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Your father's recession


It has been a generation since the world's major economies sank in unison, long enough that some had come to believe that the confluence of technological advances, improved economic forecasting and modern monetary policy had foreclosed the possibility forever.

But last week's surge in U.S. unemployment combined with more dismal economic news out of Japan -- if that were possible -- hurtles the world a step closer toward a dreaded "synchronous" recession.

Such downturns are dreaded because they can be longer and deeper than average. The last time the world's three largest economies -- Germany, Japan and the U.S. -- tanked together was in 1973, according to the Economic Cycle Research Institute in New York. In the U.S., the recession lasted 16 months. Germans endured it for a month shy of two years.

Now, the U.S. economy -- the engine that was supposed to pull the world back onto the tracks -- is instead still teetering at the brink of recession. The German economy, meantime, actually contracted in the second quarter compared with the first, on a seasonally adjusted annualized basis, and Japan has already boldly gone where few nations have gone before: into its third contraction in less than a decade.

Coincidentally or not, the last time U.S. stock markets fell for two straight years was in 1973 and 1974. With the Dow Jones Industrial Average down 10.99% year to date, after a 6.18% decline last year, a repeat of the nasty synchronous downturn of the 1970s looks likely...

And so, in a world where every major market is linked somehow to another, who leads the way back up when everyone is falling? It was supposed to be the U.S. that led the way to brighter times, but "the fact that there is no growth abroad is harming the chances for recovery in the U.S. and adding to weakness," says Stephen Gallagher, chief U.S. economist at SG Cowen in New York. Just as U.S. companies have laid off foreign workers, foreign companies have fired workers in the U.S. and in Europe. As the Nasdaq market has fallen, the Nikkei has marched along with it, with equity markets as much leading as following economies down and revealing the underside of global interdependence.

To be sure, the conditions of this recession are different enough to hold out hope of a quicker recovery. The U.S. budget is in surplus, compared with a deficit ahead of the 1973 recession. The government has been able to deliver a rare countercyclical tax cut, albeit modest and back-end loaded. Significantly, inflation isn't a concern. The ECRI's Future Inflation Gauge, which forecasts about 10 months out, is at a nine-year low. That gives the Federal Reserve ample room to lower interest rates further. Several economists now see the fed funds rate heading to 3% from 3.5%, probably in two steps beginning with the next Fed meeting Oct. 2.

But what concerns economists about synchronous recessions is that weak world economies are vulnerable to shocks that can get out of control. A relatively strong U.S. economy sailed through the Asian crisis in 1998, pulling many emerging economies out of their slumps more quickly. The possibility of a crisis -- a dive in the dollar's value, or a failure of the Japanese financial system -- amid the slump could complicate and worsen future problems. "Such crises ... could conceivably knock the U.S. into a much longer deeper recession trajectory," says Anirvan Banerji, ECRI's director of research.

In addition, the world's leading economies can't rely upon exports to provide a typical recession-time boost to growth.

Most 20th-century recessions followed a series of interest-rate increases that acted as a brake on the economy. This slowdown is following a different script: The real cause looks to have been the abrupt halting of capital spending by business after technology and telecommunications companies in the late 1990s overborrowed and overbuilt...

If a return to economic growth requires that the big multinationals get their houses in order first, the wait can be long. After the recession of the early 1990s, the S&P 500's actual earnings levels didn't regain their prerecession high, hit in the first quarter of 1989, for five years.

And that, moreover, was possible only because the world economy in the early 1990s managed to narrowly avert a synchronous recession. When the U.S. contracted a decade ago, Japan and Germany were still growing. By the time they slowed, the U.S. was launched on the powerful expansion that has just now ended.
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