By Andrew Gawith
The global financial crisis is proving worryingly difficult to shrug off.
That partly reflects the nature of the crisis and partly political dysfunction that continues to dog effective responses.
The crisis was triggered by a monumental build-up of debt, helped along by a fair bit of financial chicanery and the bursting of the housing bubble.
In November 2008, a few months into the crisis, a group of IMF economists (Claessons, Kose and Terrones) concluded from an analysis of previous financial crises that they tend to be long-lasting - much longer than the accompanying recessions which also tend to be relatively long and deep.
Moreover, house price collapses lead to more costly recessions and financial crises are often global or synchronised.
In a paper published in January 2009, Reinhart and Rogoff were more explicit about the likely impacts of the financial crisis and asset price implosion.
Analysis of previous financial crises showed that real house prices fall 35 per cent from peak to trough and that downswing lasts six years, and equity prices collapse on average by 55 per cent over about 3 years.
Further, they argued: "Banking crises are associated with profound declines in output and employment. The unemployment rate rises an average 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls an average of over 9 per cent."
Interestingly, they also noted that the "real value of government debt tends to explode, rising an average of 86 per cent ... The main cause of debt explosions is usually not the widely cited costs of bailing out and recapitalising the banking system. The collapse in tax revenues in the wake of deep and prolonged economic contractions is a critical factor in explaining the large budget deficits and increases in debt that follow the crisis."
The clear conclusion from these two pieces of research is that we shouldn't be particularly surprised that we are struggling to shake off the global financial crisis. It's a doozy, almost certainly the most severe and widespread economic crisis since the 1930s depression.
Let's look at US data to see how prescient Reinhart and Rogoff's analysis has turned out to be, roughly four years after it started:
* Real house prices in the US have fallen 31.1 per cent in nominal terms from their most recent peak in the first quarter of 2007.
Consumer price inflation over that period has totalled nearly 10 per cent implying a 40 per cent-plus fall in real house prices so far in this cycle - somewhat higher than the above analysis suggests, and the current cycle may still have a year to run.
* Equity prices, as measured by the S&P 500 index, fell 58 per cent between October 2007 and March 2009. Since then the S&P 500 has risen significantly (81.5 per cent), but as maths students will know that percentage rise still leaves the index around 30 per cent short of the level it was in October 2007.
* The unemployment rate in the US bottomed out around the first quarter of 2007 at 4.5 per cent and peaked at 10.1 per cent in October 2009. It has subsequently edged back to 9.1 per cent as at August 2011. So not quite the 7 percentage points blowout, but dramatic nonetheless.
* Output, as measured by industrial production, fell by 15.8 per cent over the 15 months to March 2009. A broader measure of output, GDP, fell a little more than 5 per cent over the six quarters to June 2009. Industrial production in the US is still 6.6 per cent below its late 2007 peak.
* US government debt has risen significantly since 2007, but not by 86 per cent ... yet.
So in a number of respects this crisis has already exceeded in severity (at least in the US) what we might have expected based on the outcomes of previous financial crises. The emphasis on "already" reflects the fact that this crisis is not over yet.
We are in the early stages of unwinding a three-decade rise in debt that spurred trade, asset prices and economic growth. It would be naive to think it can be unwound over five years without massive economic pain. Most governments are still racking up more debt as they try to keep their economies from sliding back into recession.
But there's another factor weighing on this crisis - political cramp. As Christine Lagarde, the new head of the IMF, observed recently: "This vicious cycle is gaining momentum and, frankly, it has been exacerbated by policy indecision and political dysfunction."
The debt crisis shifted to sovereigns - most acutely Greece - well over a year ago, but much like the emperor's total wardrobe malfunction, Greece's obvious insolvency has been staunchly denied by Europe's political leaders.
To be fair, it is now more to do with achieving an orderly default than any thought that Greece could actually avoid one.
Europe is a cumbersome political beast at the best of times, but this crisis has highlighted the alarming cost to its citizens and investors of its drawn out decision-making processes.
A fundamental political question for Europe is retaining unanimity when the burden of any solution is going to be so unevenly shared - Germany is still digesting the stresses of its own unification, and is now staring at the huge costs of achieving genuine monetary and fiscal union.
US politics look only marginally less scary. The poisonous atmosphere that dogs resolution of their sizeable fiscal deficits is likely to persist until after the presidential election late next year.
The nascent protests against banks and hyper-salaried executives could easily trigger wider unrest.
This grinding crisis is testing the patience of voters and investors - they will eventually exact revenge on dithering and shortsighted politicians.
Andrew Gawith is a director at Gareth Morgan Investments
This article was first published in the NZ Herald.