KEY POINTS:
In a global climate of financial ruin, and New Zealand not immune, economics editor Brian Fallow reports that once consumers are confident the bottom has been reached, things can only look upwards.
At times like these New Zealand is thistledown in a gale.
The economy has been contracting for a year now, but last year's recession was a relatively mild, made in New Zealand affair.
That has now been swallowed up by a big, ugly global recession.
How we fare from here on will be largely determined by events abroad, by how the major economies deal with what is almost certainly the worst economic slump of the postwar era.
Lately, economists' forecasts are out of date as soon as the ink is dry. "Everyone has been surprised by the severity of the downturn," says AMP Capital Investors chief investment officer Jason Wong.
The reality is, no one knows how deep or long this global recession will be.
We have not seen the modern, globalised, highly inter-dependent economy subjected to this much stress before so there is a lot a uncertainty about how it will behave.
"There's a bit of an argument," says Reserve Bank governor Alan Bollard last Friday, "between those who think it could trough in the middle of this year and be followed by a fragile recovery, and those who say no, it is a much longer event."
A key source of uncertainty is how people will react to the haemorrhagic loss of wealth that has occurred - at least $50 trillion on world sharemarkets alone, not to mention housing and other asset markets.
The babyboomer generation may be best placed to go forth and spend but will they, when it is to a large extent their wealth that has just evaporated? They might expect markets to recover but the years it could take that to happen represent a big chunk of their remaining working lives, so precautionary saving may appeal more.
And how will generation Y, which has only ever known easy credit and plentiful jobs, cope with a shock of this magnitude?
While forecasters scratch their heads over such questions, the statisticians are providing an unrelieved stream of bad news.
Among the 30 rich countries of the OECD economic output shrank 1.1 per cent over 2008, mainly in the last three months of the year when growth was minus 1.5 per cent. Annual growth of around 3 per cent is normal.
The International Monetary Fund expects the developed economies to contract by another 2 per cent this year and to claw back maybe half of that next year.
That might be called the optimistic view. Darker scenarios are plausible too. The International Labour Organisation's worst case scenario, for example, sees up to 50 million jobs being lost worldwide.
The optimists' argument runs like this: Faced with imploding demand, governments and central banks have learned from the mistakes of their predecessors in the 1930s and have acted swiftly and on a massive scale to stimulate their economies.
Official interest rates have been slashed, in some cases to zero, and trillions of dollars of taxpayers' money have been pledged to stimulus packages. These things don't work instantly but they do work.
And besides, the optimists say, markets won't keep falling forever. At some point the bungee cord of greed overcomes the gravity of fear.
"A floating dollar is one of the things in our favour," says Westpac economist Doug Steel. It is a key shock absorber when world prices for export commodities are falling.
Against the US dollar, it has dropped 37 per cent over the past year from over US81c to around 51c now, and Westpac sees it going lower still, to the low 40c.
As well as buffering exporters, a lower currency helps banks raise money overseas, Steel says. "It encourages investors to lend because they have a better prospect of appreciation."
That is useful when our banks rely on offshore sources for more than a third of their funding.
The pessimists, by contrast, point first of all to the global extent of the crisis.
No major part of the world economy is immune, unlike, for example, the Asian crisis 11 years ago when Americans kept on happily thronging the shopping malls and acted as the world's locomotive of demand.
"We can't export our way out of this. No one can," AMP's Wong says.
In addition, international credit markets, while no longer frozen as they were - scarily - last September are still far from functioning normally, he says.
Ramping up government spending and cutting taxes and interest rates could cushion the blow, but only up to a point.
Government is not a big enough part of the economy to do more than partially offset the drop in demand when households and businesses cut back their spending to the extent they are now, Wong says.
Most of all, the pessimists argue that the global recession springs from large and longstanding economic imbalances, or unsustainable trends, which will take years to unwind.
Countries in the English-speaking world and beyond have been spending too much and saving too little, consuming too much and investing too little, importing too much and exporting too little, and relying on borrowing from the surplus countries - like China, Japan and Germany, which have been doing the opposite - to fund their spendthrift ways.
"These old imbalances need to reduce and that will take years," says AXA Global Investors chief economist Bevan Graham.
"The danger is that politicians will impede that process of adjustment through protectionist measures and bailouts."
Beggar-thy-neighbour trade protection policies are generally blamed for deepening and prolonging the Great Depression of the 1930s. Such measures may be bad economics but they can be popular politics, Graham says.
"We economists talk about 'transition costs' but what that jargon means in practice is people losing their jobs and not being able to walk immediately into another one."
The circuit breaker that arrests the vicious circle of declining consumption, investment and employment will be a turnaround in sentiment, Graham says - "people having confidence that the bottom has been reached."
"The key is probably the US housing market. That is where this started and that is where it has to end. For a while it looked as if the rate of decline in US house prices was at least easing, but lately it has picked up again."
Taking a wider-angle view, Professor Tim Hazledine of Auckland University says time is on our side.
"There's a much greater growth dynamic than there used to be. Developing countries' desire to grow and lift their living standards is huge. Those fundamentals will reassert themselves eventually," he says.
"The downturn is marked by a slump in demand for durables like houses and vehicles. We can live off our stocks of these things - but not indefinitely."
The conventional wisdom is that when economies like ours emerge from this recession they will grow more slowly than in the past.
It has been a brutal lesson in the perils of "leverage" and the value of equity.
Heavy reliance on debt amplifies your gains when markets are rising, but can wipe you out when they fall. But more equity means larger deposits for homebuyers, a higher cost of capital for companies and wider margins for banks.
And the large debts governments are running up will increase the tax burden down the track compared with what it might otherwise have been.
Hazledine, however, takes a more sanguine view.
"The Golden Age of rich country growth was the third quarter of the 20th century, when people didn't go into debt nearly as much," he says.
"Maybe it's painful to get back there from here. But if that's the outcome, it's not too bad."
