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How long until we get back to normal?

Posted by admin on August 24, 2009 in Investment Information

The economy appears to be in an illusionary state of normalcy. The norm of ever increasing real estate values and cheap credit has been replaced with the norm of ever-ending government bailouts and stimulus. At some point, the capacity of governments, both political and economical, to keep pumping money into the economy will reach an end point.  Assuming everything goes right and the private sector picks up where the public sector ends, will we see normal soon?

Based on history, the answer appears to be not for a long time.  As a prelude to the release of their World Economic Outlook, the International Monetary Fund looked at economic recoveries after 88 banking crises over the past 40 years in various countries and found: “the conclusion is that, on average, output does not go back to its old trend path, but remains permanently below it… the possible good news is that the trend appears to  be unaffected: on average, crisis permanently decrease the level of output, but not its growth rate.”

In plain English, the economy may not reach the same level of output again in some countries but growth rates tend to revert to the mean- but starting from a much lower base. This means that for some industries and businesses the infrastructure built to handle capacity circa 2006 may never be used fully (see auto plants), meaning job growth will be slow as industries may not need a full complement of employees.

As I wrote before, this may explain a slow drop in the unemployment rates (think years and not quarters) based on previous recessions and an investing strategy not premised on the assumption that things will get back to normal soon.