Debt and this Great Correction …Will They Never End?

It’s been going on since the spring of 2007 when big lenders in the housing sectors – specifically in sub-prime – began going broke. That knocked out the housing industry… and the finance industry too. Wall Street started to go broke too, which is when the feds stepped in. They’ve been trying to stop it or fix it ever since.

The Great Correction is now more than five years old — and debt is still its strong companion.

We’ve heard periodic reports of ‘recovery’ but the world economy is nowhere near back to where it was. Industrial output in the US, Germany, Canada, France, Sweden, Britain, Belgium, Japan, Hungary, Italy, Spain and Greece is below the level it was in 2007.

And some of the numbers are big. Spain and Greece, for example, are producing only about three quarters as much (still talking industrial output) as they did before the correction began. Japan’s economy is down 15%.

And there is no end in sight. In Europe, reports still tell of a fractured economy that could fall into pieces at any moment. Mario Draghi has pledged to do “whatever it takes” to keep the thing together. But as you read in this space, whatever it takes to bring a real recovery, Mario Draghi doesn’t have it. Neither does any central bank. All they have is credit and cash… and too much of those are the things the private sector is trying to correct. The Telegraph (Ambrose Evans-Pritchard) explains:

Monetarists blame the ECB and the Fed for keeping money too tight in early to mid-2008, pushing a fragile credit system over the edge. They blame “pro-cyclical” regulators for aborting recovery ever since by forcing banks to raise asset ratios too fast. They are right on both counts.

Yet the ‘Austrian School’ is surely right as well to argue that a rise in debt ratios across the rich world from 167pc of GDP to 314pc in just thirty years was bound to end badly. There comes a point when extra debt draws down prosperity from the future. The future arrived in 2008.

Creditors and debtors may in theory offset each other, but what actually happens in a crunch is that borrowers cut back feverishly. Creditors do not offset the effect. The whole system spins downwards. It is debt’s fatal “asymmetry”, long overlooked by New Keynesian orthodoxy.

The numbers are always a little fishy. But if a comfortable, sustainable debt level is actually around 200% of GDP, as Michala Marcussen of Sociéte Générale suggests, this correction could go on for much longer. The world still has a lot of debt to eliminate. It could take years… even decades.

Of course, all of this could have been avoided. If the feds had just kept their noses out of it, most likely the debt problem would be behind us. It would have been wiped out in the panic of ’08-’09. We would have spent the last three years putting the pieces back together… building new companies and new institutions…instead of trying to hold together old ones.

But no point in complaining about it. We’re just observers, after all.

And the main thing we notice now is that the world economy is still in a deleveraging slump…and the authorities are still making it worse by adding more cash and credit.

In that regard, a special chapter should be reserved in the history books for Japan. As in the rest of the world, the authorities have made the situation worse – by intervening with cheaper credit and more cash. But in Japan, they seemed to have created a permanent correction. The New York Times has this story:

TOKYO — Japanese economic growth slowed to an annual rate of 1.4 percent in the second quarter, the government said Monday, as cooling global demand weighed on the nation’s exports, while domestic demand, which had helped Japan outperform other Group of 7 industrialized countries this year, appeared to lose steam.

… it signaled that the recovery after the earthquake and tsunami of last year might be stalling.

The slowdown has also highlighted economic worries just days after Prime Minister Yoshihiko Noda won his bid to double the Japanese sales tax to tackle swelling public debt, with the upper house of Parliament passing the increase Friday.

The last sales tax increase, in 1997, snuffed out any hope of a strong recovery from the Japanese banking crisis of the 1990s, and opponents of Mr. Noda have warned that the latest increase in the tax could lead to a similar slowdown.

The figures released Monday, however, showed that growth in private consumption had fallen to 0.1 percent in the second quarter, from 1.2 percent in the first quarter, raising concerns that domestic demand might not be as robust as the central bank had hoped.

Much of Japanese economic growth, moreover, still relies on government spending for its momentum, spending that is more likely to trail off than grow in the coming months, said Ryutaro Kono, chief economist for Japan at BNP Paribas Securities. The government has budgeted ¥19 trillion, or $243 billion, for reconstruction after the earthquake and tsunami.

Recent economic growth “does not imply that there is a stronger, self-sustaining momentum toward recovery in the private sector,” Mr. Kono said in a note to clients.

Is this slump in Japan permanent? Will the Great Correction there… and here…go on forever?

Nah…Government debt in Japan is still rising. It’s at about 230% of GDP already. But it can’t go up forever. And Japan’s ‘Forever Correction’ can’t continue without it.

Now people lend to the government as they once lent to sub-prime mortgage companies. Which is to say, they’ll regret it.


Bill Bonner
for Markets and Money

From the Archives…

When the Trickle Becomes a Flood
10-08-2012 – Greg Canavan

What Central Planners Can Never Know
09-08-2012 – Bill Bonner

The Central Bank Big Bazooka in Theory and Practice
08-08-2012 – Bill Bonner

In Thrall to the Iron Fist
07-08-2012 – Dan Denning

Cracks in the Foundation
06-08-2012 – Dan Denning

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail Markets and Money.
Bill Bonner

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