Fear of a “Double Dip” Recession

Politicians and the media promise us the end of the financial crisis. The International Monetary Fund (IMF) warns us of the dangers. Experts fear a brief recovery followed by a new recession.

The joyous news came this weekend from the annual meeting of the IMF and its sister organization, the World Bank, in Istanbul: The global financial crisis will end one year from now at the very latest. According to IMF Managing Director Dominique Strauss-Kahn, our problems will be behind us “in 10 to 12 months,” provided unemployment does not increase.

This insight is about as valuable as saying “if the sun shines, we’ll have nice weather.” A recovery of private demand is obviously dependent upon employment, particularly in the United States. There, however, the practice of fueling the consumption machinery by feeding it borrowed money is what caused irreparable damage to the economy in the first place.

And that has ramifications. Private households in the United States have lost $13 trillion. Even millionaires have been forced to start saving. Since the beginning of the year, not only have more than 7 million jobs been lost, the number of those expected to lose their jobs by the end of 2010 has steadily grown. Reduced working hours and falling wages and salaries have also taken their toll on the public’s buying power.

And that is still not the end. One third of all U.S. mortgages are currently “under water,” meaning their outstanding balances are higher than the value of the dwellings themselves. Even if real estate prices rise, owners cannot count on their credit ratings improving as they did prior to the crisis. Back then, many home owners took on consumer debt, backed by what they assumed would be the ever-increasing value of their homes.

The situation is not quite as bad in Europe, but a quick revival in demand, particularly consumer demand, also is not expected on the “old continent.” Because public retail consumption plans hinge largely on public perception of the economic environment, economic editors eagerly pounced on the “good news” coming from Istanbul and immediately began painting a picture of the end of the crisis with scarcely any dissent. However, the IMF put out a report about chronic problems facing the international economic community that was anything but a good sign for the banking sector.

According to the IMF, the crisis caused more than $3.2 billion in losses in the international finance sector. Of those, only about half have thus far been written off; the remaining losses are still hiding on bank balance sheets. These are losses that are not immediately recognizable because the criteria for assessing dubious investments have changed. Toxic investments show up on financial firms’ books with their inflated nominal values attached, values that show considerable company profit that raises the company’s value in the marketplace. The problems, however, do not go away.

In hopes of postponing the day of reckoning (or perhaps even avoiding it altogether), financial institutions and the governments under which they operate embarked upon a program of having reserve banks print new money and they flooded the market with a lot of virtually no-interest credit. This not only delayed dealing with the problem, it created a new speculative bubble. This is already becoming apparent in several areas of the financial market, for example, on stock exchanges and various derivative markets (i.e., where the bets are made).

At the same time, each new day uncovers more losses. This is the case with the Munich-based Hypo Real Estate Bank (HRE). Thanks to our CDU-SPD coalition government, German taxpayers are now on the hook for its debts, and the bank is now reporting a pressing need for more taxpayer assistance, to the tune of 7 billion Euros (currently over $10 billion) in addition to the $4.5 billion that has already disappeared down the HRE drain. All together, losses amounting to $30 billion or more are expected.

In the United States, meanwhile, further bank failures are the order of the day. By the end of this year, estimates state that 750 banks, large and small, will have disappeared. In spite of massive amounts of money given to them by the government and the Fed – and more to follow in the future – the amount of capital in circulation has been rapidly sinking. Credit to the manufacturing sector also seems to have had little effect thus far.

All this has raised fears of a “double-dip” recession, a so-called W-shaped recession in which another collapse happens after a weak recovery. The Bank for International Settlements (BIZ), the international organization that oversees global banking activity, also warns of this danger. BIZ Director Jaime Caruana warned of “complacency” that the financial sector had finally recovered.

A “double-dip” recession is certainly not IMF chief Strauss-Kahn’s preferred scenario, but the possibility of it definitely exists. That is why governments must carry on with their current recovery plans, then modify and coordinate them gradually. Only America’s Federal Reserve Bank holds the opinion that the danger of a W-shaped recession is over. But why would anyone trust the Fed, whose chief, Ben Bernanke, recently declared that no one could have possibly predicted the global financial crisis?