There’s no good reason for another recession, but nor does there need to be


Like most hesitant optimists, I can’t shake the feeling that much of the West is slowly recovering economically. I tell myself that we hit rock bottom sometime after the 2007 crash but now, nine years on, things are finally looking up. “We recovered from the worst financial crisis in generations”, President Obama said in his final state of the union address, implying (1) that we have indeed recovered and (2) we don’t have to worry about any more crises for a while; it was a once-in-a-generation event.

Hence my surprise as I opened my browser recently and came across an article on the Guardian titled: “fears grow of repeat of 2008 financial crisis as investors run for cover”, complete with a photo of a wild-eyed broker shouting frantically into his headset (presumably crying “Sell! Sell! Sell!”). ‘Panic selling’ has gripped markets around the world, the Guardian said, as the FTSE 100 index dropped 200 points in one day, putting the UK stock market into ‘bear territory’. And no one ever wants to find themselves in bear territory.

The article’s central quote came from William White, a former chief economist at the Bank of International Settlements (BIS), who argued “the situation is worse than it was in 2007”, as public authorities are so cash-strapped that they’ve no ‘ammunition’ to ward off a future collapse using stimulus money.

As the situation in 2007 was arguably more dire than that of the 1929 crash, which plunged the West into the Great Depression, White’s words are troubling. “The U.S. seems due [for a recession]”, the Wall Street Journal (WSJ) claimed recently, as “its economic expansion is now the fourth-longest since World War II” though it probably doesn’t feel like that for many people, unless you’ve been fracking in North Dakota or growing pot in Colorado.

Such apocalyptic declarations seem strange. As the same WSJ article notes, the fundamentals of the U.S. economy still seem solid. Employment has continued to grow and housing permits, which “typically lead […] the economy into a downturn”, have also risen.

This then brings us to external developments that could be dragging even the relatively strong American economy towards another crash: China’s stock market foibles and the ever-dwindling price of oil. In light of the data, Olivier Blanchard, former chief economist at the IMF and grade A silver fox, called the stock market panic “puzzling”. Financial linkages between the United States and China are limited, and while investors might be losing money on oil and gas stocks, low energy prices should jump-start other parts of the economy. As economist Anatole Kaletsky pointed out in a recent article: “every global recession since 1970 has been preceded by a big increase in oil prices, while almost every decline greater than 30% has been followed by accelerating growth and higher equity prices.”

Moreover, whereas the subprime crisis involved complex and largely impenetrable financial products traded on shadowy bond markets, the products that seem to be driving the current frenzy concern relatively transparent market trends that have been gradually evolving over years. Few investors could claim that they didn’t see a bubble forming in the Chinese stock market or anticipate the challenge that shale gas had in store for OPEC.

What seems much more likely is that Wall Street panic creates a self-fulfilling prophecy culminating in real economic damage. As the WSJ put it, that “rather than economic weakness triggering financial panic, the panic itself produces a crisis or recession.” Blanchard arrived at the same conclusion, arguing that “herding is at play”:

“If other investors sell, it must be because they know something you do not know. Thus, you should sell, and you do, and so down go stock prices.”

The thinking seems remarkably similar to that of the old-fashioned bank runs, in which clients would see some people milling about in front of their lending establishment and assume that they were demanding their money back, because they know something you do not. Soon, an immense crowd would be clamouring at the gates, demanding that the tellers return their clients’ savings.

In other words, our top financiers seem to have the same impulses as a 1930s gin-soaked mob. And in the finance-driven world of today, speculation matters much more than economic realities. The panic behind stock market volatility may well be founded or completely unfounded, but its effect on the ‘real economy’ is just as potentially damaging either way, which suggests that the mob has too much sway.


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