Spotting Signs Of Economic Recovery

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Unfortunately, even if Obama could wave a magic wand to mend the financial industry and stabilize the real estate market, the recession wouldn’t end overnight. Thanks to another adverse feedback loop—dubbed the Keynesian multiplier, after the dead British economist who is all the rage these days—the trouble has already spread to the rest of the economy. Take Charlotte, North Carolina, a big regional financial center. As locally based companies like Bank of America, LendingTree, and Wachovia lay off thousands of employees, the area’s restaurants, messenger services, and limo companies see their revenues plummet. These businesses, in turn, trim their operations and jettison staff, which reduces the need for produce, bicycles, and town cars. The original fall in demand generates a second-round effect, which generates a third-round effect, and so on. Imagine this happening in towns and cities all across America and you can begin to understand how a recession takes hold.

The usual way to counter a fall in demand in one part of the economy is to boost it in another. This is the principle behind stimulus programs like the one Obama has proposed, which could involve up to a trillion dollars in new expenditures and tax cuts. The ­arithmetic behind this enormous figure is strikingly straightforward. Since the start of 2007, about $10 trillion in real estate and stock market wealth has been wiped out. If, for every dollar American households have lost, they cut back their expenditures by, say, 5 cents—an assumption that jibes with historical ­evidence—the total spending shortfall in the economy will be $500 billion a year, or $1 trillion over two years, the likely duration of the stimulus package.

This emergency measure will eventually have to be paid for—as will all the recent bailouts—but the middle of a recession isn’t the time to obsess about budget deficits. A more pressing concern is making sure that additional government outlays are spent rather than saved. It turns out that much of the $150 billion worth of tax rebates authorized by the Economic Stimulus Act of 2008 wasn’t spent. So the 2009 stimulus will be targeted at cash-strapped states, the unemployed, and other recipients who won’t let the money collect dust in their savings ­accounts. It may be too much to hope for that the package by itself will revive overall spending. However, combined with the $250 billion in consumer savings that the recent drop in gasoline prices will deliver this year, it could well prevent another downward lurch.

As in any deep recession, the ultimate key to recovery will be restoring the confidence of business executives, investors, and consumers. When times are good, most people you meet are upbeat, and it’s easy to dismiss the warnings of worrywarts and cranks like yours truly. As unemployment increases, the odds of running into somebody who was just fired, or whose best friend was just fired, rise exponentially. Gloom spreads like a virus. Eventually, the few remaining optimists are the ones who start to seem crazy.

Breaking this psychological feedback loop is Obama’s toughest task. Luckily, he comes equipped with impressive oratorical skills, a calm and reassuring demeanor, and the rare ability to make Americans feel good about themselves and their country. If, after leveling with the public about what has gone wrong, he can outline a credible and fair strategy for recovery, including the establishment of a tougher and more scrupulous regulatory structure, he could buck up what Keynes referred to as the economy’s “animal spirits”—the optimism that goads entrepreneurs into action.

The model for Obama, inevitably, is Franklin D. Roosevelt, who took office in March 1933, a time when one in four people was out of work and the banking system was in a state of panic. By no means did all the policies that Roosevelt introduced in his famous “hundred days” work out perfectly. But he stabilized the financial system; convinced Americans that, at last, something serious was being done; and conveyed a sense of confidence. Bernanke, a Republican fan of Roosevelt’s, likes to remind people that one of the stock market’s best years of the 20th century was 1933. During Roosevelt’s first term, the inflation-adjusted gross national product expanded more than 25 percent.

It would be wishful thinking to expect such a vigorous upturn between now and 2012. Before we can hope for a sustainable recovery, we have to deal with yet another adverse feedback loop—deflation—which is a recipe for Japanese-style stagnation. As prices start to fall throughout the economy, borrowing money and servicing debt costs more in real terms, putting even more strain on borrowers and financial institutions.

Bernanke is determined not to let deflation gain a foothold. Between September and December, the monetary base—notes and coins in circulation, plus bank reserves at the Fed—jumped by about a third. Without announcing it publicly, the Fed has adopted a policy known as “quantitative easing,” which basically means that it’s flooding the economy with cash. With central banks around the world adopting similar policies, it’s hard to see a global fall in prices persisting for very long.

By the end of this year, if all goes well, there could be tentative signs of an upturn. How seriously do I take this rosy scenario? Recently, I moved some of my savings from cash into stocks. If the past two years have taught us anything, it’s that popular economic wisdom is often mistaken. In venturing into the stock market, I am taking out a long-term call option on the possibility that the doomsayers, my normal self included, are mistaken. I hate to sound like a shill for Wall Street, but in my mind, this is simply sensible diversification.

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