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The "elephant in the room" is debt. Try as they might, central
bankers have not been able to spur credit, hiring, or much business expansion
because of the elephant. Things are even worse in Europe.
Via email, this is a guest post from Steen Jakobsen, chief economist of Saxo
bank.
Debt - The Elephant in the Room
‘Interest on debt grows without rain’ – Yiddish
proverb
This proverb explains most of what goes on in policy circles these days. We
are now watching Extend-and-Pretend, Episode VI: Promises for improvement
amid ever growing debt levels.
Short put, we’re still working with the same dog-eared script we were
introduced to all of five years ago, when markets had stabilized in the wake
of the financial crisis: maintain sufficiently low interest rates to service
the debt burden. Pretend to have credible plan, but never address the
structural problem and simply buy more time. But while we were able to get
away with this theme for an awfully long time, the dynamic is now changing as
the risk of low inflation (and even deflation) is a brick wall for the
extend-and-pretend meme. Yes, interest does grow without rain, and the cost
of maintaining and servicing debt grows especially fast in a deflationary
regime.
Mads Koefoed, Saxo Bank’s macro economist projects US growth at around 2.0%
for all of 2014. That will be the sixth year with US growth near 2.0% - so
despite lower unemployment, despite a record high S&P500, the economy has
a hard time escaping that 2.0% level. Any talk of higher interest rates is
hard to take seriously when US growth is going nowhere and world growth is
considerable weaker than expected in January or as recently as July, for that
matter. It seems everyone has forgotten that even the US is a part of the
global economy.
The fourth quarter is always the most politically interesting time of year.
Countries need to get their new budgets in order. The EU, IMF and World Bank
will need to pretend they agree or accept the weaker data, which has to mean
bigger deficits. It’s a tiresome exercise to watch denial-in-action as EU
governments and other policymakers try to make something so obviously
unpalatable go down easy in their internal reporting. It’s obvious that
buying more time (extending) is always the number one priority, followed by
projecting (pretending) the forward looking growth will reach an ever higher
trajectory in order to make the budget fit within the supposed constraints.
Or in France’s case, the recent unilateral abandonment of meeting budget
targets for the next two years is already a fait accompli.
Who’s next?
Such behavior would cost you your job in the private sector, but in the
economic model of 2014, which reminds us more of Soviet Union than a market
based economy, its par for the course. But, many would protest, it would be
even worse if we hadn’t done so much to “save the system”, right?
Well maybe, except for the fact that those economies where belief in State
Capitalism is strongest: Russia, China and France, are all at the end
of the line. Time has caught up. Negative productivity, capital flight and a
system built on protecting the elite is failing. France is now moving from
recession to depression. China is moving quickly from denial towards a
mandate for change, Russia’s future has not looked this bleak since the late
1990’s. Meanwhile the US continues on sluggish 2.0% growth. Investors
and pundits seem to have forgotten that we were promised 2014 would be the
end of the crisis. Instead, we are speeding towards the inflection point at
which debt becomes harder to service because pretend-and-extend policy making
have created a depression in investment and consumption.
The public debt loads continue to inflate across Europe: Portugal’s public
debt has ramped to a staggering 130% of GDP – up from about 70% in 2007.
Greece’s public debt load, even after the restructuring of Greek debt a few
years ago, has swelled to 175% of GDP. The EU now has far more systemic risk
than at the beginning of the crisis. With zero growth or as our economist
Mads sees it, 0.6% with the arrow pointing down, debt levels continue to rise
relative to GDP. And most importantly, the current flirt with deflation will
make servicing the growing debt even more expensive. The nightmare for ECB
and world is deflation as it’s a tax on debtors and a boon to net savers. The
new reality is that we currently stand face-to-face with the very deflation
risk that just about everyone denied could ever happen when Q1 outlooks were
written.
Two other global threats, or time bombs, if you will, outside of the EU are
risks from the growing costs of servicing debt in China and the USA. In
China, the governments national and local have piled up considerable debt,
but it is the overall debt service costs in all of China that are the real
concern, which have only grown so large with the dangerous assumption
by Chinese banks, companies and citizens that they can count on a
public bailout. According to a Societe Generale analyst, total debt service
costs (including maturing debt and roll overs) in China area at nearly 39% of
GDP. Compare that with the closer to 25% of GDP for the USA in 2007.
In the US, interest on US government debt cost over 6% of budget outlays in
2013. This is relatively down from its worst levels when interest rates were
much higher, but only because FOMC has so drastically lowered the costs for
the US government to issue debt with a zero interest rate policy. And now the
debt load is vastly larger than it was before the financial crisis – at 80%
of GDP (net debt according to IMF) versus 45% of GDP a mere 10 years ago. So
are we actually to believe that the Fed can lift the entire front-end of the
curve from 0-1% (current rates out to three years) to 2-4% over the next two
years without massive further stress on the deficit and only adding to the
debt? Servicing 2% interest when growth is 2% means you are doing worse than
standing in place if you also have a budget deficit.
Whatever the timing, the USA, China and Europe are all headed for another
Minsky moment: the point in debt inflation where the cash generated by assets
is insufficient to service the debt taken on to acquire the asset. The US
productivity growth last year was +0.36%. The real growth per capita was
about 1.5%. Anything which is not productivity is consumption of capital. So,
the only way to grow an economy without productivity growth is temporarily
with the use of debt – about 75% debt and 25% productivity growth in this
case.
Since the 1970s, US productivity growth rates have fallen 81% - the move onto
the internet has ironically made us bigger consumers and less productive. Had
we remained at pre-1970s productivity, the US GDP would have been 55% higher
and the outstanding debt to GDP would be easily fundable.
I just returned from Singapore on business – Singapore, to me, used to be the
most rational business model around. Its founder Lee Kuan Yew was one of the
greatest statesmen in history. Now, productivity is collapsing in Singapore.
They are, like us, becoming the Monaco of the world, an economy based on
consumption and not on productivity and growth. The developed economies are
growing old in demographic terms, but we’re still not wise enough to realize
that our current model is a Ponzi scheme rushing toward its inevitable Minsky
moment. No serious policymaker or central banker is talking about the truth
told by simple maths and hoping that things turn out well. Hope is not good
policy and it belongs in church, not in the real economy.
Steen
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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