Byron Wien: So Much to Worry About
The Wall Street pro's concerns include valuations, housing, and a group scarier than ISIS.
By Byron Wien
Updated Oct. 2, 2014 5:43 p.m.
There was a brief pause at the height of the crisis, but then the rise in the global debt-GDP ratio resumed, reaching nearly 220c of global GDP over the past year. Much of the more recent growth in this headline figure has been driven by China, which in response to the crisis, unleashed a massive expansion in credit.
However, even developed market economies have struggled to make progress, with rising public debt cancelling out any headway being made in reducing household and corporate indebtedness.
Reduced mortgage finance during the banking crisis temporarily succeeded in capping and partially reversing the growth in UK household debt. Yet with a reviving housing market, these reductions may have come to an end, with the Office for Budget Responsibility expecting household debt to income ratios to start climbing again shortly.
In the meantime, the government has been piling on borrowings like topsy, not withstanding attempts by the Chancellor, George Osborne, to bring the deficit under control. Total national non financial indebtedness has therefore barely budged since the start of the crisis.
The UK remains the fourth most highly indebted major economy in the world after Japan, Sweden and Canada, with total non financial debt of 276pc of GDP. The US is not far behind with debt of 264pc of GDP.
However, the real stand-out is China, which since the crisis began has seen debt spiral from a very manageable 140pc of GDP to 220pc and rising. This is obviously still lower than many developed economies, but the speed of the increase, combined with the fact that it is largely private sector debt, makes a hard landing virtually inevitable.
The only way the world can keep growing, it would appear, is by piling on debt. Not good, not good at all.
There are those that say it doesn’t matter, or that rising debt is merely a manifestion of economic growth. And in the sense that all debt is notionally backed by assets, this may be partially true. But when rising asset prices are merely the flip side of rising levels of debt, it becomes highly problematic. Eventually, it dawns on the creditors that the debtors cannot keep up with the payments. That’s when you get a financial crisis.
Crisis or no crisis, the Geneva Report’s authors – Luigi Buttiglione of Brevan Howard, Philip Lane of Trinity College Dublin, Lucrezia Reichlin of the London Business School and Vincent Reinhart of Morgan Stanley – argue that rising indebtedness in developed economies has been crimping potential output growth ever since the 1980s.
The crisis has made an already bad situation worse, caused a further, permanent decline in both the level and growth rate of output. This in turn makes it much harder to work off debt; when economies are not growing, debt to GDP tends to rise automatically.
We now see much the same thing happening in emerging markets with output growth slowing markedly since 2008, particularly in China. Buying growth with debt is reaching the limits of its viability.
It is possibly the case that Anglo-Saxon economies, the US and UK, have done better in managing the trade off between deleveraging and output than others. However, this may be largely a conjuring trick.
To the extent that meaningful reductions in private and financial sector debt have been achieved without greater damage to output, it is only because there has been a parallel and very substantial increase in public indebtedness.
Despite the deficit reduction rhetoric, George Osborne, the UK Chancellor, has in fact been doing the bare minimum to keep the markets off his back. He’s also had plenty of help from the Bank of England, which itself has become leveraged to the gunnels with government debt to ease the path back to fiscal sustainability. None the less, this is plainly a much better place to be than the Eurozone, which has imposed entirely counterproductive debt controls on governments and thus far at least, denied them the luxury of debt monetisation by the European Central Bank. The result is a crushing depression for much of the single currency bloc.
Historically, big debt overhangs have tended to be dealt with via inflation and currency adjustment, the natural, market based way of haircutting creditors. Both these options are denied to the Eurozone economies, and when everyone is in the same high debt boat may in any case no long work as they once did.
There is no sign of the inflation you might expect after such an unprecedented phase of central bank money printing, and judging by still historically low government bond yields, very little prospect of it.
The world economy may have entered a vicious circle where excessive debt constrains demand to such a degree that both interest rates and inflation, and therefore growth too, remain permanently low. This way of thinking may be unduly pessimistic, but it is also worryingly plausible.
And in conditions where excessive debt cannot be worked off through growth, restraint and inflation, adjustment will eventually be forced much more divisively through default. It’s a toss-up who is going to breach the dam first, but unless the European Central Bank rides to the rescue with debt monetisation soon, the betting has to be on Italy, where debt dynamics already seeem to have entered a death spiral. That this is not yet reflected in bond yields is down only to the assumption that the ECB will eventually oblige. Perhaps it will, but even if it does, it will only buy time.