Assessing the damage...

Cees Bruggemans, chief economist of FNB, gave his assessment of the costs of the financial crisis in one of his weekly commentaries published on the 24th November 2009. Here follows excerpts from the article:

The original focus was very much on financial asset losses, with estimates in the trillions of dollars, and equity markets tanking with losses in the tens of trillions.

But though the financial asset losses were painful and real (ultimately some $2.5 trillion worth, of which three-quarters by now written off, yet questions remaining whether global toxic assets really have been fully dealt with), the equity paper losses have already been mostly erased as markets bounced sharply in 2009.

The global output forever lost in 2008-2009 probably amounted to $3 trillion, with at least twice that opportunity loss still to be counted through 2015-2020.

The agonising pain deluged on bank shareholders and managements, hedge funds and insurers, especially in large parts of the West, has been on vivid display throughout. But this was ultimately only a small sliver of humanity facing the piper.

Much larger numbers of people ultimately paid a major price because of the financial failure of preceding years and the manner in which the financial crisis hit the global economy broadside.

The number of US housing foreclosures runs in the many millions. A much larger multiple lost their work and livelihood. So far, some 8 million private sector jobs have been lost in the US alone, a number that will still climb by another 1 million through Easter 2010. To this must be added another 1 to 2 million discouraged workers ceasing to look for work and falling from view. And we must then still incorporate the substantial shortening in US working time, going by temporary workers and reduced working hours. And then we must still allow for the 1-2 million youngsters newly added to the labour pool during 2008-2009 for whom there was little scope overall.

This amounts to a lot of pain in a 150 million workforce, where nominal wage increases are currently minimal and bonuses mostly reduced, heavily constraining household income. Together with tightened bank credit and terms, and consumer unwillingness to take up new debt, it paints a picture of a weakened colossus.

In the years ahead, policy action in the US and elsewhere is geared to get financial markets functioning normally again, extending credit to creditworthy customers, but also to support effective demand, thereby gradually restoring business confidence in the future and a willingness to take risk and resume investing (and hiring) more boldly again.

Yet it will be slow going. Not only are employers fiercely intend on improving productivity (and repairing their bottom lines), thereby allowing GDP and national income to expand, but they prefer doing so without rehiring of new labour, at least in the short term.

Then, in the case of the US, once employers finally start hiring again, the first 100 000 of new jobs created monthly will merely absorb newcomers to the labour force (population growth and migratory changes). Only thereafter will the economy start to rehire from the unemployment pool and possibly create new opportunities for currently discouraged individuals.

Absorbing the new additions to the labour pool, and reducing unemployment to acceptable levels could well take up to a decade, considering the relative slow cyclical take-off currently underway, the high emphasis on improving productivity, the lingering uncertainty in so many walks of life, and the consequent inhibition to start hiring normally again quite soon.

Instead, the hardship for many will be spread out over many years.

The senior leadership in the various major central banks (Fed, ECB, BOE) and in national governments (US, UK, Germany, France and others) seem highly aware of these realities and their possible political implications. Under these circumstances we don't encounter any early eagerness to withdraw support for their respective economies, rather the contrary as evidence multiplies of staying the course for longer, though trying to placate bond market vigilantes every step of the way.

Yet state finances are deteriorating, calling for early remedial action. Even so, governments seem intend on discovering how far they can go with their support actions to ensure that economic recovery truly vests. And though central banks are now actively signaling a gradual reduction in quantitative easing (bond buying) next year, they will do so warily, throughout cautiously examining whether the perceived normalization of financial markets proves genuine and can continue.

Meanwhile, with resource slack as large as it is, core inflation at 1% and likely still moving closer to zero next year, and inflation expectations subdued, the major central banks have every reason to keep their interest rates near zero for longer, probably throughout 2010, as ever so gently signaled by Fed, ECB and BOE.