Double Dip?

By Allston Mitchell, July 7, 2010

On the trading floor  Photo credit Flickr member cactusbones

On the trading floor Photo credit Flickr member cactusbones

A double dip in the economy is a bit like getting a bad cold, recovering and feeling slightly better but then slipping back into pneumonia. To continue the medical analogy, the result could mean a long-term weakening of the immune system.

No, it has nothing to do with ice cream. If you are neither an economist nor a financial wizard, the last couple of years have seen some potentially useless additions to your vocabulary with all the new recession-related jargon: sovereign debt, CDSs, quantitative easing and deflation. Experts have been warning of imminent disaster on a regular basis over the last couple of years, with the bogeyman changing from one month to the next. The latest dragon to be slain is the double dip. Only a few months ago we were all spellbound by sovereign debt fears (Greece, Spain and Italy going bankrupt) but this has given way to a new form of subtle panic: a double dip. A double dip in the economy is a bit like getting a bad cold, then feeling slightly better but then slipping back into pneumonia.

Officially, a double dip takes place when the growth in GDP of a country turns negative again after one or two quarters of positive growth. Basically, a double-dip is a recession followed by a short-lived recovery, followed by another recession. How does this happen? The reason why an economy falls back into recession for a second time is usually due to a decrease in demand for goods and services because of people losing their jobs (and consequently not spending) and also as a result of the government spending cutbacks that were put in place to fight the initial downturn. So, to continue the medical analogy it is a cold, followed by a brief improvement followed by pneumonia resulting in a long term weakening of your immune system.

Economists are unable to agree about whether this is really going to happen or not, but that would be nothing new. One of the major indicators of global economic health is the Dry Baltic Index which monitors the daily average of the cost to ship raw materials by sea. This index measures the demand to transport raw materials, as well as the supply of ships available to move this cargo. It is an indicator to determine whether anybody is actually manufacturing anything and if there is anybody on hand to buy what has been manufactured. It is a key indicator of economic activity. So what is it telling us? The price of shipping goods is currently falling and set to fall further. This is a clear indication that goods are not being shipped and that economic activity is declining. This is not good news for the global economy. If this indicator is pointing in the right direction then another recession may be in the offing.

In the US, the government stimulus package is being wound up, retail sales are slowing indicating that consumer confidence is not robust, job creation data is not heartening and the housing market is still weak – all of which means that the recovery is fragile, but not necessarily that there is going to be a double dip. However, analysts fear that a major blow like a serious hike in oil prices could prove fatal – pushing the economy over the edge. The problem is one of fragility.

In the UK, the levels of worry are more dramatic. The new coalition government is betting the house on interest rates remaining low for the next five years and that the massive government spending that they are cutting away will be “almost magically” replaced by exports. Some cynical observers have pointed out that it has been over 20 years since UK manufacturing had the plug pulled on it, being replaced by a service economy. The Chancellor of the Exchequer is also asking for 25 to 40% cuts throughout the public sector with the exception of a few ring-fenced departments. The effects of this pulling of the public funding plug has frightened many and those who are not frightened do at least question how quickly the private sector will pick up the baton and replace the lavish public financing of the Labour years. If there is a British equivalent of voodoo economics then this may well be it.

The threat of a double dip, coupled with the fear of sovereign defaults in Europe is keeping everyone on their toes. The general consensus on the double dip is that currently the chances of it happening are no higher than 30%. For this to actually happen, GDP would have to turn negative and the current forecasts do favour positive growth – modest positive growth, but at least growth.

The real problem is that we are dealing with what economists call “animal spirits” and “investor sentiment”, the two most unquantifiable criteria ever invented. Animal spirits tries to measure (by calculating consumer confidence) the deep and dark emotions that affect the human behaviour of investors. Investor sentiment rather unremarkably identifies either confidence or a lack of it when huge numbers of people are either selling or buying – something of a late indicator. This is along the lines of “if you are reading about a second recession here, you are too late”. What might trigger a double dip is a mysterious force and when you realise what is happening, it will probably be all over bar the shouting.

Failed and failing banks and insurance companies have shifted their liabilities to government balance sheets and these balance sheets are looking shaky as a result. Corporate defaults transforming into sovereign defaults. As a result Finance Ministers are making drastic cuts to public spending, just when they should be doing the exact opposite. Will they get lucky?

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