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JEFFREY SIMPSON

Recession recovery: We've only just begun … Add to ...

Three years after the onset of the recession, the world economy remains deeply unsettled. This state of affairs should surprise no one.

Arguably, the most instructive book since the recession - This Time Is Different - has analyzed the history of financial meltdowns going back to the 14th century. What U.S. economists Carmen Reinhart and Kenneth Rogoff discovered explains much of what the world faces today.

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In a nutshell, they found that financial meltdowns are the worst kind of recession. They produce immense levels of debt, raise unemployment and shrink output. Recovering from them is very hard, and takes a long time.

"These crises have a deep and lasting effect on asset prices, output and employment," Profs. Reinhart and Rogoff wrote. Unemployment and housing price declines go on for five or six years; government debt explodes. Getting that debt under control is difficult, to say the least. In half of the financial meltdowns since the Second World War, recoveries were aborted by double-dip recessions. Is that where we're headed? The experts say no, but …

Government and economic experts can study all the data available. But, the authors warned, "economic theory tells us that it is precisely the fickle nature of confidence, including its dependence on the public's expectation of future events, that makes it so difficult to predict the timing of debt crises."

The timing of trouble, then, is hard to predict. The failure to get the latest recession's timing right augments the nervousness about where the economy is heading. If so many "experts" got so many things wrong before, why should we believe them now?

Last year, economists were predicting a steady recovery in 2011. But the first half's growth in North America and Europe has been lower than predicted.

Interest rates will be going up. But when and by how much, and what's the impact on the debts built up by governments and individuals? At some point, said the Bank for International Settlements in Basel last week, growth is going to slow further and interest rates are going to rise.

This combination would seem like a recipe for higher unemployment. But how can politicians in high-unemployment countries such as the United States, France or Britain accept even higher levels of joblessness without suffering politically?

Central banks have used record-low interest rates to stimulate economic activity. These rates have certainly helped, but they've also encouraged people to borrow more. What happens to that borrowing repayment when rates rise? What happens to government debts? Germany and France are headed to debt-to-GDP ratios of 80 per cent to 90 per cent, the U.S. to somewhere near 100 per cent. The U.S. debt-to-GDP ratio will soon be at its highest since 1945.

Canada's situation is better, to be sure. Along with Australia and Germany, Canada is less burdened by deficits than the other major industrial countries. But if we put Canada's federal deficit together with the provincial ones, and then add the debt they've accumulated during the recession with consumer debt, it's no wonder the Bank of Canada is worried about the national debt situation.

With the U.S. economy slowing - the housing market remains bad, among other signs of weakness - and the country's political system incapable of grappling with its deficit/debt mega-challenge, Canada's biggest trading partner is going to be an ocean of uncertainty for years to come. And Canada simply can't grow appreciably faster than its largest customer.

Canadian governments won't be adding stimulus to the economy, as they did during and immediately after the recession. Most of them will be cutting back for the next few years as they try to restore their battered finances.

That's what the Reinhart/Rogoff analysis suggests: that returning debt to pre-crisis levels takes three to seven years. In other words, Canadians have barely begun. And once begun, the cleanup takes a very long time, is subject to international uncertainties, and can be expected to be opposed by all sorts of domestic groups and political parties.

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