All that is necessary is a failure of the subject economy or its dependent economies to continue the trajectory of growth out of recession.
Economic crises are not precipitated by declines in asset values; they are the consequence of the change in sentiment. Crises begin with the signals of continuation in recent trends failing to materialise.
In 2007, when so much private debt was secured against homes, the over supply of new build housing in the US caused the growth in domestic real estate values to stop. Not to fall but simply not to grow further.
The financial sector had gambled on a continuation in the trend of value growth and hence it’s failure to materialise led directly to the unwelcome notion that a new economic paradigm, in which values rose without interruption, had not been found.
Sentiment changed at that moment and the rest, as they say, is (almost) history.
So a second decline in economy activity closely following an apparent resumption in growth (the double dip) will be caused by the reporting of some significant hesitation in the trend of recovery.
Sentiment will change, people’s fears will dominate their expectations and economic activity will diminish in confirmation.
These economic after shocks are usually not as severe as the primary event. The reason is that the amount of leverage in the system has not had time to be rebuilt and consequently the distance to fall is less than is the case when the economy has enjoyed an extended period of expansion.
You may recall that at the start of the recession I explained the 80% rule. To remind you it is that you cannot forecast the shape of the outturn until 80% of the recession has passed.
Without going into detail the US & UK economy exhibits few features of a sustained recovery and some characteristics of regression. So the balance of probability is for a slowing of growth over the next 6 months.
Usually this ‘second dip’ is not as deep as the first and is relatively short lived. In this recession I believe that central banks will intervene by injecting liquidity into the banking system to reduce the impact.
False dawns appeal to people’s recession fatigue and often are seized upon as evidence of a sustainable recover. Managers of companies that have survived the recession and are financially healthy can be enticed into investment prematurely only to encounter an unexpected reversal as economic activity enters another period of decline. Healthy companies can easily be transformed into damaged businesses as a result.
You might say that every silver lining has a cloud.
Paradoxically I would suggest that the timing to begin investment planning is if the economy dips again. This is usually a good marker of the 80% point. There are very few instances of a triple dip although there remains the likelihood of a medium term trend of only slow growth. Money will remain relatively cheap, notwithstanding that real bank margins are at a 22 year high.
The difficult situation is if there is no second dip and the economy drifts in a low growth state which retains the possibility of a new decline. This is the uncertain world in which pessimism thrives and management becomes consumed by a series of short term measures never sufficiently confident to invest in the long term.
a. That the initial risk evaluation was erroneous or, b. That their expediture has risen beyond expectation or c. Their revenue has fallen beyond expectation
The shape of the recession has surprised many informed observers. At this early recovery stage it looks as if it has traced a ‘V’ shape. A year ago this was the least likely outcome.
How, you might ask, is it feasible to brush off the most pernicious economic event in over 70 years as if it were just an inconvenience?
Of course we have not reached the final chapters yet but it is interesting to speculate.
Governments are better able than private sector institutions to spread the impact of financial impairment over the very long term.
This may also be the consequence of the massive government intervention.
You may consider the sovereign debt crisis in the Euro zone is one such event. It is not coincidental that it has arisen now although the linkages were sufficiently obscure for the markets not to predict its severity.
The private sector can only compensate for this if it is able to finance growth in excess of the recent norm and to so will require the volume of new debt to expand. Under this scenario, to escape the lagged consequences of the recession just past we must embrace the debt devil that created it.
The private sector can only compensate for this if it is able to finance growth in excess of the recent norm and to so will require the volume of new debt to expand.
Under this scenario, to escape the lagged consequences of the recession just past we must embrace the debt devil that created it.
Are there lessons to be learned from this that will inform our future policies?
The answer has to be ‘yes’ but undoubtedly it will be several years before we fully understand what they are.
However one thing is abundantly clear. It is that we, an interconnected interdependent world economic community, are unable to predict economic turning points until they are undeniable.
We know, as a matter of certainty, that there will be such turning points as the proposition that we have defeated the cyclical pattern of boom and bust has been utterly discredited.
We know also that predictions of bust are derided when they are made in the context of several preceding quarters of uninterrupted growth. We fear that if we accept the probability of a collapse our actions to protect our interests will lead to a cascade of imitative behaviour and the prediction will be self fulfilling.
Predictions of boom are also received with scepticism as sentiment in the depression requires evidence of relief before hope can become expectation.
We need to accept the inevitability of boom and bust and develop better tools to both predict and manage the extremes.
Adjustments that moderate a boom and prevent bubbles forming or minimise their size are healthy as more frequent corrections cause less economic damage over the medium term.
If it is beyond our statistical capability to forecast naturally occurring turning points with an acceptable level of confidence then perhaps we should turn our attention to how we can stimulate them through economic management and hence, through deliberate action, render them predictable.
One of the great dangers to recovery from the recession was the emergence of another seismic event that rocked the international financial system.
Greece provided this. The extent of its unsupportable debt burden had been apparent for some time but, like the US sub prime toxic debt, very few thought it a significant danger to economic stability.
Secondly the EU seemed to ignore the risk of contagion from Greece to the similarly fragile economies of Spain, Portugal and Italy implying that the Euro zone was strong and able to endure the global economic turbulence with comparative resilience.
