FinancialGuy Writes!

Back at the end of July 2009, your author wrote a post titled: ” 2016: The End Of This Recession? “. At the time I felt a little bonkers, it was the out-loud musings of an amateur economist and nothing more. But the tide of economic thought seems to be moving in this direction…

In The Economist this week (16th January 2010 – Economics Focus | Digging out of debt) is analysis and opinion of the analysis and opinions of another. The other in this case is a report about debt and global deleveraging by the McKinsey Global Institute. No lightweights here then.

Both report and article are worth the read if you have any interest in the medium-term economic future of the world.

As The Economist notes, there are only three ways to reduce the debt levels of us all (government, corporations and individuals) to a sensible level. They are default, inflation and a prolonged period of belt-tightening.

As you might imagine, both report and article focus on prolonged belt-tightening as the preferred route out of debt. It is fair to say that the prospect of countries such as Spain, Britain, the US, South Korea and Canada choosing default – and the consequences for us all thereafter – is not an appealing one. However, the elected officials of the day may well choose inflation as their preferred escape hatch. While this is obviously unappealing to economists and the general public, it may prove to be popular with government officials. Regrettably.

When looking at past examples of deleveraging, The Economist tells us that, “Typically deleveraging began about two years after the beginning of the financial crisis and lasted for six to seven years. In almost every case output shrank for the first two or three years of the process.”

It continues, “big increases in public debt, while cushioning demand in the short term, increase the overall debt reduction that will eventually be needed. Once private deleveraging is done, the public sector will need to cut back.” And closing with, “Investors may worry about the sustainability of public debt long before private-debt reduction is over, forcing a lot of belts to be tightened at once. The most painful bits of deleveraging could well lie ahead.”

Thus, it seems that more respected voices than mine fear that this recession could run and run.

The part of this that never ceases to amaze me, is the capacity of politicians to avoid the reality. The pronouncements about the recession being over have slowed a little to my mind in recent weeks, but that might simply be a change in focus to Christmas and climate change. Of course, the sales numbers on the high streets of the world have had their temporary December fix and so consumer spending has – at least in the very short-term – come to the rescue.

But the article seems to suggest – though not actually say – that this process of debt repayment will have the effect of dragging the recession out for more years than we are currently hoping for. Of course, the economists are saying something slightly different, “If history is a guide, many years of debt reduction are expected in specific sectors of some of the world’s largest economies, and this process will exert a significant drag on GDP growth.” which I think is the same thing…

Thus, my thoughts remain the same, if slightly enhanced. I know that recommending yourself is no recommendation at all, but I shall end this post as I ended the previous post, “What this all means is that we all ought to be managing our finances as if we may never see the good times again and that things are going to get much worse before they get any better.”

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  1. Wow. Scary Stuff. If the decision-makers do choose inflation as a way to ride out the crisis surely this will hurt the few amongst us who were cautious with their money, as savings will be worth less, and so will baby boomers’ superannuation? Why would that be popular with government officials?

  2. The quick answer is that they don’t have to cut public spending – and endanger precious votes – by using inflation. Belt-tightening will also demand tough decisions and alienating some voters – as David Cameron and the UK Conservative Party are currently learning.

    It goes without saying that default is considered poorly by everyone, including politicians and the general public. But inflation isn’t well understood by most voters, and so there are many possible explanations – many of which do not include political or economic incompetence.

    But you are right about your thoughts. Could / will it hurt savers that have been prudent and now have accumulated assets? Yes, of course. But who owes the most money in society and so has the most to gain from increased inflation? Government.

    For me at least, a real worry is that inflation and hyperinflation are usually contained – more or less – within one nation and currency (think of Zimbabwe as an example – it didn’t help it’s neighbours economically, but the problems were not so great either it seems) but if lots of major countries choose it simultaneously, there could be a real and dangerous global impact. Add in shared currencies (the Euro) and who knows where this might lead…

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