GDP, Deleveraging and Economic Growth…
May 28, 2010
It would appear that drastic public spending cuts particularly when it comes to loss of jobs can have a negative impact in the short term on any return to growth and can further impede GDP.
Bearing in mind the NAMA project is predicated on a return to growth and not a dampening of growth due to debt reduction, deleveraging and debt reduction is bound to have an effect on GDP in the years ahead. This factor is very much disguised in positive outlooks on the future growth of our economy as in the following OECD report. This OECD report disguises the effects of a contraction of GDP in the years ahead compounded in our case by an across the globe similar contraction in other economies. It also ignores the increasing debt servicing budgetary obligations in the face of the necessary adjustments that require to be made to achieve deleveraging in the short to medium term. Return to growth projections ignore or avoid the effects of the necessary adjustments outlined by McKinsey while also ignoring the dangers of maladjustment to the need to correctly manage deleveraging.
Some notes from McKinsey:
“large amounts of foreign capital. Ireland’s total debt relative to GDP more than doubled from 2001 to 2008, to over 700 percent. Financial sector debt accounted for more than half of the total, at 421 percent of GDP. At the same time, the inflow of foreign capital fueled a property boom.”
“6 The mature economies we examined are Canada, France, Germany, Italy, Japan, South Korea, Spain, Switzerland, the United Kingdom, and the United States. The emerging economies we examined are Brazil, China, India, and Russia.”
“45 episodes since the Great Depression in which the ratio of total debt relative to GDP declined, and 32 of them occurred following a financial crisis………..”
“The historic episodes of deleveraging fit into one of four archetypes: 1) austerity (or “belt-tightening”), in which credit growth lags behind GDP growth for many years; 2) massive defaults; 3) high inflation; or 4) growing out of debt through very rapid real GDP growth caused by a war effort, a “peace dividend” following war, or an oil boom.
The “belt-tightening” archetype was by far the most common of the four, accounting for roughly half of the deleveraging episodes. If today’s economies were to follow this path, they would experience six to seven years of deleveraging, in which the debt-to-GDP ratio declines by around 25 percent. Deleveraging would begin two years after the start of the crisis, and GDP would contract for the first two to three years of deleveraging, and then start growing again (Exhibit 4).”
“Many historic examples, from the United States in the 1930s to Japan in 1997, show the danger of withdrawing support of the economy too soon. ”
“A revised Basel II framework could require banks to adjust their internal risk weights to reflect levels of leverage in the relevant sector of the real economy.”
“Middle-income households have much lower default rates and instead deleverage by saving more and consuming less, a process that avoids credit losses but slows economic growth.”
“Rapid appreciation of commercial real estate prices, like residential real estate prices, has been at the heart of many financial crises. In their definitive study of financial crises, Kenneth Rogoff and Carmen Reinhart find a strong association between real estate booms and banking crises.”
“lending takes place with only limited disclosure available on the businesses of real estate developers, most of which are private companies. Third, long lead times in real estate supply can result in big price shifts when there is a change in demand. Finally, real estate developers have an asymmetric payoff due to limited liability, with large potential profits if the project succeeds while losses in the case of default are borne by banks and other investors.”
“While governments could have done more to reduce debt during the boom years, it is fortunate that most entered the crisis with ample room to expand public spending, as they have since done.”
“This deleveraging has been associated with rapid declines in bank lending as banks have sought to slow the growth of (and in some cases even shrink) their balance sheets and as they have raised capital. Further deleveraging by the financial sector may result from changes in capital requirements, particularly the requirement that banks hold more common equity.”
“This leads us to the conclusion that the simplest and only effective policy tool to address the deterioration in the quality of capital is to mandate minimum levels of core capital (such as Core Tier 1 capital), as regulators in some countries have now done.”
“of the larger Spanish banks compared with the smaller, regional ones. Going forward, the deflating Spanish real estate bubble is likely to affect most heavily the small and medium-size savings banks (the cajas ), which have a larger proportion of their balance sheets exposed to domestic real estate and which have experienced significantly higher rates of nonperforming loans than larger banks. ”
“All of this leads us to a conclusion that the most likely path forward today—particularly in the United States, the United Kingdom, and Spain— is one in which deleveraging is postponed until after the crisis passes and government debt growth is reined in.
Then, these economies’ debt burdens will most likely decline more slowly and over a longer period than the historical average. That is because not only will the private sector need to deleverage, given precrisis growth in debt, but the public sector will also have a large debt to pay down (see sidebar, Sovereign deleveraging through history ). These highly leveraged economies may therefore remain vulnerable to economic shocks for some time. While we do not forecast GDP, it is likely that deleveraging will dampen GDP growth compared with what it would have been otherwise, possibly slowing the recovery.”
“POLICY MAKERS CAN TAKE STEPS TO PREVENT FUTURE CREDIT BUBBLES
Our analysis has several implications for policy makers and regulators seeking to ease the deleveraging process and enhance future financial market stability, and for business executives as they navigate through these turbulent times.
