Tuesday, September 30, 2014

Debt, deleveraging and depression

by Michael Roberts

Last week the Economist magazine reiterated its view that global growth has been slowing (http://www.economist.com/blogs/buttonwood/2014/09/markets-and-economy). This would be no revelation to readers of my blog, as I have been arguing that the world capitalist economy has failed to return to previous trend growth rates since the end of the Great Recession in 2009. And this confirmation that the world is a depression.

What is a depression and how does it differ from a ‘common or garden’ recession? Think of it schematically. A recession and the ensuing recovery can be V-shaped, as typically in 1974-5, or maybe U-shaped, or even W-shaped as in the ‘double-dip’ recession of 1980-2. But a depression is really more like a square-root sign, which starts with a trend growth rate, drops in the initial deep slump, then makes what looks initially like a V-shaped recovery, but that then levels off on a line that is below the previous trend line. In a depression, pre-crisis trend growth is never restored for anything up 10-15 or even 20 years.
In its piece, the Economist highlighted the significant slowdown in global trade growth. This is a point that I have made before (http://thenextrecession.wordpress.com/2014/07/21/global-trade-doldrums/), that world trade has slowed to the to the point where the growth in trade is slower than world GDP growth – a situation that means economies with weak domestic demand cannot compensate by selling more goods in world markets.

The Economist adds that the World Trade Organisation has now cut its forecast for trade growth this year from 4.6% to 3.1% and for 2015 from 5.3% to 4%. And that is optimistic as actual trade growth in the first half of the year was just 1.8, lower than in 2012 (2.3%) and 2013 (2.2%). Economists at Citibank, the huge American bank, now reckon global real GDP growth will be just 2.8% this year rising to 3.3% in 2015, well below trend, the slowdown being led by the so-called emerging economies.

And a new report warns that this slowdown coupled with a failure to cut back the overhang of debt, both public and private, built up in the major economies, threatens to cause a new slump in the world economy. This is the so-called 16th annual Geneva report, commissioned by the International Centre for Monetary and Banking Studies and written by a panel of senior economists including three former senior central bankers (http://www.voxeu.org/article/geneva-report-global-deleveraging).

As bankers, naturally the authors of the report are worried about the level of debt and the failure to ‘deleverage’ while the global economy struggles to recover. The report warns of a “poisonous combination of high and rising global debt and slowing nominal GDP, driven by both slowing real growth and falling inflation”.

According to the Geneva report, the total burden of world debt, private and public, rose from 160% of national income in 2001 to almost 200% in 2009 at the depth of the Great Recession. But the slump did not deliver any deleveraging and total debt rose further to 215% in 2013. “Contrary to widely held beliefs, the world has not yet begun to delever and the global debt to GDP ratio is still growing, breaking new highs,” the report said.
Global debt-to-GDP ratio, 2001-13
Debt did not fall in the developed capitalist economies because the banks were bailed out by huge dollops of public sector funding raised through government borrowing. So while financial sector debt was ‘written off’, it was replaced by public sector debt so that the banks did not lose out. But in the ‘recovery’ period since 2009, the debt build up has been more in emerging economies. The advanced capital economies have debt levels (excluding the banking sector) of around 260% of GDP in 2009 while the emerging economies had ratios half that, but now heading higher (mainly in China).
Debt dynamics for a selection of advanced and emerging economies
Debt EM and DM
Note: DM = developed markets, EMU = Eurozone; EM = Emerging Markets.
Excluding the public sector, only the US and the UK have seen a reduction in private sector debt, (mainly household debt and households defaulted on their mortgages or paid them down. But corporate debt has stayed high and with pitiful levels of growth in real GDP, if interest rates were to start rising significantly, then the corporate sector could find itself in trouble.

That is what happened in 1937 during the Great Depression, when the Federal Reserve decided that it could safely hike interest rates again and the government could stop running budget deficits as the US economy had recovered. That proved badly wrong (see my post, http://thenextrecession.wordpress.com/2014/08/01/the-risk-of-another-1937/).

The continual optimism about a ‘return to normal’ has been dashed again and again since 2008. Another figure from the Geneva report shows the slowdown in growth forecasts for both advanced and emerging economies, as captured by the progressive reduction in output projections in the different vintages of the IMF’s World Economic Outlook since 2008. Global growth is now way off trend and well below where it was expected to be in 2008 and every year since.
GDP forecasts
Behind the failure of the world economy to get back on track is the failure to restore the profitability of capital in nearly all economies from the peak of 2006 and certainly from the peak of 1997. In addition, given that the burden of debt on capital remains so high, it is no wonder that smaller companies are unwilling to invest in new technology in any significant way, while larger companies prefer to hold cash, buy up their own shares or issue higher dividends to their shareholders rather than expand productive capacity.

The irony is that if companies do start to expand capacity they will eventually drive profitability down further and so lay the basis for a new slump that would be triggered by any significant rise in the cost of borrowing. That is what the Geneva report’s debt analysis is telling us. And they are worried.

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