Recovery of economy may not be soon

The recovery of economy may not be coming soon but seen are various things that could contribute to a recovery but nothing strong enough to achieve it. In the US, housing and construction has totally collapsed pulling down the GDP. Housing starts are a third of what they were about a year ago.

Economist Martin Feldstein was a surprise choice when Brack Obama finalized the members of his Economic Recovery Advisory Board. Closely identified with past Republican presidents Feldstein was chairman of Ronald Reagan’s council of economic advisors the choice was seen as an example of Obama’s bipartisanship in action. He wanted people outside the administration and he wanted different voices.

The recession is going to last longer than expected particularly in developed countries. There is an under current of pessimism to get the world’s growth engine – the US economy out of the worst recession since the Great Depression of 1920.

In the US, housing and construction has totally collapsed pulling down the GDP. Housing starts are a third of what they were about a year ago and that has taken $250 billion out. The fiscal stimulus will help but it won’t fill the very large demand gap that comes from the decline in housing construction, exports, consumer spending. It will give a temporary boost that will be misinterpreted because if it raises GDP by roughly 1.5% and stays there, and in that first time, the government statisticians will translate that into an annual 6% rate. So, even if the economy falls at 5%, we could get a positive quarter or two because of this mechanical translation of this level effect into what looks like a growth effect. So the stimulus will do something but not enough except very temporarily.

The third is private lending of which there is very little. The Fed is trying to fix this through public private partnership. That will help but not big enough scale to cleanse the balance sheets. Then, neither banks nor potential counter parties are going to have enough confidence to over come the problem.

Buying toxic assets with help but the question is whether that will be enough. Banks have to cleanse bank balance sheets so that banks feel confident about lending. The idea is to get rid of all the toxic assets. But, it is not clear if spending $1 trillion will get rid of all of it. Remember that the aggregate bank balance sheet is around $10 trillion and not all of that is impaired; but, maybe enough of it is that even $1 trillion will not succeed in cleansing. Moreover, even if you did manage to clean it, house prices will continue to fall. Those homes that today have positive loan value ratio will turn negative. They will again add to worries about these impaired securities and could go bad in one year. Till then there is no full solution.

India will not be impacted by the US recession:

India’s trade to GDP ratio was less and India’s exports were different largely services trade and business to business trade. But the impact of manufacturing exports was non-trivial. And the pure financial impact of funds being withdrawn obviously hurt the ability of larger Indian companies to finance themselves in the global markets.

But experts are still optimistic about India. Also most optimistic about China because the Chinese are committed to increasing aggregate demand and they have the levers and the ability to make positive decisions and implement them. India, because in the long term what India can do, both in manufacturing and services, can be quite important. But it may take more than a few months to get back on track.