Double-dip

In the past week alone, the New York Stock Exchange dropped 300 points. Markets in both Europe and Asia were in retreat.

In our own market, the expected post-inauguration bounce did not happen. On the day after an orderly transfer of power happened, three days of gains were wiped out in one session at the Philippine Stock Exchange.

No single event explains the general slide in equities. Analysts are telling us that there is simply not enough good news to hold up investor confidence worldwide. On the other hand, a slew of bad news — from the financial problems in Europe to the oil spill in the Gulf of Mexico — undermines optimism.

The recovery from the last bout with global recession has been weak. Unemployment remains high despite the massive amounts invested by governments in economic stimulus packages. In several major economies, public debt stands at levels that test the limits of manageability.

The price of oil resumed its climb. The constant rule, we know from historical experience, is that spikes in oil prices continue until they precipitate a recession. The resulting drop in demand brought on by a recession halts the oil price spiral.

Pressure for oil prices to climb is caused, ultimately, by the supply and demand configuration. In a few years, depending on the strength of the global economic recovery, demand for oil is expected to match supply. Beyond that point, there will be shortages.

The oil supply situation presents us with a perfect dilemma. On the one hand, economic growth will create demand pressure on oil prices. On the other hand, the supply with be ample only if the global economy stagnates.

Because of that dilemma, there is a sense that when global economic growth escalates, we run the risk of running into a brick wall. That brick wall is the oil industry’s existing production capacity.

In order to raise production capacity, we will have to drill in permafrost areas or deep under the sea. The irresolvable BP oil spill vividly illustrates the risks posed by drilling in difficult conditions.

A number of very influential economists have warned that the global economy is now headed for a double-dip recession. One Nobel laureate has, in fact, warned that the second dip will almost certainly bring us into a depression on the same scale as what we saw in the 1930s.

That is a chilling scenario. With those influential voices of doom, it might be hard indeed to muster the confidence required to prop up the equities markets.

A double-dip recession may be compared, to use medical analogy, to a recurring bout with flu. The first time, the body’s defense systems are tested severely. On the second bout, happening shortly after, a weakened defense system might be unable to defeat the virus. The symptoms will be more severe.

When the global financial crisis struck in 2008, governments responded by dramatically stepping up public spending through a variety of bailouts and stimulus packages. The effort was intended to avert a descent into depression by shoring up the demand side of the economic equation.

The step-up in public sector spending required heavy government borrowing. That, in turn, exhausted the financial resources available for private investments. It also served to worsen the fiscal situation for most governments.

Greece is the most striking demonstration of the risks posed by heavy public borrowing. The country’s fiscal situation deteriorated sharply, bringing it to the brink of defaulting on its debt payments. When the possibility of default rises sharply, the health of the banking system (which lends money to governments) comes into serious question.

Because of the worsening fiscal condition of Greece and several other European economies, people began selling down the euro and sought sanctuary in the US dollar or in gold or in oil futures. The stronger US dollar, in turn, undermined American economic recovery. Speculation in oil futures pushed up the price of oil. Since oil is traded in dollar prices, the commodity became more expensive for the euro zone economies, threatening their recovery.

At any rate, the simultaneous stimulus spending by the major economies raised the debt stock of governments, therefore also increasing the risk of further lending to them. The governments that borrowed heavily to finance stimulus packages in the first round of recession are hardly in a position to do the same should a double-dip recession happen in the near future.

That, I suppose, is the root of the general sense of vulnerability now infecting the markets.

Should the recovery eventually turn out to be really weak and signs of a recurring recession appear, governments will not have the same volume of financial resources they had in 2008-2009. It is like fighting rekindled fire with very little water.

In our case, we were very fortunate to have escaped a slide into recession in the last bout. But, like the others, that was largely due to the timely execution of an economic stimulus plan to head off a downward spiral.

The stimulus plan we put in place, however, cost money. Because of that, we had to scrap the goal of achieving a balanced budget by 2008 and accept a large deficit. We have financed that deficit by increased borrowing while the interest rate regime was low.

We have now reached what is considered the prudent limits of debt servicing. If we are forced to borrow more in the event of a recurring recession, the costs of money will likely be higher and the enthusiasm to lend might no longer be there. –Alex Magno (The Philippine Star)