Out of freefall

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Almost two months after Ben Bernanke, chairman of the US Federal Reserve, uttered the words “green shoots” of recovery in a television interview, debate continues to rage as to whether the world economy is starting to stabilise and will soon turn the corner.

Compared with the start of the year – when the global economy was falling off a cliff in a synchronised contraction of unprecedented rapidity – the situation has improved dramatically. While almost all of the world's leading economies are still shrinking, some at a still very rapid pace, forward-looking economic data point at least to a moderation in the rate of decline and potentially much more.

The outlook in many parts of Europe – including the UK and Germany – and in Japan has not brightened very much, but the outlook in the US and China, the two most plausible engines of global recovery, looks better.

Four developments in particular hold promise for the future: some easing in financial conditions globally; a pick-up in growth in China; an apparent bottoming out in US home sales and house construction; and a patchy increase in US consumer spending.

The question is whether the plateauing in global activity apparently in train is the final bottom in this economic cycle and whether the so-called “green shoots” represent the beginnings of a sustainable rebound.

Lawrence Summers, senior economic adviser to US President Barack Obama, remains cautious. He told Fox News on Sunday April 26: “That sense of unremitting free fall that we had a month or two ago is not present today.” But he added: “It's going to be a very long road. There are going to be steps forward and there are also going to be steps backwards.”

In most recessions, a slowing in the rate of decline naturally leads to a bottoming and then a recovery as investors, businesses and consumers stop worrying about economic Armageddon, satisfy themselves that past excesses have been worked out and start buying, hiring and spending again.

The New York-based Economic Cycle Research Institute says the US is “on the cusp of a growth rate cycle upturn” – a slowing in the rate of decline. It adds: “Over the last 75 years, growth rate cycle upturns during every recession were followed zero to four months later by the end of the recession itself. No exceptions.”

In fact, as the ECRI admits, there is one exception: the Great Depression in 1931. This may not be Great Depression Mark II but nor is it a normal recession, and the parallels with 1931 are close enough to worry that the usual transition from slowing decline to stabilisation and recovery might not hold this time either.

There will be a temporary filip to growth later this year from a classic inventory cycle. Manufacturing companies cut production so fast in the final quarter of 2008 that production is now running below sales. At some point, companies will be satisfied that they no longer have excess inventories and will raise production to match the current prevailing level of sales. This should deliver a quarter or two of growth. The question is what happens afterwards.

China returning to strong growth mode and avoiding a meltdown of its own is a necessary condition for a global upturn, but not a sufficient one. With Europe and Japan in rapid decline, it will probably take a homegrown US recovery to produce an early global turnabout. This is remarkable, considering the US was the epicentre of the crisis, and in all past cases such countries have exported their way back to growth.

It is possible to sketch out what might power a US recovery. The brutal contraction in the home construction industry is abating (even if home prices are still declining), taking away a big drag on growth. An end to economic freefall could unleash pent-up demand in sectors such as autos, where sales are running below the level required to maintain the current stock of vehicles. Moreover, there is tremendous fiscal and monetary stimulus in the pipeline.

US consumer spendingreturned to growth at an annualised rate of 2.2 per cent in the first quarter of this year, after falling at about 4 per cent annualised in each of the preceding two quarters. If this can be sustained, the prospects for global recovery look good.

However, Sheryl King, an economist at Merrill Lynch, fears “it is a one-quarter wonder”. Higher spending was underpinned by one-off increases in social security payments and decreases in personal taxes that boosted disposable income even as earned income fell as a result of huge job losses.

Looking ahead, even with further aid from stimulus tax breaks and transfers such as benefit payments, unless the US jobs market improves sharply it is hard to see where consumers will find the money to support significant increases in spending.

Moreover, the US savings rate – currently 4.2 per cent – could rise a lot further if households try to repair lost wealth. This is very hard to predict. To restore their net worth as of mid-2007, they would have to save or gain through capital appreciation $12,885bn (

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