According to the financial times, we may only be half way through a two-step correction.
Deleveraging can be understood through a metaphor in which a car symbolises the economy. Borrowing is like stepping on the gas and accelerates economic activity. When borrowing stops, the foot comes off the pedal and the car slows down. However, the car’s trunk is now weighed down by accumulated debt so economic activity slows below its initial level.
With deleveraging, households increase saving and re-pay debt. This is the second step and it is like stepping on the brake, which causes the economy to slow further, in a motion akin to a double dip. Rapid deleveraging, as is happening now, is the equivalent of hitting the brakes hard. The only positive is it reduces debt, which is like removing weight from the trunk. That helps stabilise activity at a new lower level, but it does not speed up the car, as economists claim.
Bloomberg article quotes Mohamed El-Erian, co-head of PIMCO:
El-Erian said. In 2010, inventory rebuilding will end as consumer spending flags, leaving government programs as the major growth engine.
The “new normal” includes a higher level of government intervention in the economy, El-Erian said. “The potential growth rate of the U.S. is going to come down.”
Even if a second Dip was only a remote possibility, doesn't it make sense to keep at least some powder dry.. I'm just saying.
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