Pay attention to long-term debt cycle
Limits to spending growth financed by debt and money raises risks of policy ‘pushing on a string’
I have a controversial view that is based on my alternative economic template, and I feel a responsibility to share at this precarious time.
In brief, the Federal Reserve’s template, and that of most economists and market participants, reflects the business cycle.
Based on it, tightening should occur when a) the rate of growth in demand is greater than the rate of growth in capacity and b) the usage of capacity (as measured by indicators such as the GDP gap and the unemployment rate) is becoming high.
As a result, tightening now makes sense.
However, as I see it, there are two important cycles to pay attention to — the business cycle, or short-term debt cycle, and the debt supercycle, or long-term debt cycle.
We are seven years into the expansion phase of the business/short-term debt cycle — which typically lasts about eight to 10 years — and near the end of the expansion phase of a long-term debt cycle, which typically lasts about 50 to 75 years.
It is because of the long-term debt cycle dynamics that we are seeing global weakness and deflationary pressures that warrant global easing rather than tightening.
Since the dollar is the world’s most important currency, the Fed is the most important central bank for the world as well as the central bank for Americans, and as the risks are asymmetric on the downside, it is best for the world and for the US for the Fed not to tighten.
Since the long-term debt cycle issue is the biggest issue that separates my view from others, I’d like to briefly focus on its mechanics.
What I am contending is that there are limits to spending growth financed by a combination of debt and money. When these limits are reached, it marks the end of the upward phase of the long-term debt cycle. In 1935, this scenario was dubbed “pushing on a string”.
This scenario reflects the reduced ability of the world’s reserve currency central banks to be effective at easing when both interest can’t be lowered and risk premia are too low to have quantitative easing be effective.
Since we commonly understand why lowering interest rates stimulates debt and economic growth, and less commonly understand how QE works, I’d like to explain it.
QE works because those “risk premia” — which are the spreads between the expected return on cash and the expected returns on other assets such as bonds, stocks, real estate and private equity — draw the buying of investors who sell their bonds to the central banks during QE.
You see, our whole capital allocation system — banking and investing — is driven by spreads so that when they are large, QE works better than when they are small.
When there are good spreads — in other words a large risk premia — and those who sold their bonds take their newly acquired cash to buy those assets that offer attractive spreads, bid up their prices and drive down those expected return spreads (ie risk premia) of those assets.
That is where things now stand across the world’s reserve currencies, where the expected returns of bonds (and most asset classes) are relatively low in relation to the expected returns of cash.
As a result, it is difficult to push the prices of these assets up and it is easy to have them fall. And when they fall, there is a negative impact on economic growth.
When this configuration exists — and it is also the case that debt and debt service costs are high in relation to income, so that debt levels cannot be increased without reducing spending — stimulating demand is more difficult, and restraining demand is easier, than is normally the case.
At such times the risks are asymmetric on the downside and it behoves central banks to err on the side of waiting until they see the whites of the eyes of inflation before tightening.
That, in my opinion, is now the case.
This post originally appeared in the Financial Times Markets Insight column.
#://CNXT | $://THeXDesK | $://THeXCHaNGe #://CuRReNCyx | $://ANCHoRx | $://ASSeTx $://iSSueRx | #://BoNDx | $://CeNTRaLBaNx | $://BaNx | $://THeFeDWiRe | #://CoNTRax #://CNXTAi
8 年CNXT EoE
Operations
8 年I don't see anything mentioned with regards technology and it's effect on jobs. More and more people are losing jobs because of technology, and you need the middle class to have jobs to keep the cycle going. With more and more people out of work, (current figures l do not believe) you have less spending, and more and more people paying down debt rather than buy goods they don't need. Surely we are closer to Stagflation now, and coming toward the end of Deflation. This is surely more dangerous, with regards to any country moving forward.
General Management/Energy Sector/Strategic Initiatives/Operations/Board Experience/Financial & Risk Management/ P & L
8 年This is an interesting article with an unusual perspective. We certainly face a time of historic levels of debt and they have build up over decades. That point is not really arguable. (see the McKinsey report on debt from about 2 years ago, with little changed since). Ray provides us with a way to understand what is happening economically. But does the article provide the right solution? If I understand Ray’s comments correctly he is arguing that we should be easing rates because the long-term debt (from long cycle) is high and so high that people will not add to their debt, instead the easing will help people reduce debt (presumably they will not spend because high debt is interfering with spending - their debt payment take too much of their budget). It is clear that debt (looked at from many perspectives, government, private industry, consumer in the U.S. and many other nations) is at high levels if not the highest levels ever. However they were high in 2009 and nearly the highest ever (they were the highest when not influenced by ongoing war or just ended war, for example WWII and years following). But we added to debt after 2009 anyway. To be more precise the U.S. consumer has reduced debt somewhat but the ratio to income still remains very high and virtually all other groups of debtors have increased debt (governments and industry and consumers internationally). It is not clear that easing will in fact reduce debt. It may entice enough groups to add to their debt causing aggregate debt to continue growing in the U.S. and elsewhere. Just as debt grew post 2009 with central bank easing. If it did this would only store up more trouble for a future date when the high level of debt must finally get resolved. This does not seem to be a solution, just an argument to postpone the day when we must face the problem of accumulated debt.
Creator of Impact Economics. Modern business leaders are the most important people in the sustainable future room.
8 年Always incredibly well though through
Client Portfolio Specialist and Former Economist
8 年Agreed. One cannot analyze the real economy without understanding how geared or levered the system is and which sectors & industries are relying on or in some cases abusing leverage. Thanks for your leadership in critical thinking in our business. You and your work were always mentioned favorably at The Capital Group. Be well!