Your editor is in Vancouver at the Agora Financial Symposium, listening to the best and the brightest from around the world talk about US debt default, the nature of risk taking in a Ponzi finance world, and much more. Despite the gloomy sound, you’d be surprised.
One theme is prevalent: Optimism.
Didn’t see that one coming, eh?
The debate is essentially about when we can be optimistic again. Some say 2020. Others think the miracle cure for cancer – and ageing generally – is just around the corner. The most optimistic speaker of all expects governments to finally cease being able to fund themselves, thereby releasing all the power of human (and the market’s) potential.
But your editor has some concerns. So yes, this will be another miserable tale of why things might get bad before they get better. And here’s why: we may have been through tough economic times before. But this isn’t a recession. Not even a depression. It’s a credit crunch – a debt deflation, as explained last week.
We’ve been through those before too of course. But when have we ever been through a global credit crunch? Everyone is levered up. In the past, it has only ever been one or two regions of the world, or one economic sector of the global economy, at the most. This time, governments, households and companies in all major economic regions are levered to the hilt.
And nowhere can the trend continue. All the charts that extrapolate various nations’ debt-to-GDP ratios are ‘charts of things that cannot happen’, according to one speaker here at the Agora Financial Symposium. Especially with all of them continuing to lever up at the same time. There just isn’t the money for it.
This new dimension to the business cycle – essentially a synchronising of business cycles from around the world – is what might make you question the valuable conclusions of economists Carmen Reinhart and Ken Rogoff. That dynamic duo studied the aftermath of financial crises of the past and published their results and conclusions in the book, This Time is Different.
The analysis discovered several common factors, including the fact that a sovereign-debt crisis usually follows a financial crisis several years later. As one speaker here in Vancouver pointed out, ‘we are right on time’ for one (a sovereign debt crisis). But remember, it’s not just the sovereigns. Private debt is also out of control.
Back to why Reinhart and Rogoff might be wrong – this time could actually be different, even from the debt deflations of the past. Their book makes fun of those who always seem to claim that a nation will be able to avoid the debt deflation that inherently follows a credit bubble.
This applies to our situation today. The leaders of nations around the world all think they can escape the crisis. But things might be different this time for a different reason altogether. Never once has the entire world been on the cusp of a debt crisis at the same time. Let alone to the extent that we are in one.
This goes well beyond the old ‘globalisation’ and ‘being self-reliant’ debate. Debt has afforded us living standards that were not imaginable until recently. But as our level of debt moved higher, the tightrope beneath our debt-financed standard of living got thinner. Just a small push could send a household and national budget into chaos. That kind of instability goes along with unsustainable levels of debt.
Now that debt is extremely interwoven – both geographically and across different sectors of the economy – each tightrope walker is tied to the other. It only takes one to fall and the others will go with it.
Even China’s indebtedness has reached dangerous levels, once you combine the various levels of government. There is no nation left to leverage up and take on the mantle of providing global growth. Japan, Europe, the US, China… all are called into question by different sets of experts for different reasons. The underlying problem, debt, is the common denominator. And it makes all problems many times more dangerous.
If this time is, in fact, different – and the fact that debt levels are excessive almost everywhere means there is nobody to regenerate economic growth – things could get bad. And contagion could be rapid.
Worldwide, high levels of inflation may be the path of least resistance for governments. Bankers will want their bailouts and voters will want their benefits. Those predicting deflation have a point. The levels of inflation necessary to offset the enormous deflation inherent in a debt deflation of this size will have to be unprecedented. But big price tags have not stopped policy makers in the last three years.
You can expect bank bailouts and nationalisations. Then, government-mandated lending. And then, the inflation we have been worried about.
So, there you go. In one article your editor has said ‘this time is different’ and predicted the always expected, but never arriving, inflation. Could we be out on any more limbs?
On a more positive note, we’ve discovered a way for governments to make significant inroads on their debt: Sell advertising on their money notes and coins. We’ll asks the experts at the RBA if they are interested.
Until next week,
Markets and Money Australia Weekend