ and a return to economic growth.

 

In order to asses this one would need to look at the factors that caused the recession and then analyse if they still are present or have they been replaced by economic conditions that will bring new and sustainable growth.

The growth in Western economies in the last decade was driven by the real estate bubble which stimulated the remainder of the economies of the West. The bubble reached exceedingly colossal proportions because banks were able to create various financial products from debt which were then sold to other banks based upon the assumption that the housing bubble will continue to expand.

The collapse of the worlds largest Sub prime company – New Century Inc in April 2007, the collapse of Northern Rock in February 2008 and then AIG, Lehman brothers and a whole host of other banks brought to the forefront that the boom of the last decade was unsustainable and built upon the wild assumption that real estate prices will continue to rise. The subsequent collapse in housing prices exposed gaping holes in lending practices of the worlds largest banks, many banks were forced to write off billion in debt, as they on mass were being defaulted upon. As banks collect customer deposits and lend to new business and projects all of this came to a grinding halt and because of this a crisis that was inherently financial, shifted to the real economy, hence production fell, many companies collapsed and unemployment increased. Hence the economies of the West were driven by real estate which had now run out of steam.

To avert catastrophe Western governments intervened on colossal scale to save their economies from collapsing. The idea being, whilst many would not be able to spend and hence stimulate economic activity, the state would provide the necessary money to stimulate the economy and this would bring back confidence and kick start the economy. Western governments took three key approaches to the crisis: nationalisation, stimulus packages and the printing of money.

Analysing the Economic Recovery

Many economists and policy makers are arguing that the world’s premier economies have shown economic growth between April and June 2009 and this marks the end of the great recession.

Germany lost 6.7% of national income over the course of the recession. Germany is the manufacturing heart of Europe. It relies upon exports to fuel growth. So its biggest problem has been the huge fall in global trade, which the World Trade Organisation predicts will have contracted by 10% this year. However populist polices by Chancellor Angela Merkel and the agreement to supply Russia with German automobiles shows that growth in the German economy at best based upon temporary factors and not underlying economic fundamentals. In February 2009, the country approved a 50 billion euro (£44bn) stimulus plan, Germany also launched a car scrappage scheme in February 2009 where drivers receive a cash incentive to scrap their old car and buy a new one – to boost the ailing car industry. The scheme has been widely deemed a success, with more than 1.7 million applications.

The peak-to-trough decline (the beginning of the first quarter of decline to the last) for France was s 3.5%. The French government announced a 26 billion euro (£23.5 billion) initiative designed to revitalise the economy. France and Germany have come out of the recession because their financial sectors, account for a smaller proportion of their economies.

The total decline for Japan has been a whopping 8.4%. Government stimulus measures totalling $260bn (£159bn) helped to boost the economy, including cash handouts and subsidies to buy energy-efficient cars and home appliances.

If the US has come out of recession its loss in income will have been 3.7%. Third quarter GDP data reveals that August retail sales surged a seasonally adjusted 2.2% over the previous month, producing the largest monthly percent increase since January 2006, However the surge in August was driven primarily by an 11.6% increase in automobile sales, which was a direct result of Cash for Clunkers scheme. The end of this scheme saw retail sales fall 1.5% in September.

Stimulus Packages = Leg up

At the peak of the economic crisis many Western states developed Stimulus packages in order to save their economies from collapse, the most infamous being the US $1.2 trillion stimulus package in 2008. However any stimulus is a high-octane boost and a temporary measure. They are designed to kick-start stalled economies, not to fuel sustained economic growth. Hence the current growth seen in some nations are the inflated results of stimulus measures achieving their intended effect to be temporary. Government initiatives such as Car Scrappage schemes as seen in most nations, the reduction in the general sales tax in the UK and tax credits for first-time home buyers as seen in the US and France contributed to the respective 1 percent and 0.5 percent portion of the total GDP increase attributable to increased motor vehicle sales and residential investment. As these programs end, so will the contribution to the economy.

Brian Bethune, economist at IHS Global Insight said with regards to the end of the recession: “It’s good to have the economy growing again, but we don’t think that rate of growth is sustainable because it is distorted by all the government stimulus. The challenge here is to get organic growth – growth that isn’t helped by fiscal steroids.” Unemployment is currently 9.8% in the US, that is over 15 million people.

When looking at the quality of growth much of the economic factors are temporary and not driven by any factors that can be considered sustainable. Dana Saporta, an economist at Stone & McCarthy Research in Skillman, New Jersey confirmed this: “Much of the strength in theUS economy is due to temporary factors such as fiscal stimulus initiatives like the home- buyers credit.” In fact the leg up provided by governments around the world shows the importance of government aid to the emerging economic recovery, when this is removed – which eventually governments will have to as they cannot continue with expensive stimulus plans, it is very much possible that Western economies will fall into recession again.

The stimulus packages have driven artificial growth, once Western states remove the leg up they have provided we will need to see if the free market can function on its own. With the busiest shopping season of the year approaching – Christmas, the coming quarter will provide a good gauge of ‘unstimulated’ consumer activity. However with unemployment at its highest, national production at best premature and debt still very high this quarter’s turnaround is in no small part due to government stimulus measures, and is therefore most likely artificially inflated and not sustainable.

Conclusions

Whilst the US, the worlds largest economy appears to have moved out of recession its economy is dependent on consumer spending, which makes up approximately 70% of its GDP, exports make up only 11% of its economy. So sustained consumer spending will be essential for the US and consumer spending shows no signs of recovering.

The leg up provided by the Capitalist world in no way dealt with the underlying economic problems of unsustainable growth, debt driven spending, casino finance and bubble economies. What such stimulus packages have done is kept Capitalist economies afloat when unemployment, repossessions and bankruptcies have all increased. So whilst statistically Capitalist economies maybe coming out of recession the reality on the ground is much different. Socialist intervention by Capitalist governments have for the moment halted any economic collapse, however once all the temporary initiatives are removed from the free market it is highly unlikely the market will stand on its own feet. Hence the world economy in reality is in the same position it was a year ago.

Whilst the majority of Capitalist societies face the grim prospect of unemployment and repossessions, they will not be receiving any handouts to ease their situation, the recent bonuses announced by some of the worlds largest investment banks shows where the bailout packages have gone. This shows the agreements made at the G20 summits were really only for public consumption. Western governments have still not passed any legislation to stop bonuses.

The conditions in the world economy have stopped worsening, however unemployment remains high and consumer spending is still low to sustain any economic recovery. At best the current quarter growth seen in some of the world’s major economies is premature, the underlying economic fundamentals remain absent. Hence economic recovery currently is in reality just a mirage.

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