Page 40 - Accelerating out of the Great Recession

THE DAMAGED ECONOMY

clients. The profitability of banks will be under pressure for
years to come—not least because of greater regulation and a
new corporate culture that frowns on risk taking. Unlike bank-
ruptcy—which is resolvable through recapitalization—bad core
economics are much harder to address. Given all these factors,
we cannot avoid the conclusion that it may take years for the
banks to become truly healthy again, especially if the real econ-
omy fails to achieve a sustained recovery.
Unhappily, this situation—in which governments and banks
refuse to acknowledge the extent of their potential losses and
so have failed to recapitalize aggressively—is similar in some
ways to the situation in Japan in the early 1990s. The risk is
that credit flow to consumers and corporations will continue to
be seriously constrained. Indeed, the outstanding credit volume
in the United States shrank in mid-2009 compared with the
year before. At the same time, credit growth in Europe slowed
significantly. While this is in part the result of less demand for
credit, the IMF has shown that credit supply shrank by a
greater degree than demand in 2009, a trend it forecasts will
continue through 2010. This trend is particularly strong in
Europe, and the IMF expects lending capacity to shrink by 3.9
percent in the United Kingdom and to grow by barely 1 per-
cent in the rest of Europe.
Shrinking credit is bad news for the growth of these economies
given that conventional wisdom says that it takes between $3 and
$6 of credit for every $1 of GDP growth. In fact, the level of new
credit needed to generate economic growth increases every
decade: in the 1950s, a little over $1 of credit was sufficient to gen-
erate $1 in additional GDP; the comparable number in the 1990s
was $3; and in the last 10 years, it has averaged $5.

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