Let’s get the bad times over with quickly
Is a slow recovery better than an imminent crash? Governments are trying their best to ensure stability even if it means a long haul: business might be better off seeing the economy allowed to sink to its natural level now so that the recovery can start sooner.
The housing market offers an easy analogy of the choice. If property values are 20 per cent too high, then six years of flat prices while inflation creeps up at 3 per cent would bring values back to their equilibrium level. Alternatively, prices would be allowed to crash by 20 per cent now and then start rising again as soon as the market has bottomed. That analogy can be applied to stock markets, consumer confidence, business profits or the whole economy.
The argument is that instead of, in the above example, six years of stagnant markets during a return to ‘natural levels’, it would be better to have a short period of pain then the recovery with activity returning to normal levels much faster.
The argument against is that the short-term pain can be quite severe – businesses (and home owners) go bust, people lose jobs, spending patterns change dramatically. And that markets overshoot: house prices falling 30 per cent, for example. However, those symptoms are also seen as one of the advantages: shocks to the system produce opportunities and efficiencies.
The effects of the choice are illustrated by those companies that bring in a new chief executive who ‘kitchen sinks’ the business – radical management changes, writing down asset values, selling off redundant operations, sacking surplus staff. It is painful, but it allows the business to restart on a viable basis quickly and to rebuild while a similar business that avoided dramatic changes would continue struggling for years.
On a national scale, Black Wednesday or other devaluations have shown how ending the problem quickly allows the recovery to start sooner. Japan has shown how to get it wrong: after confidence and asset values collapsed in the early 1990s its government chose to manage a long slow recovery that meant many years of negative inflation and which is still continuing.
The snag with the long slow recovery is that someone breaks ranks and takes their losses now, moving up a gear while its rivals slog it out. It is a choice governments and corporates face, but while the temptation is to go for stability, the right answer if probably the short-term shock.
April 24th, 2008 at 10:51 am
The other problem with the slow approach is it gives companies/politicians and even consumers more time to ‘game’ the system and play the new economic reality, rather than take the pain to return to a more productive economic footing.
To return to your example of Japan, you see see this in the Japanese housewives who’ve effectively played the carry trade by saving cash off-shore for higher interest rates rather than investing in their own stock market, and the indeed the companies in that market who’ve had years now to create poison pills to ward off the takeovers Japan’s sluggish economy really needs.