Leading article: We have avoided disaster, but much pain lies in store

When economic recovery arrives it could easily be weak and fragile

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A consensus is forming among investors and policymakers that the worst of this global downturn is behind us. Hopeful signs of recovery have been spotted in several places. Stock markets have been rising for a few weeks. Some of the world's largest banks have been reporting profits, with Barclays the latest to do so. The Obama administration's "stress test" of America's major banks yesterday ruled that none is at risk of insolvency (although some will have to raise more capital).

It is true that housing markets remain depressed and unemployment continues to rise, but these are considered "lagging indicators" of a nation's economic performance. The first signs of recovery were always going to come from elsewhere.

In one sense, the consensus seems correct. We are now most unlikely to witness a repeat of the Great Depression, when whole economies were pushed to the brink of collapse and global trade broke down.

And it is clear why. Policymakers have thrown so much at the banking and economic crisis in the past year, from slashing interest rates to emergency deficit spending, that it was bound to exert some impact.

Yet while these unprecedented measures have averted total disaster, we should not be lulled into a false sense of security about what lies ahead. Much of the recent confidence among investors has been inspired by signs of profitability returning to the banking sector. But there remain difficult questions over whether lenders have fully faced up to the bad loans on their books.

If the recent predictions from the International Monetary Fund of likely credit losses by the world's banks are even half accurate, there are colossal write downs still to come. These losses could easily precipitate another sudden evaporation of investor confidence.

The weakness in the balance sheets of the large banks is matched by the weakness in the finances of many private individuals, particularly in America and Britain. A great many borrowed recklessly in the boom. And the priority of many households in the coming years will be to use income to pay off debt, not to spend. Consumer confidence in indebted countries is likely to remain depressed, impeding any recovery.

This is why some believe that the stock market rally of recent weeks will prove to be a "dead cat bounce", meaning prices will fall back again just as sharply as they rose.

There is another dangerous scenario that policymakers need to be mindful of. Many of the figures from the non-financial world economy suggest the rate of deterioration has slowed, not that output is growing. We could be in for a prolonged period of low to non-existent growth of the sort that Japan experienced through the 1990s after the spectacular bursting of its own property and banking bubble.

Sluggish growth is preferable to what we have been experiencing in recent months, but it is hardly something to look forward to. Furthermore, the debts that governments around the world have accumulated in the course of fighting this recession will, in time, impose a cost in the form of public spending cuts and tax increases. Even in the event of relatively robust recovery, we could end up feeling poorer.

We would seem to have successfully avoided a return to the misery of the 1930s. And for that we can breathe a sigh of relief. At the same time we should be under no illusions about the austere new world into which we have emerged.

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