Will the U.S. Enjoy a Swedish-Style Rebound? Don't Bet on It

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bank lendingIn a New York Times article on Nov. 6 by Gretchen Morgenson, "He Saw Trouble Coming. Now He Sees It Going," a private-sector economist with a track record better than most suggests that the U.S. economy is on the verge of a sustainable recovery.

According to Ian Shepherdson, chief U.S. economist at High Frequency Economics, the total stock of commercial and industrial credit has stopped falling, signaling that lending to businesses, especially small firms that play a key role in driving economic growth, could soon be on the upswing.

He should have stopped there. In what I view as an egregious example of selective memory and/or wishful thinking, Shepherdson attempts to bolster his argument by drawing parallels between what the U.S. has been going through and the experience of another country that faced a similarly devastating financial crisis in the early 1990s. Writes Morgenson:
The expansion of bank credit before the peak was similar in both countries. Furthermore, Sweden's boom, like ours, resulted in rocketing real estate prices and overleveraged consumers.

When the bubble burst, both countries experienced similarly awful contractions. Gross domestic product declined 5.1 percent in Sweden at the trough, compared with 4.1 percent in the United States.

Mr. Shepherdson hopes that the Swedish experience on the upside also repeats itself in the United States. After Sweden's output bottomed out in early 1993, the country began an upswing that soon became supercharged. The initial growth was at an annualized rate of 2.5 percent, but by the second year of the rebound, G.D.P. growth was 5.3 percent, annualized.

We may not end up with a recovery that hot, Mr. Shepherdson said. But if the credit expansion he is expecting does transpire, he said, we could achieve annualized growth of between 3 percent and 4 percent in the second half of 2011. And the year after that looks even more promising, he said, because "credit conditions will be back to something like normal."



Unfortunately, Shepherdson's comparison is seriously lacking. Unlike in the U.S., the Swedish authorities flushed their financial system clean after the crisis. They restructured the banks. They wiped out shareholders. And they got rid of management at the institutions that had contributed to the mess. They forced lenders to disclose loan losses and to assign realistic values to real estate and other assets. They shut down the basket cases and allowed only those with real potential to survive.

Riddled With Cancer

U.S. authorities did none of that. They rewarded failure. They threw taxpayer money at troubled institutions without extracting any real concessions. They allowed banks to pretend they were solvent and carry on with business as usual, which, in contrast to the "Swedish solution," was not in the best interests of the economy as a whole. Few managers suffered the consequences of their bad behavior, illegal or otherwise.

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Consequently, America's financial system is now riddled with a cancer -- as in Japan, which is still suffering from the fallout of similarly shortsighted decisions taken over the course of two decades -- that will inhibit economic recovery in the U.S. for years to come.

As with so many other mainstream analysts nowadays, Shepherdson 's views on where the U.S. is in the economic cycle are colored by a myopic sense of history and a (completely understandable) desire to see the situation improve. However, history -- the long version -- suggests that it's better to see things as they are and respond accordingly.

With that in mind, persistently high unemployment, untenable domestic and global financial imbalances, and a banking system that's dependent on cheap money and other forms of public assistance are among the many realities that suggest now is not the time to be making big bets on better times ahead.
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