Economy 2011: The Half Empty Case

Like most of you I think that we are in the midst of a recovery though it is tepid at best and fraught with peril from any number of different quarters. The market action today certainly kicked the New Year off in a positive direction. So with that qualification let me direct you to two decidedly downbeat appraisals of our current state.

The first comes from Paul Krugman who takes off his partisan hat long enough to write a sensible assessment of the current situation.

If there’s one piece of economic wisdom I hope people will grasp this year, it’s this: Even though we may finally have stopped digging, we’re still near the bottom of a very deep hole.

Why do I need to point this out? Because I’ve noticed many people overreacting to recent good economic news. What particularly concerns me is the risk of self-denying optimism — that is, I worry that policy makers will look at a few favorable economic indicators, decide that they no longer need to promote recovery, and take steps that send us sliding right back to the bottom.

The best part of his piece concerns the continuing issue of unemployment. He properly points out that given the growth that is expected there is little hope of the problem self-correcting. I think his prescription for curing the problem — a new WPA to rebuild the country’s infrastructure — is hopelessly out of date. Building bridges, repaving roads and the like are done today with big machines and a few workers, not with hordes of men wielding shovels and picks.

Frankly, I think it likely that the unemployed are likely to become the neglected class of 2011. Recognizing there is no good short-term solution to the problem I fully expect the political class to choose to ignore the issue. The long-term unemployed become the collateral damage of the Great Recession and will have to fare for themselves as best they can. The rate of full employment will be redefined upwards, bones tossed in the form of retraining and education and at some point the problem pronounced to have been solved.

Now for a pessimistic view of 2011 courtesy of who else but Ambrose Evans-Pritchard.

This bear is not for turning. It would be joyous indeed if a fresh cycle of global growth were safely underway, but I don’t believe it. Sorry.

Policy levers in the US, Europe, and Japan remain set on uber-stimulus with the fiscal pedal pressed to the floor and rates near zero everywhere, yet OECD industrial output has not regained the peaks of 2007-2008 by a wide margin. Leading indicators are tipping over again. We are one shock away from a liquidity trap.

The East-West trade and capital imbalances that lay behind the Great Recession are as toxic as ever. Surplus states are still exporting excess capacity with rigged currencies — the yuan-dollar peg for China and, more subtly, the D-Mark-Latin peg within EMU for Germany.

Dangerously high budget deficits of 6pc, 8pc, or 10pc of GDP in countries with dangerously high public debts near 100pc may have prevented an acute depression, but they have not prevented the weakest rebound since World War Two, and they cannot continue, whatever the assurances of New Keynesians and pied pipers of debt.

Cyclical bulls may see the surge in 10-year US Treasuries — and therefore mortgages rates — as a sign that growth is about to blast off: structural bears suspect it may be the first convulsive shudder of bond vigilantes dismayed at the easy willingness of Washington to spend $1.4 trillion above revenues next year, with no credible plan to contain the monster thereafter.

Of particular interest, to me at least, are his comments on the fate of the EU and the Euro. He sees the German courts caving on the issue of the clearly illegal bailouts so far undertaken by the EU. As such Evans-Pritchard forecasts the union limping along until Germany agrees to subsidize debt reduction among the basket cases of the South. A cluster if ever there was one.

So there you are. A little dose of vinegar for your New Year. Personally, I don’t disagree with either of these gentlemen to any great extent. It does seem to me, though, that as we basically seek to reestablish the status quo, albeit in a diminished form, we are simply sowing the seeds of a bigger crisis. Failing to resolve major structural problems doesn’t cause them to disappear so much as it allows them to fester and manifest themselves later as devastating political and economic issues.

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