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Popular Economics Weekly

Why do we say that this could be a ‘V’ shaped recovery, instead of ‘U’, ‘L’, or ‘W’ shaped? Last week’s column included a graph that portrayed the history of recoveries from 1980, the last ‘W’ shaped recover. The W was because it was really 2 recessions—in 1981 and 1983, as the economy recovered from double-digit inflation and job losses.

In contrast, a ‘V’ shaped recovery means that because output, jobs and housing prices “fell off a cliff” last fall, to use Warren Buffet’s term—the down leg of the V—panicked investors and consumers over reacted. Some pundits predicted another Great Depression, after all. The stock market is one example of a more ‘V’ shaped recovery. The stock market became oversold and so investors jumped back in when the credit markets recovered, which caused the very sharp rise in the various stock indexes from March—the up leg of the ‘V’.

The labor markets are another example. The loss of more than 6.5 million jobs in just one year is unprecedented, the result of panicked business owners who didn’t know what the future would bring. They therefore dropped workers while selling off their inventories, which means their shelves are now relatively bare.

But second quarter GDP figures show that demand is picking up. In particular, real estate, manufacturing and service sector activity is increasing, so businesses will have to over correct in the other direction to replace their inventories—the up leg of a V-shaped recovery again.

The Federal Reserve Open Market Committee met again, and decided to keep their low rates for an “extended period”, as before. But they are also anticipating a recovery. Their release said:

“Businesses are still cutting back on fixed investment and staffing but are making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.”

The Fed also said they might have spent all of the $300 billion set aside to buyTreasury securities by October, and then no more. What will it do to interest rates is the question? They have already bought more the $250 billion. Here is their statement on the matter.

“To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets.”

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There is no question that the massive amounts of Federal Reserve stimulus—mainly in aid to banks, but also to the credit markets—have kept rates at historic lows for this extended period. The Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency (Fannie Mae and Freddie Mac) debt by the end of the year, as well.

But there is no way real estate values will even begin to recover until 2010 and beyond. So the Fed will have to continue their stimulus efforts in keeping rates down into 2010, at least. Since only when real estate recovers will the rest of the economy (and consumers) follow.

Harlan Green © 2009