Intersecting Minds: Education, Business and Technology at the North Carolina State Jenkins Graduate School of Management

Still Bearish on the Economy

Unfortunately, I haven’t had much time to follow the global economy since I arrived in Denmark. However, now that things are settling down a bit, I’ve had the opportunity to catch up a little bit on what’s going on. And best of all, one of my classes, Strategic Risk Management is covering in nitty gritty detail the mechanisms (derivatives trading, credit defaults swaps and collateralized debt obligations) by which the global finanical system almost melted down last year.

Meanwhile, the US market has had a nice little run over the summer. Entering trading this morning, the Dow sat at over 9,600, a far cry from the mid-6,000’s at which it was trading just 8 months ago. There are plenty of proverbial “green shoots” suggesting the economy is beginning to pull out of its funk: a slowing of the rise in unemployment, expansion of manufacturing, and stronger than expected corporate earnings over the summer months.

Despite all of this, I’m still fundamentally bearish on the US economy over the next 5-10 years. The U.S. is unwinding itself from 30 years of overleveraging on the individiual, corporate and government levels. Coming down from that will take time. Consumer spending, the primary driver of US economic expansion since the 1970’s, hasn’t picked up the necessary amount of steam to drag the country out of the economic doldrums.

Additionally, we still haven’t addressed the primary causes of what got us here in the first place. Simon Johnson has an excellent piece up at Baseline Scenario today summarizing what we have learned about the global finanical system over the last 12 months. It’s not pretty:

But how much good does all this new knowledge now do for us?  There is very little real reform underway or on the table.  We can argue about whether this is due to lack of intestinal fortitude on the part of the administration or the continued overweening power of the financial system, but the facts on the ground are simple: our banks and their “financial innovation” have not been defanged.

In fact, they are becoming more dangerous.  The “Greenspan put” has morphed into the “Bernanke put”, to use the jargon of financial markets, where “put” means the option to sell something at a fixed price (and therefore to limit your losses).  The Greenspan version was always a bit vague, involving lower interest rates when a speculative bubble ran into trouble; the Bernanke version is huge, involving massive cheap credits of many kinds (as well as interest rates set essentially at zero).

In other words, we’re incentivizing financial institutions to make all the same mistakes they did the first time around. Only this time, the Fed won’t have the weapons at hand (low interest rates) to combat another huge bubble.

Ultimately, nobody is entirely sure where the global economy is headed: optimists say a V-shaped recovery could still happen, the majority of economists think it will be a U-shaped recovery, and the pessimists think we’re sitting right in the middle of another bubble. If I had to pick, based on what I argued earlier, then I would go with the latter scenario. Call me a pessimist at the moment.