Signs of Optimism?

source:www.zmelifetips.com

Warrren Buffett is buying American stocks, commodity prices are crushing, latest leading indicators are pointing north and massive liquidity is pumped into the system. Governments attempts to unclog the credit markets.

Despite all efforts on asset markets, recessionary conditions have arrived on the real economy side of the equation. September retail sales numbers suggest that consumption is declining rapidly and falling consumer confidence is likely to further delay housing recovery. Combining with a large scale reduction in capital spending plans, it would not be surprise to see a substantial recession lasting into at least 1Q2009 with sharp rises in unemployment extending past mid year.

The Japanese economy stagnated for a decade or so, following the collapse of its asset price bubbles in the early 1990s. Question now is that will the US economy experience a ‘lost decade’ in the wake of its own burst asset price bubbles?

The only difference between then and now is the responsiveness of policymakers. Unlike the case in Japan, which was quite slow to support the Japanese financial system via monetary easing and direct assistance to financial institutions, US policymakers have responded very aggressively. The Treasury Department is about to embark on a program to recapitalize financial institutions, hence it will help to reduce the risk of a downward spiral of bank lending and economic activity.

Having said that, Japan’s experience during the 1990s shows that the US economy could experience a few years of sub-par economic growth due to corporate deleveraging, in turn investment spending.

Over the past few months, the press has been filled with stories claiming that current dislocations in credit markets are the most severe financial crisis since the Great Depression. The 20% decline in the Case-Shiller 20 metro market housing price index since 2006 is prima facie evidence that residential real estate was overvalued and there are indications that further declines in house prices lie ahead.

What is apparently lacking is the policy stimuli to support traditional Keynesian type of aggregate demand boosting. This in my view will constitute the final component in turning around the current dilemma. Otherwise, equity market will be subjected to torrid weeks, perhaps months ahead as concerns over recessionary economic conditions returned to the fore. Of more concerns, I see the current deterioration in the labour markets as only the start of a process that is likely to see unemployment rise further by end of next year.

The challenge to policymakers and for market to watch for is the minimization of pass-through of what transpired in Wall Street to Main Street! Otherwise, it would be highly impossible to guess how much economic activity will be lost with the timing and pace of repair in credit market conditions. Likewise, the guess part for the psychological impact of the financial crisis on highly interdependent consumer and business behaviour.