Recovering from all this debt will take time

September 13, 2011

Global Macro, RBA and Interest Rates

It is fair to say that the mess we are in at present with the global economy and even to a lesser extent here at home in Australia is because of debt, too much, too widely spread and too burdensome. The problem is that we are still stuck with a global economy and global business models that are built on an environment were the next sale came or is expected to come, from a consumers desire to increase his or her stock of debt.

But the global push toward austerity, as miss guided as it is in some cases, speaks volumes for the realisation that the extrapolation of current income to infinity and therefore appetite to take on more debt has had to change. The higher savings rate and lack of demand for credit (debt) in Australia is householders version of the global austerity.

The net result of all this debt from my point of view is that the recovery from this global malaise will take a very long time perhaps even another 5 years or more. Certainly i have written about David Hackett Fischer’s prescient book “The Great Wave” and also Reinhart and Rogoff’s “This time it’s different” as highlighting the historical precedent for the duration of the recovery.

But while we all know what history has told us not enough people are writing about what the future might look like. In my view we need more forward-looking analysis of where we might be or how we might best rebuild the economy because when we get a false dawn like we did in 2010 which turns into the debacle of the 2011 global economy and markets confidence gets sapped when in reality this is just part of the recovery.

So I was glad to read an article written by Simon Johnson whose stuff I really like. Johnson was Chief Economist of the IMF in 2007 and 2008 and I find, at least IMHO, that IMF people have a unique hybrid take on the economy. Kind of like a merger of academia and business acumen.

Anyway Johnson has written an article on Bloomberg today where he is discussing the current malaise and the way forward. As readers know I was never a buyer of the recovery – rather I thought it was the “easy bounce” out of the 2009 lows and that the malaise we have before us now is just another act in a long running play.

The source of the GFC, even the Australian much milder version, is and was the credit boom that we saw in the run up to 2007. Johnson says that in order to think about and fix the global economy

start by thinking about just three countries: the U.S., Germany and China. For all three, the central issue is the same: Credit. Each nation is contending with a different kind of credit crisis, but the crux of the problem is the same for all: How to move away from a model of growth based on very high leverage, while still managing to grow.

On the US Johnson says,

If you compare nominal GDP per capita for the second quarter of 2006 with the number for the second quarter of 2011, the U.S. has had about 8 percent growth. Yet inflation during the same period — using the standard indices — has been a bit higher. In other words, the world’s largest economy, accounting for about 25 percent of global output, has already lost a half decade.

The U.S. could begin to pull out of its malaise. It still is home to a great deal of innovation and big companies are making plenty of money. The equity-financed part of the private sector has strong prospects and new technology-based ventures continue to attract top talent from around the world.

Still, it isn’t helpful that our politicians insist on pounding down consumer confidence through rhetoric and confrontation, and by doing nothing to prevent job cuts by state and local governments.

Those cuts make little sense. The U.S. is the world’s best credit risk and there is wide agreement that strengthening education is the path to long-term productivity growth, yet teachers are being laid off around the country.

Amen to that – the fractious politics in the US is becoming the global developed world norm. It speaks of short termism and the political cycle – which of course we understand on one level but it does not serve the interests of the economy as a whole going forward.

I won’t quote the article in its entirety but it is certainly worth a read. Johnson notes that China may not be any better than the West at handling easy money and concludes,

the prospects for global growth in the short term greatly depend on whether China can avoid following in the footsteps of the U.S. and Europe.Growth based on a great deal of leverage has proved fragile, but we haven’t yet moved to a different model. For now, the transition away from high levels of private and public sector debt will most likely be prolonged. It will certainly be painful.

For me this is the crux of the issue at hand for Australia as much as for the globe. So far Australia has been lucky insofar as that the RBA and the Government combined nicely to underpin growth while China didn’t fall into the mire either. So the Australian economy was buttressed by a combination of Houses and Holes.

But as Australian borrowers are showing a reluctance to take on more debt and are paying it down and as the mining boom doesn’t seem to be washing through the economy, Australia too has some adjusting to do – it will take some time before we have robust growth once again and probably some time before the budget is genuinely back in surplus. if the economy needs it then what’s wrong with that. lets not squander our luck by letting the politics of deficit reduction out weigh what the economy needs. Australian households are already conducting austerity Australian style, lets leave it at that.

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