Thursday, August 22, 2013

22/8/2013: Why This Time Things Might Be Different...

The readers of this blog know that I am seriously concerned with the issues of private (household) debt sustainability in the Euro area, as well as in other advanced economies around the world. In fact, my (simplified or stylised) POV on the current crisis is that we have now reached the point of long-term saturation with leverage and this is the main driver for the current Great Recession.

In a normal recession, deleveraging by one side of the economy is accommodated by leveraging up in another. For example, in a Keynesian policy set up, deleveraging of the households and non-financial corporates is accommodated by leveraging up of the fiscal side of the GDP equation. In a monetary policy setting, deleveraging of fiscal / public sector side is accommodated by lowering debt costs and thus increasing credit to the private economy. Lastly, in a normal balancesheet recession, both side of the economy can be helped in deleveraging by a combination of two policies accommodation.

In the current Great Recession, neither one of the three approaches above can work, unless at least one approach directly reduces debt levels - either via a sovereign default/writedown or a private sector writedown on a systemic scale. The reasons for this are two-fold:

  1. Too much debt on all lines of the economic balancesheet: fiscal, household, NFCs and, thus, banks means that lowering the cost of debt financing is not sufficient to deliver signifcant enough room for new debt expansion; and
  2. With emerging markets and middle income economies showing increasingly South-South internalised trade and investment flows patterns, the advanced economies are witnessing structural reductions in the pools of surplus (investable) savings available to them - the effect that is compounded by the adverse demographics in these economies. This means that monetary policy accommodation is funding the liquidity in the financial markets, where normally it would have been going to fund real activity.
In short, debt is the source of the crisis this time around, not the solution to the crisis as in previous recessions. And it is a proverbial perfect storm, as it comes on foot of demographic decline coincident with severe fiscal crises. The resulting squeeze on pensions in the advanced economies and on other age-related public services is yet to come.

Here is an interesting view on the continued crisis dynamics in the area of household debts in the US (with an ample warning for the rest of the advanced world) from Michael Hudson: (H/T to @rszbt Beate Reszat).

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