Courtesy of Mish.
The "elephant in the room" is debt. Try as they might, central bankers have not been able to spur credit, hiring, or much business expansion because of the elephant. Things are even worse in Europe.
Via email, this is a guest post from Steen Jakobsen, chief economist of Saxo bank.
Debt – The Elephant in the Room
‘Interest on debt grows without rain’ – Yiddish proverb
This proverb explains most of what goes on in policy circles these days. We are now watching Extend-and-Pretend, Episode VI: Promises for improvement amid ever growing debt levels.
Short put, we’re still working with the same dog-eared script we were introduced to all of five years ago, when markets had stabilized in the wake of the financial crisis: maintain sufficiently low interest rates to service the debt burden. Pretend to have credible plan, but never address the structural problem and simply buy more time. But while we were able to get away with this theme for an awfully long time, the dynamic is now changing as the risk of low inflation (and even deflation) is a brick wall for the extend-and-pretend meme. Yes, interest does grow without rain, and the cost of maintaining and servicing debt grows especially fast in a deflationary regime.
Mads Koefoed, Saxo Bank’s macro economist projects US growth at around 2.0% for all of 2014. That will be the sixth year with US growth near 2.0% – so despite lower unemployment, despite a record high S&P500, the economy has a hard time escaping that 2.0% level. Any talk of higher interest rates is hard to take seriously when US growth is going nowhere and world growth is considerable weaker than expected in January or as recently as July, for that matter. It seems everyone has forgotten that even the US is a part of the global economy.
The fourth quarter is always the most politically interesting time of year. Countries need to get their new budgets in order. The EU, IMF and World Bank will need to pretend they agree or accept the weaker data, which has to mean bigger deficits. It’s a tiresome exercise to watch denial-in-action as EU governments and other policymakers try to make something so obviously unpalatable go down easy in their internal reporting. It’s obvious that buying more time (extending) is always the number one priority, followed by projecting (pretending) the forward looking growth will reach an ever higher trajectory in order to make the budget fit within the supposed constraints. Or in France’s case, the recent unilateral abandonment of meeting budget targets for the next two years is already a fait accompli.
Who’s next?
Such behavior would cost you your job in the private sector, but in the economic model of 2014, which reminds us more of Soviet Union than a market based economy, its par for the course. But, many would protest, it would be even worse if we hadn’t done so much to “save the system”, right?
Well maybe, except for the fact that those economies where belief in State Capitalism is strongest: Russia, China and France, are all at the end of the line. Time has caught up. Negative productivity, capital flight and a system built on protecting the elite is failing. France is now moving from recession to depression. China is moving quickly from denial towards a mandate for change, Russia’s future has not looked this bleak since the late 1990’s. Meanwhile the US continues on sluggish 2.0% growth. Investors and pundits seem to have forgotten that we were promised 2014 would be the end of the crisis. Instead, we are speeding towards the inflection point at which debt becomes harder to service because pretend-and-extend policy making have created a depression in investment and consumption.
The public debt loads continue to inflate across Europe: Portugal’s public debt has ramped to a staggering 130% of GDP – up from about 70% in 2007. Greece’s public debt load, even after the restructuring of Greek debt a few years ago, has swelled to 175% of GDP. The EU now has far more systemic risk than at the beginning of the crisis. With zero growth or as our economist Mads sees it, 0.6% with the arrow pointing down, debt levels continue to rise relative to GDP. And most importantly, the current flirt with deflation will make servicing the growing debt even more expensive. The nightmare for ECB and world is deflation as it’s a tax on debtors and a boon to net savers. The new reality is that we currently stand face-to-face with the very deflation risk that just about everyone denied could ever happen when Q1 outlooks were written….
Picture: Banksy’s stenciled elephant from “Barely Legal,” 2006.
