View the article online at http://citywire.co.uk/money/article/a595888
Eurozone's in debtor’s prison with half the sentence still to go
We're only halfway through this crisis, argues Stuart Thomson, chief economist at Ignis Asset Management.
‘This time it’s different’ is the most dangerous phrase in the financial lexicon, leading to economic myopia and asset price bubbles.
The current global economic situation is no different: it's exactly the same as previous periods of paying down debt ('deleveraging') after a major financial crisis.
These crises have invariably been preceded by a massive increase of banking leverage and an accumulation of consumer and corporate debt. The resulting deceleration leads to a prolonged period of volatile and sub-trend growth. Economists call this unsatisfactory growth ‘a growth-recession’. In other words, growth is above zero but below the productive potential required to satisfy productivity and labour force growth.
Halfway through a lost decade
The global economy is only halfway through a lost decade, and this is the reason for the decline in government bond yields among safe-haven government bond markets such as the UK, Germany and the US.
Indeed, government bond yields in these economies have dropped back to levels prevailing in previous periods of deleveraging. There is an acute shortage of these safe-haven bonds, and we believe that benchmark rates in these safe havens can fall significantly further in the next few years, with 10-year spot yields falling below 1% over this period.
The official interest rates, which anchor these government bond yields, are already at record lows, and will be replicated across the curve. The major central banks will provide more stimulus through quantitative easing (QE) over the next few months. [This is the policy of creating new money electronically to buy back government bonds]. However, their reaction is becoming slower as the impact of these policies become subject to the law of diminishing marginal returns.
The official response to Lehman’s collapse was rapid and appropriate. The deleveraging of bank, consumer and corporate balance sheets will lead to deep recession and deflation as the simultaneous rise in savings produces the paradox of thrift.
There has to be an expansion of some other balance sheet to compensate and support demand, but there is a limit to both monetary and fiscal support. Government balance sheets are also contracting across the major industrialised economies. There is also a limit to monetary policy actions.
QE is designed to lower the term structure of interest rates and bring forward deferred consumption. However, consumer savings need to rise in the longer term to rebalance these economies. This explains why QE can support demand and help prevent recession, but it is not enough to produce strong growth or escape velocity from the current debt burdens.
Europe presents the biggest threat to the global economy. While the rest of the global economy is experiencing an unsatisfactory growth recession, Europe faces a prolonged real recession.
Debtors’ prison don’t work
The Victorian era of Oliver Twist was blighted by debtors’ prisons, where those who got into debt were forced to work until their debt was paid off. This was extremely damaging both socially and economically, and governments eventually realised the fallacy of this policy by amending bankruptcy laws.
The euro is a form of debtors’ prison, with creditors demanding increasingly draconian austerity as a means of forcing repayment of their debts. This is counterproductive and threatens to tear the single currency apart.
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