Why the world really has gone “mental”

The following comment by me from Fund Strategy argues it is useful to describe this economic downturn as “mental”.

A senior American politician and economics expert got into trouble recently for saying America was in a “mental recession”. Phil Gramm, vice-chairman of UBS and a former senator, was forced to resign from his position as a top economic adviser to John McCain, the Republican presidential candidate. Barack Obama, McCain’s Democrat rival, had already pilloried Gramm saying – in a reference to a prominent TV talk show therapist – “America already has one Dr Phil”. Despite the hostile reaction, the idea of this being a “mental recession” is a useful one. Both in America and Britain this economic downturn is substantially different from the typical recession. This should be clear from an examination of the magnitude of the slowdown and its character.

In terms of the numbers, it would be easy to assume from the gloomy discussion that the economy is already contracting. But, at least so far, that is not the case. For example, the latest British GDP figures show the economy expanded by 0.2% in the second quarter. It is certainly possible that Britain could dip into recession – defined as two consecutive quarters of contracting GDP – next year, but it has not crossed the threshold so far. Nevertheless, the average independent forecast predicts GDP growth of about 1.5% in 2008 and 1.1% in 2009. It may not be as pleasant as more rapid growth, but it is hardly the Great Depression.

The global figures appear even more robust. According to the latest forecasts from the International Monetary Fund, global output should grow by 4.1% in 2008 and 3.9% in 2009. America is forecast to grow by only 1.3% this year and 0.8% next year, while emerging economies will grow far faster.

The figures do not tell the whole story. Not only is the slowdown far more muted than generally assumed, it is also different in character. Traditional recessions have focused on the production side of the economy. Industry has suffered a shakeout and workers have lost their jobs as companies are restructured. This time, the driver of the slowdown seems to be much more on the consumption side. A reining-back on credit and a squeeze on disposable income seem to be key factors.

A more balanced view of the slowdown should help deal with it in a calmer and more rational way. At present, politicians of all shades seem prone to panic.