Liz Kurtz, a reporter for BigLaw, asked me earlier this week:
The stock market has been quite volatile lately, and intimations of a “double dip recession” seem always to be lurking, in the reports of a persistently weak economy and in dire predictions of slow growth (in terms of various significant metrics) or actual economic decline. Some people think we’re in a recession now (though you never really know until after the fact). The question is whether large firms are now equipped to weather a recession, or if they’ll have to resort to layoffs again.
I replied with a few points, including:
- The kind of volatility we’re seeing in the stock market is, I believe, perfectly rational. We’re being buffeted by good and bad news of great magnitude on what seems like an accelerating time-frame–the debt-ceiling showdown, “QE3” or not QE3, the Japanese reactor accidents, Greece/Portugal/Ireland/Italy on the brink, the S&P downgrade of US Treasuries, the Arab Spring, and on and on. That said, I would not assume that whatever the stock market does any given week or any given month means it has any unusual forecasting prowess. There doesn’t seem to be a solid trend established and until that comes I think it’s predicting nothing but uncertainty–which we’re acutely aware of already.
- Six months ago I would have said a double-dip recession was extremely unlikely. Now I think it’s a 50/50 bet. Consider:
- Essentially as many Americans as ever remain underwater on their home mortgages. Until that overhang of supply can be worked off (which will take years at current rates), don’t look for consumer spending to come roaring back.
- Same re domestic US unemployment; we face perhaps a decade of “supra-normal” unemployment. Many lost jobs are simply not ever going to come back
- The EU is extremely difficult to sustain, I believe, in its current configuration. Putting France & Germany together in a monetary union with Greece, Portugal, perhaps even Spain, was to ignore 500 years of history. If a breakup comes, “strong” European banks will have to write down large amounts of sovereign debt, severely hobbling them.
- As for law firms, the most important thing to remember about our industry is that we do not control our destiny. When consumers stop buying and businesses stop investing in growth and hiring, our clients are hurt two ways: Their plain old top-line revenue falls, and they have less to “do”–fewer deals, lower IP investment, etc. So they need less in the way of legal services. We can never, in the long run, grow substantially faster than our clients, although the increasing complexity of global regulation helps us out a bit.
- In other words, if our clients go into a second recession, we will inevitably go along with them.
On sober reflection, I’ve become dissatisfied with my response, because I did not come to grips more forthrightly with the premise of the question.
I’ve believed since at least the Fall of Lehman three years ago next month that this is not your garden-variety recession: It’s a financially-driven contraction, which as Carmen Reinhart and Ken Rogoff eloquently and I think conclusively demonstrated in This Time is Different (2009), using eight centuries of data, take years and years of slogging to recover from as everyone simultaneously pursues the goal of deleveraging their balance sheets.
Why am I assuming everyone is keen to deleverage? I’m not assuming anything; that’s what everyone is doing, from governments to corporations to households. We had a credit-binge-driven boom before the bust, and all that overindulgence needs to be worked off. The ordinary policy tools, be they Keynesian or Friedmanite, basically are beside the point. Or, as The New York Times pithily put it today on the front page, in the first line of its story reporting on recently released minutes of the Fed’s Open Market Committee, “No one knows what to do to fix the economy.”
So what was wrong with my answer; why am I disappointed in myself?
Because I thoughtlessly accepted the premise that (a) we had a “recession” (a phenomenon we think we understand, or at least we used to think we understood); (b) it ended, as faithfully reported by the National Bureau of Economic Research (its official duration was December 2007–June 2009); and therefore (c) if we are still feeling punky, economically speaking, it must portend a “second dip.”
Nonsense, I now believe. Or at least a crabbed and strained reading of what has actually been going on for about the past five years.
Consider these charts which appeared in Martin Wolf’s column in the Financial Times yesterday:
The fallacy this time around with the conscientious and always authoritative NBER’s approach is that while focusing on the change in output rather than its absolute level normally makes sense, this time none of the Big Six economies cited in the top chart has even recovered to its pre-“recession” starting point. As Mr. Wolf puts it, this “will not feel like recovery,…especially if unemployment remains high, employment low and spare capacity elevated.”
Now what about Chart #2, government bond yields?
What it shows is that the US and Germany are now converging on the unhappy state of Japan, where 10-year bond yields have been under 2% since 1997 and deflation has been a serious risk throughout the “Lost Decade” (which is approaching a 14-year-long decade, by the way).
And the point of Chart #3?
Looking at the S&P 500 P/E ratio, we’re still almost a quarter above the long-term average and three times higher than we were in 1982. This scarcely suggests that the market’s recent gyrations have come anywhere close to “capitulation,” classically the last phase of a bear market. In other words there could be worse to come.
But back to our inquiring reporter.
A proper response from me would have been to say that we are not at risk of a “double dip” recession, we are still in the same bloody extended recession.
Oh, and yes, there was a follow-up question: “What would prevent firms from engaging in the massive bloodletting of 2008-2010 or ‘stealth layoffs,’ albeit on a smaller scale?”
My response: Nothing whatsoever would prevent that. We have learned our lesson and are unlikely to become as undisciplined about capacity exceeding demand as we were back in the palmy days of 2007. Or, to put it more bluntly, we have lost our virginity.
Wish I could offer more optimism but it’s hard to see what policies, or what politicians, here or in the Eurozone, could show the way out of the forest.
