Saturday, September 19, 2009

The Shapes of the Economic Recovery: U, V, W, L, Square Root?

We have been flooded with economists predicting this or that type of economic recovery. Will it be a U, a V, a W, an L, or something else?

This article looks at some of the types being talked about.

V-shaped recovery:

The best type of recovery. Economy goes fast down the tubes, it recovers like a rocket. If you read the media  today you'd be inclined to believe this is it. Don Ussis from e-commerce guide wrote 9 years ago that this type of recovery would count on low unemployment bolstering consumer confidence, in turn sustaining consumer spending. Inventories would be bought, capacity would have to be expanded to meet demand. Investment would be high, capital spending would bounce back. Bargain hunters pour back into the markets, reinforcing the "wealth effect." Rich on paper, due to their stocks, investors spend on new houses, cars, furnishings, and apparel, and of course consumers continue to rack up credit card debt. Have you seen this scenario before?

U-shaped recovery

A gradual fall and a gradual recovery which takes longer and is more difficult. I am not sure the recent fall was so gradual but te theory is that growth continues but at a slower pace. Consumer confidence is low, unemployment rate is high, corporate earnings are poor, there is an over capacity in goods. Every one saves a little more and cuts back investment and spending. Rallies happen on the stock market, but it still goes down slowly. After major capitulation, an upward trend happens in the market and there is light at the end of the tunnel. Things slowly improve.

W-shaped recovery

A double-dip recession. Paul Krugman is in this camp. It's a V, followed by another V, oops!

L-shaped recovery

The letter says it all: economy falls hard and flatlines. This is the scenario that is dreaded by everyone. It's Japan's lost decade all over again. They are still in the horizontal flat part of the L. Their interest rates are near zero. Sounds familiar? Stock markets go on a deep very long slump. I quote from 2001: "The Japanese economy and their stock markets have been saddled with very bad economic policy, including 1) a lack of transparency in banking and asset valuation, 2) a reluctance to mark inventory to market and 3) an "honorable system" in which too many failing enterprises are supported". Sounds familiar?

Spending dries up. Stagflation arives. Stocks continue to dive. Fear sets in that the U.S. Markets will become Japan 2.

Then to make it more interesting, there is the "italicized L" recovery, as reported by the Times in the UK.

Reporters, Chief economists and pundits worldwide are also offering their predictions, Keep reading.

Square root-shaped recovery

Brian Millner from the Globe and Mail talks about the square root recovery. I assume it's a V with a flatline:
So this means some recovery occurs, but then it stops. The question is what happens when the various government stimulus packages cease (if the cease)? The right side of this square root depends on this.

Douglas Porter, chief economist with BMO Nesbitt Burns Inc. says it will be an "inverted square root" recovery. Hummm. Does he mean this:

or this:

or this?

Neither alternative seems too pleasant.

Download you pdf poster of the Shapes of the Economic Recovery.

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