A new kind of normal

“…..The recession is very likely over at this point, but it’s still going to feel like a very weak economy for some time….”

Chairman Bernanke remarked during a question and answer session on his recent visit to the Brookings Institute.  That statement serves as an eerie reminder of the speech given by then US President George Bush declaring the end of major combat in Iraq. The famous “Mission Accomplished” banner was visibly displayed in the background on the aircraft carrier USS Abraham Lincoln evoking a feeling of military hegemony and national pride.  Since then we have all become familiar with the guerrilla warfare that has taken hold of the country resulting in the loss of thousands of civilians, Iraqi combatants and coalition forces.

Such assessment from the chairman and consistently supported by at least four other Federal Reserve Bank presidents has provided much needed confidence to our broken financial system.  But much like President Bush’s declaration on the war, the confidence attained from this optimistic yet cautious overtone may be short lived.  That is, until investors and market participants realize this impending recovery may not be like any other. 

The consumer continues to face some strong headwinds from sluggish income growth, unavailability of credit and lower wealth.  Coupled with the changing sentiments towards increased savings, spending will undoubtedly be weak going forward.  This is likely to worsen as companies continue to slash jobs and the unemployment rate rises to the estimated 10% by year end. The strength of the consumer, historically a major catalyst in past recoveries, has weakened substantially. With this 70% contributor to GDP out of the picture, the economic and financial landscape will certainly present a new kind of normal moving forward.

Private Investments are subject to the same fate. Capacity utilization rates are at some of the lowest levels since records began as businesses continue to reduce fixed investments, staff and inventory levels and improve their cash reserves.  While this bodes well for mergers and acquisition activity, operational efficiencies and stock performance in the medium term, it will require a substantial change in sustainable demand before yet another significant contributor to GDP is positively impacted.  One bright spot could emerge however. Given the massive inventory liquidation in the first half of the year we could see a short term recovery in manufacturing similar to that experienced by the auto industry.

The greenback may also be a non-factor in this recovery. The sharp depreciation of the US dollar greatly aided in improving net exports and GDP post the 1981-82 recession. But this crisis is global, decimating every single part of the economy including exports. Without the consumer, exports and private investments driving the current recovery, how can we expect any thing other than a tepid recovery?  The option remains quite clear, it is now up to the government to maintain their spending and keep the economy afloat. 

The Fed firmly remains in the driver’s seat shoring up the gap to become the exclusive source of liquidity for the markets. Policymakers are also being quite accommodative in their melange of initiatives becoming the driving force behind the consumer’s ability to spend and business’ ability to borrow and invest. With the potential failure of expected growth rates to close the resource slack, the Fed may need to become even more accommodative. They must now try to skilfully balance the threat of worsening unemployment and deflation with the size of the slack which ultimately shapes inflation.

Undoubtedly the role of global governments has expanded in a profound way. To achieve the robust growth of the last decade a new catalyst will need to replace the leverage that catapulted us to the peak of economic activity. The consumer must adapt prudent spending and saving patterns, and businesses must reengineer themselves, making judicious decisions within a sound risk management framework gradually taking back the reins from government.
 
In the words of William Clayton, ‘gird up your loins, fresh courage take’ as our economy gets more global, regulation gets tougher, productivity and innovation takes centre stage and businesses wrestle with the courage to act; for the uncertainty of this altered landscape may be with us for a very long time….

Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited.  The Bank accepts no liability for errors or actions taken on the basis of this information.

 

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Stock Watch: by Butterfield Bank’s Brendalee Scott-Novak

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