Buiter's Green Shoots In The Ruins Of Global Economy

Willem Buiter runs a good analysis of current state of global economy and possible outlook at his Maverecon blog at FT.com. Here I post some excerpts (conclusions) for a lazy web-navigator, but it is definitely worth reading the full missive:

There are signs that the rate of contraction of real global economic activity may be slowing down. Straws in the wind in China, the UK and the US hint that things may be getting worse at a slower rate. An inflection point for real activity (the second derivative turns positive) is not the same as a turning point (the first derivative turns positive), however. And even if decline were to end, there is no guarantee that whatever growth we get will be enough to keep up with the growth of potential. We could have a growing economy with rising unemployment and growing excess capacity for quite a while.
The reason to fear a U-shaped recovery with a long, flat segment is that the financial system was effectively destroyed even before the Great Contraction started. By the time the negative feedback loops from declining activity to the balance sheet strenght of what’s left of the financial sector will have made themselves felt in full, financial intermediation is likely to be severely impaired.
All contractions and recoveries are primarily investment-driven. High-frequency inventory decumulation causes activity to collapse rapidly. Since inventories cannot become negative, there is a strong self-correcting mechanism in an inventory disinvestment cycle. We may be getting to the stage in the UK and the US (possibly also in Japan) that inventories stop falling an begin to build up again.
An end to inventory decumulation is a necessary but not a sufficient condition for sustained economic recovery. That requires fixed investment to pick up. This includes household fixed investment - residential construction, spending on home improvement and purchases of new automobiles and other consumer durables. It also includes public sector capital formation. Given the likely duration of the contraction and the subsequent period of excess capacity, even public sector infrastructure spending subject to long implementation lags is likely to come in handy. A healthy, sustained recovery also requires business fixed investment to pick up.
At the moment, I can see not a single country where business fixed investment is likely to rise anytime soon. When the inventory investment accelerator goes into reverse and starts contributing to demand growth, and when the fiscal stimuli kick in, businesses wanting to invest will need access to external financing, since retained profits are, after a couple of years of declining output, likely to be few and far between. But with the banking system on its uppers and many key financial markets still disfunctional and out of commission, external financing will be scarce and costly. This is why sorting out the banks, or rather sorting out the substantive economic activities of new bank lending and funding, that is, sorting out banking , must be a top priority and a top claimant on scarce public resources.
Until the authorities are ready to draw a clear line between the existing banks in western Europe and the USA, - many or even most of which are surplus to requirements and have become parasitic entities feeding off the tax payer - and the substantive economic activity of bank lending to non-financial enterprises and households, there will not be a robust, sustained recovery.

And here are some thoughts by Simon Johnson at The Baseline Scenario, as he discussed and debated the likely shape of the US and global economic recovery:

I argued that the nature of our economy has changed profoundly over the past 30 years, and we are only now beginning to understand the consequences. There has been some pushback against the main argument of our Atlantic piece, which is that a (very modern) financial oligarchy has taken disproportionate economic and political power in the US (aside: “we’re just stupid” is not much of a defense; the people involved are very smart, so how exactly did they get to create stupid organizations with the power to blow up the entire economy?) But no one is seriously disputing (1) the financial sector has become very large, (2) it was able to take on risks that were massive relative to the system, (3) these risks were not well managed, to say the least. We have experienced the financial equivalent of Three Mile Island; you will never look at finance again in the same way.
What does this imply for shorter-run macroeconomic dynamics? Do conventional US-based macro models still apply in the same way? Can finance drive growth in the same way as it has over the past 20+ years? How easy is it to switch people and capital into new sectors, for example so growth can be more driven by non-financial technology development? To the extent that banking survives the waves of contagion that are apparently still with us (look at the CDS spreads for major US banks over the past few weeks; during the rally!), won’t bankers hunker down for a while and refuse to take risk - until the next bubble, of course?
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The main short-term issue for the shape of our recovery is surely that balance sheets are perceived as damaged all around the world. Plenty of creditworthy consumers think they need to be more careful. Firms with sensible investment projects are worried about the future availability of credit. Governments have only a limited ability to engage in fiscal stimulus; almost no one ran a sufficiently counter-cyclical surplus during the boom. And policy responses in most of the G20 remain inadequate
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Emerging markets do, it is true, often recover quickly from steep declines. But they usually achieve this through managing a large real exchange rate depreciation (i.e., the nominal exchange rate falls by more than prices increase), which produces an export boom. At the level of world economy, we cannot export our way out of this recession.

So, watch out! These bank CDSs are crazy ...