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Why the Double Dip Is Real

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Many economists are wrong in thinking that the crisis will go from recession to recovery.

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Frank writes:

Peter, just finished reading Gene Epstein's article in Barron's saying there will be no double dip. Recovery will be slow, but steady. Blue Chip Economic Indicators, which polls 50 economists, says not one of these economists predicts there will be a double dip. All seem to be cognizant of sovereign debt issues, housing woes, commercial real-estate problems, unemployment highs, etc. What are they missing versus your view of a catastrophic double dip? This is more than perplexing to an observer like myself!


So many of the authors that I read consider 2008 to have been an event. We had a banking crisis. And in the context of the past 80 years, the natural response would be a move from crisis/recession to recovery.

Unfortunately, from my perspective there have been two very distinct recoveries.

The first one is a recovery in asset prices -- which I attribute exclusively to the unprecedented level of liquidity provided by the Federal Reserve and the resulting "forced march" into risk. (i.e. people will tolerate 0% returns on their deposits for only so long before heading into something yielding more).

The second one is the recovery in consumer spending -- which I attribute to high levels of fiscal policy spending by the government and the "reprioritization" of consumer debt payments away from their monthly mortgage to something else.

Both note that both recoveries are manufactured. Meanwhile unemployment continues at near double digits; there remains enormous overcapacity of production and there is no wage inflation.

To me we have flooded an engine with no spark plugs.

And to me the spark plugs to a true recovery only arrive when you get true market clearing prices at the bottom. We got "panic" bottom prices, which reflected the confidence that "the government can save us once again."

But we paid dearly for the market turn.

Most Americans arrogantly believe that we can continue to finance our way out of this crisis just like we have over the past 80 years. In fact this weekend, the New York Times editorial page even offered that "it is hard to envisage that [a downgrading of US debt by Moody's] would have a huge impact."

To me this is woefully naïve, as Greece is about to demonstrate, particularly as the United States, like so many nations -- in an effort to stem the banking crisis in 2008 -- took steps that only increased the reliance of the banking system on government support. We've moved from "too big to fail" to "too interdependent to fail." The outcome is now binary -- both governments and the banks succeed or they both fail. We've eliminated the middle ground.

Finally, and for what it's worth, most US economists take a very US-centric view of the world. As I offered to my clients at the beginning of the year, for 2010 I suspect that we'll be the tail to someone else's very big dog. Europe and China both feel like they fit that canine description to me. And I suspect that we're about to grasp how truly international the US economy is.

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