The Coming Recession

The downturn in the global economy is now 11 months old, if one takes the subprime crisis of August 2007 as the starting point. It has spread like the forest fires in California, establishing itself in one area after another, putting out tongues of fire that extend the area of the fires, always a step ahead of the firefighters.

The housing and mortgage crisis is far from having burnt itself out. The oil price crisis also started in August 2007, when the oil price was only $70 per barrel, half what it now is. The price of other commodities, particularly foodstuffs, has moved with the price of oil. Equity markets behaved as though they were immune from the recession. That pretense lasted until last October.

Since that time, the U.S. stock market has fallen by 20%. Only the art market seems to be exempt, with billionaires buying conceptual art at speculative prices. This may reflect the sheer weight of billionaire money, or it may follow the precedent of the art market being the lagging indicator among all asset classes.

Everyone would like to know how long — and, implicitly, how deep — the 2007 recession is going to be. There are always commentators who think that the end of recession is about six months away. In 2007, there were those who expected a recovery in the second half of 2008; that expectation has now shifted back into 2009, with the recovery starting in the second half of next year and persisting through 2010. Hardly anybody now expects even the first signs of a recovery to appear before the November presidential election in the United States, the fist big political date. If the American voters follow precedent, they will elect a Democrat as president; since the classic case of Herbert Hoover in 1932, economic depression has usually led to the incumbent party being turned out.

In the 1930s, the slump led to almost every democracy turning out the party in power, starting in Britain with the massive defeat of the Labor Party in 1931 and following with the election of Franklin Roosevelt in 1932 and the change of the German regime, with the election of Adolf Hitler in 1933. It looks now as though the present recession will lead to the defeat of the Republicans in 2008 and the defeat of the Labor Party in Britain in 2010. Other European governments must regard themselves as at risk.

Recessions can be short, medium or long, and they can be mild, medium or severe. It is already clear that this is not going to be a short and mild recession, but we cannot yet be sure — for lack of evidence — whether it will be medium or long and severe. Of course, it will not take the same form in different countries. As in the California fire, some districts will largely be spared, but others will suffer square miles of conflagration.

The original basis of the recession was financial, linked to housing and banking. The banks are still in trouble, with Bradford & Bingley in trouble in Britain. I have worked with Rod Kent, the chairman of Bradford & Bingley. He is not the chief executive whose business plan has collapsed, but is one of the best bankers I have ever come across. If this can happen to him, it can happen to anybody. The trouble is that the business plan of global banking as a whole was unsound, in Switzerland or New York as much as in London.

In Britain, we have had a forecast that the housing crisis has further to fall in asset value, and it may last for 20 years. The first forecast is almost certainly correct, the second almost certainly false. Britain has a genuine shortage of housing, caused by the breakup of marriages, which led to the formation of new households, and the strict planning laws, which act as a cartel. In five years, it is possible that this unsatisfied demand will have resurfaced, but the market still has some way to fall before it reaches affordable values.

I am writing at a point at which the world’s stock markets are in a rather belated adjustment. At such a moment, it is difficult not to be drawn into the feeling of incipient panic. I would think that an early stock market recovery, or an early fall in the oil price, is very unlikely, and I do not expect anything better than a bear market rally before 2010. The global economy is in a bear market that is still only one year old. It is little comfort to be able to say that many of us saw it coming.

Lord William Rees-Mogg
July 9, 2008