Five years into the Great Recession

Ambrose Evans-Pritchard analyzes where we're at, and where we're likely to be going, five years into what he calls the Great Recession.

Five years into the Long Slump it almost seems as if we are back to square one.

China is sufficiently alarmed by the flint hardness of its "soft-landing" to talk up trillions of fresh stimulus. The European Central Bank is preparing to print “whatever it takes” to save Spain and Italy. Markets are pricing in an 80pc chance of yet more printing by the US Federal Reserve in September or soon after.

There is no doubt that the three superpowers acting in concert can launch a mini-cycle of growth early next year - assuming they deliver on their rhetoric - but the twin headwinds of debt-leveraging and excess manufacturing plant across the globe cannot easily be conjured away.

The world remains in barely contained slump. Industrial output is still below earlier peaks in Germany (-2), US (-3), Canada (-8) France (-9), Sweden (-10), Britain (-11), Belgium (-12), Japan (-15), Hungary (-15) Italy (-17), Spain (-22), Greece (-27), according to St Louis Fed data. By that gauge this is proving more intractable than the Great Depression.

Some date the crisis to August 9 2007, the day it became clear that Europe’s banks were up to their necks in US housing debt. The ECB flooded markets with €95bn [over US $117 billion] of liquidity. It seemed a lot of money then. The term “trillion” was still banned by the Telegraph style book in those innocent days. We have since learned to swing with the modern dance music from central banks.

. . .

Five years on it is clear that subprime was merely the first bubble to pop, a symptom not a cause. Europe had its own parallel follies. Britons were extracting almost 5pc of GDP each year in home equity by the end. Spain built 800,00 homes in 2007 for a market of 250,000. Iceland ran amok, so did Latvia and Hungary. The credit debacle was global. If there was an epicentre, it was Europe’s €35 trillion [over US $43 trillion] banking nexus.

. . .

A study by Stephen Cecchetti at the Bank for International Settlements concludes that debt turns “bad” at roughly 85pc of GDP for public debt, 85pc for household debt, and 90pc corporate debt. If all three break the limit together, the system loses its shock absorbers.

“Debt is a two-edged sword. Used wisely and in moderation, it clearly improves welfare. Used imprudently and in excess, the result can be disaster,” he said.

Creditors and debtors may in theory offset each other, but what actually happens in a crunch is that borrowers cut back feverishly. Creditors do not offset the effect. The whole system spins downwards. It is debt’s fatal “asymmetry”, long overlooked by New Keynesian orthodoxy.

It is how people behave, and how countries behave.

. . .

As soon as the debtors hit the brakes and slashed spending, the underlying reality was exposed. There is too much saving and too little consumption in the world to keep growth, and people in jobs. It is the 1930s disease. On this the Keynesians are right.

None of this would have been any different if banks had been saints. The forces at work are tidal in power.

. . .

As for our debt mountain, we have barely begun the great purge. Michala Marcussen from Societe Generale says the healthy level is around 200pc of GDP for advanced economies. If so, we have 100 points to cut.

This cannot be achieved by austerity alone because economic contraction would tip us all into a Grecian vortex. Such a cure is self-defeating.

Much of the debt will have to be written off. Whether this [is] done by inflation (1945-1952) or default (1930-1934) will be the great political battle of this decade. Pick your side. Pick your history.

There's more at the link.  Worthwhile reading - and, from my perspective, a pretty accurate read on where the global economy is at right now.  Unless the authorities 'bite the bullet' and write off debt, as Mr. Evans-Pritchard indicates, we'll be in this mess for years yet . . . if not more so.  Der Spiegel reported today that European investors are actively preparing for the collapse of the Euro.  If that happens, it's going to hit our economy like a tidal wave.  Investors can't help but recognize the same warning signs of debt imbalance here.  At the moment, the US dollar seems to them like a safe haven from the Euro's problems.  When those problems crescendo into collapse, they'll realize that the same thing's inevitable here too.  When they wake up to that reality, it'll be 'Katie, bar the door!'

Peter