Great Recovery an 'Illusion': Economist

The great recovery is an illusion, and the banking crisis is likely to be very costly for the world economy, according to economist Jamie Dannhauser at Lombard Street Research.


“Investors don’t yet appreciate just how costly (the banking crisis) will be,” Dannhauser said Tuesday.

“Recapitalizations and bailouts have only shifted the problems from the private to the public sector." The banking crisis will also have significant effects on developed-world demand, creating structural government deficits, he said.

Consumers will also struggle to recover as credit remains tight, Dannhaueser said.

“The banking crisis -- which was caused by, one, too much leverage in the banking system, two, underpricing liquidity risk, three, banks too dependent on cheap funding -- will have significant effects on the developed world demand, creating structural government deficits,” he said.

The “saver” countries are set to be dragged down by “spender” country weakness, according to Dannhauser.

The Lombard Street report echoes other ecnomic assessments that activity in the advanced economies will stay muted in the short term.

An International Monetary Fund report published in April said, “global activity is recovering at varying speeds, tepidly in many of the advanced economies but solidly in most emerging and developing economies.”

The European Debt Crisis - See Complete Coverage
The European Debt Crisis - See Complete Coverage

"There are few indications that private spending in these three economies (The US, EU and Japan) will lead a strong recovery, given that credit will remain hard to come by for many agents, investment will be held back by low capacity utilization, and unemployment will weigh on consumption,” the report said.

The recession was exacerbated by panic after Lehman Bros. collapse, according to Dannhauser, and the emergency government support which ended the panic, led to a huge inventory bounce propelled growth.

But public deficits will have to be scaled back, which is likely to dampen growth by cutting into incomes and reducing consumer demand, he said.

The IMF estimates that the total cost of the banking crisis for the UK, when considering public commitments to recapitalization, creditor guarantees, and asset protection and liquidity schemes, is somewhere in the region of £1.3 trillion ($19.5 billion), not far off the the UK’s annual GDP.

Dannhauser also said he sees growth prospects for the European Union remaining rather dismal.

“If the Club Med economies (Greece, Italy, Portugal, Spain) can no longer borrow, who will buy German exports? The great recovery will prove to be an illusion.”