Friday, July 26, 2013

The Markets’ Worst Kept Secret

James Gruber
Despite the extraordinary government intervention of the past six years, despite continuing optimism of a recovery, despite the reassuring words of central bankers, the world is more indebted now than it was at the height of the financial bubble in 2007.
From this, there are several inevitable conclusions that Gruber discusses:
The policies pursued since the financial crisis haven’t worked. Otherwise, debt to GDP ratios would be decreasing, not increasing.
Interest rates can’t rise above GDP rates, otherwise debt-to-GDP ratios will climb further. If they do, expect more money printing, budget cuts and tax rises.
That means low interest rates are likely to stay for many, many years. It’s the only way to bring the debt down to more sustainable levels.
The startling thing about the past 6 years is the almost total lack of reform to fix the problems that led to the 2008 debt bust. It’s ironic that communist China may well be the one to soon lead the way on substantive capitalist reforms.
Emerging markets, including Asia, may be better off than the developed world when it comes to debt, but rising asset and commodity prices have papered over several problems. And these problems are now coming to light.
Debt crises happen because incomes can’t support the servicing of the debt any longer. If there is any drop-off in economic growth, a 2008 re-run could well be around the corner. That’s not being dramatic; it’s just the way the math pans out.
To conclude, it’s hard to imagine the US, Europe, Japan and other developed world countries implementing reform in time to prevent their debts from rising further and possibly imploding.
That may sound pessimistic but the reality is that little has been done in the past 6 years to restructure economies and cut debt; i.e. learning the lessons of 2008. Instead, the partial recovery led to complacency. All the while, the debt that caused the bust in the first place has compounded and threatens to undo the world again.
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