Everything is bleak. It seems that forever the business news has been a sea of gloom. Companies announce layoffs by the tens of thousands. The stock market had its worst start to a year ever. People criticize the proposed stimulus plan as something that will take too long to work. Concerns rise that with interest rates already close to zero, monetary policy can't help. It's easy to see what industries --- autos, housing -- are struggling. It's much less clear what will lead us out of the mess.
But big problems lead to big solutions. It's the yin and yang of economics. In good times, problems accumulate and they are dealt with in bad times. The seeds of prosperity are planted in the bad times. In recent decades, the U.S. has been fortunate. The down parts of the business cycle, recesssions, have been short and mild compared to earlier periods. In the 1980s and 1990s we had record post-war expansions. In the 1990s growth and productivity accelerated to levels that many thought were no longer possible given the size and maturity of the U.S. economy.
The bad news will continue for a long time, likely several more years. Already, though, there are many encouraging signs. We won't know for some years when the economy hits its trough and the shape of a recovery are still a matter of conjecture. But many important things are clear.
The best news is that it's likely that the greatest systemic risk is well behind us. In mid-September, panic raged globally. In one week in mid-September at least one huge event happened every single day that I never thought I'd see in my lifetime. That week Lehman Brothers failed, AIG and money funds needed to be bailed out, Merrill Lynch, Goldman Sachs and Morgan Stanley needed to be rescued and put under the cover of commercial banks and the TARP program initiated and the stock market had its worst week every. That week was perilous to the system. Each misstep carried the risk that panic would so dominate the system that confidence would be crushed and recovery would be measured not in months or years but decades.
Subsequent weeks were not as bad but the cumulative effects of the financial crisis kept building. Matters hit a head over Columbus Day Weekend. By then various rescue plans had come and gone and global markets kept shrugging them off. Risk aversion and fear reached record levels. The danger was that these bad impacts become self-reinforcing and would not burn out of their own accord until they laid waist to large swaths of the world economy.
Over that weekend, Britain took the lead by directly injecting capital into its banks and the U.S. and others followed. That Monday, Columbus Day, the global markets responded favorably and the cycle of fear and panic was temporarily broken. The peak period of fear, while diminished, lasted another month but the greatest danger of widespread failure was past.
People are creatures of habit and fear can remain at extreme levels for only a short period (it's unusual for peak fear in the markets to last two months). Then they revert to their normal routines. People adjust and behaviors change but the strongest habits persist as long as the environment permits.
Outwardly, daily life for most people has changed little but in some ways economic life has had drastic changes. A generation will retire later. Many people will lose their homes, move, switch industries, require further education and have much diminished lifestyles.
But out of this widespread pain, many opportunities will arise. Just as a forest fire enriches the soil and opens sunlight for new plants, an economic downturn creates new opportunities. It forces people and businesses and the government to rethink old and outmoded ways of doing things and be open to new opportunities. In good times,it's hard to shed old habits. In bad times, people have to change. The U.S. had grown fat and happy, now it's time to switch to lean and mean.
It's easy to see where the difficulties lie. The financial system, judging by past bubbles, will not fully regain its vibrancy for many years if not a decade or more. But new industries will take its place. It's less obvious where the new leadership will be. Starting off the 1990s, no one predicted that high technology will play the leadership role that it did and the Internet did not begin to shine until midway through the decade. The New York Times had a cover story this week exploring where the new opportunities lie, http://www.nytimes.com/2009/02/01/magazine/01Economy-t.html?_r=1&ref=magazine.
A possible encouraging sign is that this downturn has been so fast and so sharp that the economy may have overshot to the downside. Car production is down by nearly half and home building has plummeted. The same happened in many industries but to a lesser extent. As a consequence, inventories may become too lean sometime in the first half of 2009. With hundreds of billions of dollars parked at near zero interest rates and the stimulus package underway, a reversal of the extreme risk aversion could get economic activity flowing rapidly again.
The rebounds from the past few recessions have been sluggish but this is the sharpest and longest decline in a long-time. The rebound, whether it begins this year or next year, could be equally abrupt. Even if its not, the financial markets have been beaten down so much that their response could be surprisingly swift.