The Guest Blog

Busch: Curse of 2002

Remember back to the good old days when we were only worried about terrorist attacks on the United States? Let's jump in the "Wayback" machine and set the dial to 2002. I distinctly remember, we were worried over terrorists and the collapse of the NASDAQ. If growth from the technology boom was over, where would growth come from?

Well unfortunately, Alan Greenspan answered that question by deciding to ameliorate the recession by cutting interest rates aggressively to 1% and keeping them there for an entire year. Think back to what housing prices did in the middle of a recession at that time: they went higher. The game was on and the housing market exploded with a boom.

But the Fed went further. They decided that it would be a great idea to soften the blow from hiking interest rates by doing it very slowly with 17 rate hikes over 2 plus years.

This seems like a great idea, but it perpetuated and elongated the housing boom much longer than it needed. Remember, the really sour loans were made from 2005 to 2007. Also, companies did not make the difficult decisions to cut a large amount of jobs at the time because the recession was extremely mild. GDP only fell one quarter and unemployment rose from an extreme low of 3.8% to a high of 6.3%.

Today, we are asking the same questions. Where will new growth come from? Is it going to green technology? Is it going to be health care? Is it going to be education? All of these are trying to answer the better question: when will it stop? When will the recession/depression ease?

I think the Federal Reserve policy that aimed to ease the impact from the original recession and the monetary tightening did the nation a serious disservice that continues today. The expectations that we can smooth over the problems that took decades to create by fiscal and monetary policy are very high. It's like going to a weight loss center expecting to drop 30 pounds in two weeks that took ten year to put on. Extremely unrealistic.

The reality is that our problems extend globally and therefore the timeline is long. Yes, the efforts by the Federal Reserve, the US Treasury, and the Obama administration are going to be initially helpful. The stimulus money is beginning to hit and will have it's biggest impact over the next two months. However, these programs are not a medium term nor long term replacement for private sector growth. They actually carry massive risks for reducing growth as the programs have to be paid for and government revenues have to be raised.

The actions by the government may also slow down the normal restructuring process that companies go through to make themselves healthy and profitable. Autos are a great example. Since the crisis extracted credit from an industry in which 95% of sales contained credit, they are massively under water. Both the Bush and Obama administrations have provided loans to keep them going. It's only now that the lifelines have been pulled and they are making the difficult decisions like shutting plants and laying off workers.

With the massive drops in demand, globally industrial production has collapsed over the last 3 months. The United States has been the most aggressive in cutting jobs, but will need to see more. The rest of the world is just getting started. Today's housing sales, inventories, and prices show we still have a long way to go.

Due to avoiding it in 2002, the pain we're going to feel now will be more intense and last longer.


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Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and
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