End in sight?

What a difference a month can make! Economists, that till a month ago were forecasting gloom and doom, are now predicting that the recession is over. The stock markets have zoomed ahead and there is a sense everywhere that the worst is behind us. Is it really so?

For economies to grow, people have to spend. When customers spend more, factories produce more goods and services, and hire more people - thus generating more employment, which further increases spending. This leads to a virtuous cycle. The stunning growth experienced by India, for example, has been lead in large parts by the Indian middle class spending more. China is the chief exporter to the US, and the American customers spending beyond their means has been the key reason for China's growth.

When consumer spending goes down, it can lead to a recession like we are seeing now. During these times, the government increases its spending to compensate for the drop in consumer spending. Government can take up huge infrastructure projects like building dams and ports, constructing roads and rail, etc. The hope is that by doing so the consumer spending will pick up, and the government can then go back to its normal spending levels.

We have seen the increase in government spending thus far in 2008 - 09, with governments across the world coming up with billions of dollars of bailout packages. However, there is a chance that this may not result in the expected increase in consumer spending, especially in the US.

There were three key reasons for the huge US spending:
1. Home prices were going up making people ‘feel’ rich. Also people could get more loans against their higher home prices. Consequently they ended up spending more.
2. The stock market rally had led to a huge increase in ‘perceived wealth’ for investors, who went ahead and spent more.
3. The credit card companies, in their race to growth, gave away cards to all and sundry, leading to a huge spending.

Now with the recession, all these factors have been reversed. However, what compounds the problem is the fact that 'baby boomers' are retiring. They are suddenly finding out that their net-worth has been severely depleted. They will have to save a lot more, to make sure that they have a comfortable retirement.

This is a serious long term trend that seems to mirror something that happened in Japan 20 years ago. As a large portion of the Japanese population approached retirement, they started saving more, which exacerbated the recession and worsened it into the ‘lost decade’. As the baby boomers retire, it may prolong the recovery from recession for the world in general and US in particular. We may still have a recovery, but it will be a slow grinding process, rather than a quick one.