new york stock exchange 248.88.
(photo credit: AP)
The buzz of good news around the global economy as Easter week ends is less about the Second Coming and more about the "second derivative."
Perhaps it would be better to start with the welcome fact that there is good news at all. There is and its focused on this "second derivative" thing. Since people have belatedly become allergic to anything to do with derivatives, and now tend to consider that term in any economic or financial context as synonymous with "toxic," it might help to explain it.
Derivatives actually have to do with algebra (if that term also makes you feel uncomfortable, skip to the next paragraph). What we are interested in is rates of change, which you need algebra to calculate. Think of a car: how fast it goes is called velocity and is measured in miles or kilometers per minute or hour. It can go faster or slower, i.e. change its velocity. The process of speeding up (acceleration) or slowing down (deceleration) is the rate of change in velocity. That makes acceleration a second derivative, because it is derived from velocity, which is the first derivative. Think of that when buying your next sports car: when they offer you 0-100 kph in five seconds, they are tempting you with a second derivative.
Economies, like cars, move forwards (growth) and backwards (recession, or, more correctly, negative growth). This growth is measured by the change in GDP, usually in annualized percentage terms (e.g. up 5 percent, or down 1%). In fact, all economic indicators are measured by their rates of growth, whether it's retail sales, housing starts or prices (inflation/deflation). Currently, all the developed economies are in recession, meaning they are showing negative rates of growth in most of their economic indicators.
Because this recession is so bad, the focus is not on the actual rate of growth (because everyone knows that is negative) but on the rate of change of the rate of growth: is the speed with which things are getting worse getting faster or slower? In short, the focus is on the second derivative, and the good news we were talking about is that, overall, things are getting worse more slowly. Some indicators have even stopped getting worse at all and are looking to get better.
That's as far as it goes, at the moment - which is fine. After all, the dynamics of any move from negative to positive requires that first the intensity of the negative trend eases, and then it starts improving. It's worth emphasizing what that means: minus 1 is an improvement over minus 2 - but it's not positive. So things can improve, yet still be bad, because "getting better" is merely a relative state, not at all the same as actually being good. What has happened in the global economy in recent weeks is that things have gotten better, although they remain far from good.
This is a tremendously important development. Long-time readers of this column will recall the watchword coined here back in the summer of 2007: IKGW - It Keeps Getting Worse. In March-April 2009, for the first time in almost two years, it has stopped getting worse. That is genuine cause for celebration - and explains and largely justifies the party underway in global equity markets since March 10.
After such a prolonged and intense hammering, it's hardly surprising that this change of tone and direction has triggered so much hope and relief. But for that reason it's easy to get carried away and jump to unwarranted conclusions - such as that we are now firmly on the up escalator and will shortly emerge from recession. That is definitely not the case.
Even the most optimistic reading of the recent data does not support that. It is noticeable that even the Obama team, who are obviously in the optimistic camp, are very careful to dispel any such illusion. In the best case, the improvement will be slow but fairly steady, requiring an extended period of "better" before the economy eventually breaks back into "good" territory.
Many others think that this is wishful thinking and that even the "better" is not firmly established. In other words, the second derivative will change direction again, perhaps several times, swinging from "better" to "worse" and back, before finally turning consistently positive and dragging the economy from "bad" to "good." The pessimistic analysis sees the current episode as an interim stage in which "better" tries - but ultimately fails - to overcome the forces at work making things "worse."
All agree, however, that a major milestone has been passed. To use Churchill's terminology, this is definitely not the end of this economic crisis and it may not even be the beginning of the end. But it is, at the very least, the end of the beginning.