Monetary and fiscal policy
Where are we in the debt cycle and what are the implications for the future?
Dear Reader,
What part of the debt cycle are we in now, and how will the COVID19 induced economic shut-down play out? In order to discover where we are, we must first retrace where we have been.
In the leadup to the 2000 dot-com bubble, total household, corporate, and government debts were at historic highs. From 1999 to late 2004, global monetary-policy rates (on a GDP weighted average) (GMPRs) were reduced by central banks from 9% to 3.5% in order to relieve the pressure of the debt burden. Then, from late 2004 to late 2007, GMPRs were raised to 5% and the economy started to collapse under the crushing weight of the debt. Central governments and banks stepped in and aggressively lowered GMPRs to 1.8%, initiated unprecedented levels of money creation, bond buying, acted to guarantee debts and credit facilities and acted as a lender of last resort.
Instead of debts being restructured, written down and defaulted on in order to reduce the debt burden and deleverage the economy, centralised institutions across the globe acted to pull the economy up by its hair. This meant that following the 2008 crisis, GMPRs could never be raised in any kind of meaningful way. Global debts had gotten so large that raising GMPRs, reducing fiscal stimulus and slowing down monetary policy would lead to the global economy being crushed under the weight of all that debt.
The GMPR fluctuated around 1% from 2010 to late 2019 and total global debts as a percentage of GDP, which had been between 100-120% from 1950-1980 and had risen to 200% in 2007, had now exploded out to over 325% in the final quarter of 2019.
The global economy needs to begin deleveraging and the COVID19 outbreak may just force this deleveraging upon us whether we want it or not. There are a number of ways this could play out.
The first is that government stimulus fails to prevent a deflationary depression. Layoffs create mass unemployment, people spend less and incomes drop, debts are defaulted on en masse and taxes are raised to pay for the welfare and stimulus packages - the result of this would be a sustained depression.
The second is that governments balance the inflationary and deflationary measures, debts across unproductive parts of the economy are wiped out, but the effects are not prolonged. Interest rates are raised and confidence and incentive returns to equity and credit markets, and the economy turns around quickly.
The third is that inflationary policies create a fear of hyper-inflation and a flight from reserve currencies, bond prices tank, yields go through the roof, and the cost of debt sky-rockets. Governments can no longer afford to service their debt, the value of their currency wanes, they are either forced to default or accept inflation.
The final way this can play out is that government policy prevents the deleveraging that is so desperately needed, interest rates stay at historical lows and the debt burden looms ever larger making any future deleveraging even more painful and difficult to manage.
Let us hope that we can successfully balance the inflation and deflationary measures so that the deleveraging is not prolonged. Although, this seems increasingly less likely.
Until next time.
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