Now we may be exposed to a further financial sector tsunami arising this time from EU banks.
Now factor in the inconclusive UK election in which no party obtained a mandate to govern. Policies faded to an indistinguishable light grey and the electorate found no party compelling.
These events are indicative of emergent turbulence arising at a time when most people regard the recession as ending. They are suggestive of a world in which many of the old certainties are dissolving.
Too many managers and especially those running successful companies devote disproportional and misguided effort into protecting the integrity of their business model.
It has become increasingly clear that the corporate problems that often follow a period of success are rooted in the rigidity management creates in an attempt to preserve the conditions of success.
Success is just a passing phase and it is impossible to maintain the conditions in which the organisation prospered.
Consequently managers should begin to question their business model at the height of their success and also when a major external event, such as the current recession, changes the operating environment profoundly.
Corporate failures tend to peak during the early recovery phase . UK insolvency specialist Begbies Traynor recently predicted that the annual record of 30,000 UK business failures set in the early 1990s will be exceeded in 2010.
Begbies also estimated that 140,000 UK companies experienced significant or critical financial problems during the final quarter of 2009 (an increase of 6% over the preceding quarter) and that many of these will be unable to cope with the increasing interest rates expected during the second half of 2010.
26,000 UK companies failed in 2009 before the important early recovery phase began and, significantly, without the effect of large company failures precipitating the failure of a cascade of dependant companies.
We should not believe that companies have become more resilient or that they entered the recession with lower leverage (although low interest rates have tended to make debt more supportable than is usually the case in a recession).
The reason why there have been fewer large company failures lies in the financial position of the lenders. Exposure to internationally traded financial institutions and instruments deplete a lender’s capacity to absorb the significant additional write offs that would arise if major companies collapsed.
Lenders and regulators realise that when a large company collapses, the financial consequences are multiplied by the cascade effect as smaller dependent companies cannot endure the financial impact of bad debts and lower sales.
The cascade of collapse cannot easily be arrested until it has run its course. When several large failures arise in close succession unemployment increases, asset prices decline, sentiment deteriorates and the recession deepens.
So perhaps we can argue that the financial difficulty of lenders has benefited the corporate arena by restraining lender’s normal tendency towards intolerance of corporate distress, leading them to support companies operating at the margin of survival.
What, in other conditions, may have been unsupportable leverage in many large companies has been re-engineered by lenders who have converted ‘excessive’ debt into new equity, giving banks effective control of many companies. Low interest rates have also contributed to the extent to which banks are able to tolerate non-performing credits for an extended period.
But lenders are now rebuilding their capital and will not remain holders of diversified investment portfolios. As a result they will sell their equity positions, with private equity being the principal buyer and, significantly, as the capacity of lenders to take a financial hit is restored, they will start to take less a less supportive attitude towards impaired credits.
They will get tougher with SME’s and the rate of collapse will increase but significantly they will also allow large companies to fail, believing that the cascade of failure will be moderated by a more buoyant economy.
This depressing possibility will be compounded by the almost certain significant reduction in public sector spending, which will act as a drag on economic recovery and will lead to more company failures than would otherwise have been the case.
So we should conclude that the paucity of company failures makes this a less pernicious recession than we’ve seen in the past. Nor should we assume that survival to date implies a resilience that will strengthen as the economy improves. What we can say is that the forces that lead to company failure may have been redirected but have not diminished. The peak may simply have been deferred….
It's tempting to believe the media and to budget for economic recover towards the end of 2009 but is this sensible?
In an editorial publish elsewhere I cautioned that that turning point of a recession is harder to call that the onset. If you remember there was no consensus about the likelihood of a recession happening and hardly anyone called the chaos that has ensued. Moreover most economists have classified this event as the most pernicious since the great depression of the 1930’s saying the a ‘V’ shaped recover was unlikely.
Well, if you extrapolate the recent press comment a ‘V’ shaped event is what we’ll get with UK growth resuming in the final quarter of 2009.
I’m cautious because this scenario is what we would all hope for and we tend to overweight data which appears to suggest the best case. There are undoubtedly some encouraging signs but without a resumption in bank lending I cannot see how any recovery in consumer sentiment can be translated into a sustained recovery.
‘Green shoots’ are always vulnerable to an early frost and the economic spring is currently insufficiently robust to withstand another shock.
My advice is to be cautiously optimistic but wary of a ‘W’ shape with another decline following a brief period of apparent recovery.
I suggest that you regard the next 9 months as likely to be a fragile period in which there is an equal chance of growth and decline.
Also bear in mind that more companies tend to fail in the 18months following a resumption of growth that did so in the decline phase of the recession. If you are a business to business company then you must be wary of the credit risk amongst your customers.
You should construct 12 month budget as usual but revise it, at least, every 3 months as no one can say for certain what the conditions will be in months 6 to 12.
Plan to ensure that your business can survive a period of 12 months with no real improvement in the economic conditions.
The key indicators will be a resumption in the growth of net bank lending, sustained growth in mortgage lending and the ability to credit insure customers without difficulty. Any two is good. All three is a recovery in progress.
Don’t gamble on economists calling an end to the recession that they failed to predict.