Financial Market Commentary

Posted by Rob Weigand. The academic Doom-and-Gloomers are out in full force these days. It reminds me of the old Monty Python skit “Four Yorkshiremen.” Each character tells a story of woe from his childhood, with each trying to out-do the other. The last character pulls out all the stops with the following recollection:

“I had to get up in the morning at ten o’clock at night — half an hour before I went to bed — drink a cup of sulphuric acid, work twenty-nine hours a day down at the mill, and pay the mill owner for permission to come to work. And when we got home, our Dad and our mother would kill us and dance about on our graves singing Hallelujah.”

Which provides the perfect segue for a review of a recent paper by Stijn Claessens, M. Ayhan Kose and Marco E. Terrones, entitled “What Happens During Recessions, Crunches and Busts?” (paper available online here). The paper finds that economic recessions are significantly deeper and longer when they are precipitated by simultaneous credit crunches and housing recessions. In the authors’ own words:

We provide a comprehensive empirical characterization of the linkages between key macroeconomic and financial variables around business and financial cycles for 21 OECD countries over the 1960-2007 period. In particular, we analyze the implications of 122 recessions, 112 credit contraction episodes, 114 episodes of house price declines, and 234 episodes of equity price declines and their various overlaps in these countries over the sample period. Our results indicate that interactions between macroeconomic and financial variables can play major roles in determining the severity and duration of a recession. In particular, we show that recessions associated with credit crunches and house price busts are deeper and last longer than other recessions.

With respect to ongoing events in the United States, they write:

These comparisons suggest that, while the current slowdown may share some features with the onsets of typical U.S. and OECD recession, it is worse in some dimensions, particularly in terms of speed of credit contraction, drop in residential investment and decline in house prices. These statistics suggest that the adjustments of credit and housing markets in the United States are only in the early stages relative to historical norms and might still take a long time. This could bode poorly for the path of overall output, which, as we show, falls more in recessions associated with credit crunches and house price busts than in recessions without such events.

What about the prospects for the US economy? Peter Hooper, Thomas Mayer, and Torsten Slok undertake an analysis and write in the July 28 issue of Deutsche Bank’s Global Economic Perspectives (not available online) that the de-leveraging of US financial institutions would lead to a reduction of credit to US non-levered entities of about USD 1 trillion (4.4% of the total assets of the US financial sector), and shave about 1.3 percentage points off GDP growth over the year following the negative credit shock. Their analysis suggests a substantially larger cut-back in the credit supply than other researchers. They also conclude that the negative effects will play out over a considerable period, shaving about 1.5 percentage points off US GDP growth (and something approaching that amount off euro area growth) over the next three years.

Surely there’s someone out there who can out-do the above Doom-and-Gloomers. If you’ve got a forecast for the global economy that’s even more pessimistic than those summarized above, please send it to me. I’ll check my inbox right after I brew up a nice hot cup of sulphuric acid.

You can write to Rob Weigand at profweigand@yahoo.com or find him on the web at Rob Weigand’s Home Page.