An L of a recession – reform is the way out

By Wolfgang Münchau

"So it looks like it is going to be an L – not a V or a U. I mean an L-shaped recession, one that starts with a steep decline, followed by very low growth for many years.
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In a V-type recession, the recovery is instant. In a U-type, it comes eventually. My guess is that we are currently somewhere in the middle of the vertical bit of the L, but it is the horizontal bit that is the scariest. History never repeats itself exactly, but we know from economic history that financial crises are surprisingly similar.
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This looks like Japan all over. Without financial restructuring, the economy is not going to recover. And Japan was lucky. It was surrounded by a booming global economy."
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"An L-shaped recession will make the adjustment of balance sheets even more painful. Unemployment will continue to rise. House prices will keep on falling. US consumers and banks will spend the next five or more years deleveraging, getting their respective balance sheets back in order. In that period, the US current-account deficit will fall sharply, as will that of the UK, Spain and several central and eastern European countries. This process can take a long time, and in an L-shaped recession it takes longer.
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But the effect is also brutal on the rest of the world. The fall in current-account deficits will be partially compensated for by lower surpluses from oil and gas exporters, such as Middle Eastern countries and Russia. But the bulk of the adjustment would be borne by the world’s largest exporters: Germany, China and Japan. Globally, current-account deficits and surpluses add up to zero – minus some statistical reporting errors. You can do the maths. If the US stops buying German cars, Germany will eventually stop making them."
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"We are nowhere near a solution to the crisis. After committing errors of omission, global leaders are now producing errors of commission. The Americans dream about a return to a world of credit finance consumption while the Germans dream about assembly lines. In an L-shaped world, these are nightmares."