Bill Jamieson: this is no normal recession

Bill Jamieson
Bill Jamieson
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Had anyone suggested in May 2012 that within a year the US stock market would have climbed to record highs and that our own FTSE 100 would have gained almost 20 per cent, their sanity would have been questioned.

But here we are, with the S&P 500 index above 1,600 for the first time ever and the FTSE 100 standing at 6,521.50 as of Friday’s finish, close to its six-year high.

Shares have been driven higher by encouraging US employment figures and here in the UK by improving trends in purchasing managers’ index (PMI) surveys. Housebuilding shares have been notably buoyant, and statements from Royal Bank of Scotland and Lloyds Banking Group suggest progress towards normality.

Markets seem to be sensing that on the far horizons the broad sunny uplands of growth can be seen. What could possibly go wrong?

A better question might be: “What has really changed?” And to answer that, we need to pose an even trickier one: “What exactly have we been dealing with?”

Conventional wisdom has been that we have not been dealing with a depression – at least not in the popularly understood historical sense – but a deep cyclical recession which would in due course prove amenable to government and central bank remedial action.

But it is by no means clear in my mind whether it has been a recession as is generally understood. And while government and central bank words and actions have certainly helped us to avoid the worst features of a depression, it is equally unclear that a depression – meaning a prolonged period of economic stagnation unresponsive to conventional policy measures – is not an appropriate description of what we have been up against.

For five years, central banks have resorted to unprecedented measures to stave off a financial and business collapse. But the world is still struggling to find policies that would both deliver sustained growth and bear down on the colossal levels of public debt.

In America, the recovery is well short of what was expected. Japan still wrestles with deflation. The UK economy has escaped a statistical “triple-dip” recession but is showing little by way of robust recovery. In Europe, many economies are in severe distress and the eurozone overall is trapped in recession. There has been no “cyclical recovery” of the conventional type. And there has been no amelioration of the government debt crisis. Indeed, it has, if anything, worsened.

Consider the extreme measures to which the world’s central banks have been driven over the past five years. I am grateful to Stephen Lewis, economist at Monument Securities, for this tour d’horizon.

Interest rates were slashed to epochal lows and have been held there. The US Federal Reserve has embarked on a programme of monetary expansion without modern precedent, growing its balance sheet by $1.2 trillion (£770 billion). Meanwhile, US federal government debt has risen from 60 per cent to more than 75 per cent.

The Bank of England has expanded quantitative easing to a massive £375bn, while government net debt has shot from 44.5 per cent of GDP in 2008-09 to 73.5 per cent today – and is still rising fast.

The European Central Bank has extended loans to the banking system through refinancing operations and bond purchases totalling €800bn (£675bn). And across the eurozone, net government debt has risen from less than 50 per cent of GDP to more than 63 per cent.

But despite all these extreme measures, is the eurozone nearer recovery? Or the UK closer to a reduction in government net debt, heading remorselessly to 90 per cent of GDP and above? As Lewis points out: “The advanced economies are still nowhere near performing as their finance ministers and central bankers would like to see.”

It should be clear by now that what we have been confronted with is no normal recession, not even one greater than any seen in any previous post-1945 business cycles, but something more akin to a depression where “austerity” measures fail to work.

Economists Reinhart and Rogoff who provided an intellectual justification for austerity (debt to GDP ratios above 90 per cent resulting in low growth) may have come under fire recently, but their analysis is true in two key respects: that major private sector boom/bust credit cycles and banking crises tend to be followed by deep recessions; and recoveries from these tend to be slow. That has certainly been reinforced by the UK’s sluggish path.

Does any of this matter a bean to today’s equity investors? They are, after all, looking some months ahead. It does, and for these reasons. First, equity markets have no cause to celebrate a policy-driven improvement in monetary and macro-economic conditions. Second, looking ahead, both the earnings and particularly the sales growth of companies are likely to be muted and share ratings will reflect this. Third, markets will display doubts over the ability of governments to undertake the painful structural remedies required (deep spending cuts in particular). And fourth, the eurozone still has every capacity to deliver more global shocks. What can go wrong? What really has come right?