History shows that policy makers can enable healthy deleveraging by supporting GDP growth through the process. This will require working through multiple channels, such as spurring increases in net exports, productivity growth, and the labor supply. Additionally, policy makers need to carefully consider the timing of reducing government support of aggregate demand. Many historic examples, from the United States in 1938 to Japan in 1997, show the danger of prematurely withdrawing fiscal and monetary support of the economy. However, faced with rising public debt, many governments face an acutely difficult decision on the precise timing of the necessary public spending cuts. ”
“large amounts of foreign capital. Ireland’s total debt relative to GDP more than doubled from 2001 to 2008, to over 700 percent. Financial sector debt accounted for more than half of the total, at 421 percent of GDP. At the same time, the inflow of foreign capital fueled a property boom.”
ECB – The New Anglo!
May 3, 2010
So, instead of allowing Greece to leave the euro and face the consequences, the chief being devaluation, Greece is to be bailed out to the tune of €120bn. Lets examine the detail: http://bit.ly/db08X0
“April 26 (Bloomberg) — Greece is unlikely to be the last euro nation to need an International Monetary Fund bailout, with Ireland, Spain and Portugal “conspicuously vulnerable,” said Harvard Professor Kenneth Rogoff.
eurozone and the IMF to offer Greece euro110 billion ($145 billion) over three years to give it some breathing to deal with its massive debts. In return, the country pledged to push through a further euro30 billion of austerity measures through to 2012, cutting wages and pensions and increasing sales taxes.”
“It’s more likely than not that we’ll need an IMF program in at least one more country in the euro area over the next two to three years,” Rogoff, a former IMF chief economist who has co-authored studies of financial and sovereign debt crises, said in a telephone interview. “The budget cuts needed in Europe in many countries are profound.”
Up to €90bn of the total will come from Eurozone member states including €1.3bn from Ireland. Ireland will borrow its contribution from the ECB and contribute this to the fund in a small percentage premium on its borrowing costs. The effect of this is Ireland will make some money on the transaction, see later paragraphs for more focus on this issue.
Portuguese, Spanish and Irish bond yields jumped last week as investors questioned their ability to reduce budget deficits and avoid Greece’s fate. Greece on April 23 triggered a 45 billion-euro ($60 billion) rescue package from the IMF and the euro region after its soaring deficit sent borrowing costs surging and sparked concern about a default.” Rogoff (who predicted major bank collapse in the USA prior to Lehman’s demise), figure updated in paragraph 1.
Once again, the solution to the borrowing crisis is kick the can down the road with more borrowing and more bailout money in the hope that an economic upturn will allow heavily indebted countries to pay back when times are better. However, when bailout money is offered to eurozone countries in tandem with the need for greater taxation levels, curbs on expenditure such as a contraction of public service services and increasing percentile obligations in debt repayments, the recipe makes recession and not economic recovery. Risk of maintaining repayment levels, clearing the balance sheet of debt, and economic recovery all become increasingly remote. Instead of freedom from debt, risk of default is increased.
The eurozone over the Greek crisis had 2 ways to jump in response. Either it asked Greece to leave the euro and go back to the Greek drachma, devalue and clean its financial state of affairs perhaps introducing more transparency, fairness, accountability and justice into a system of corruption/tax dodging nepotism and croneyism; or, it could bailout Greece with more loans with conditions attached. It chose the latter course using the argument that this was the better way to protect the euro.
This was a mistake. The euro is in a much weaker state following a Greek bailout than without such a bailout. Jean Claude Trichet was not happy with the way Lehman’s was allowed to go under by the FED. He would have preferred if the FED had helped save Lehman’s. Its a judgment call but in this writer’s view the failure of Lehman’s has led to a strengthening of the US financial system evidenced in the recent economic upturn in the US, whereas we await the response of the bond markets to the rescue of Greece. Evidence so far has not been great that there is any bondmarket confidence that the Greek bailout is a good move. A more tactile, flexible, durable and efficient response may have been to allow some of the PIIGS (Portugal, Italy, Ireland, Greece, Spain) to leave the euro, to cut out the toxic part of the eurozone that can only lead to further contagion and to strengthen the remainder.
ECB has issued bonds to support the PIIGS and the money has not been spent wisely, evidence Ireland, Greece and Spain with their property bubbles and inefficient public service wastage. In these cases the ECB has behaved much like an Ireland’s Anglo acting without due diligence handing money over without proper conditions and oversight as to its eventual target. With money on tap, low interest rates, these countries coined it and blew it in a free for all that had no bounds. Instead of punishing these countries, removing them from the eurozone, consolidating and strengthening the remaining countries in the eurozone belonging to the euro and raising the bar of membership, they decide on a bailout for Greece. Why would they do this?
To both ask this question and to answer it requires a level of information that is difficult to get and not freely given out. We need to ask who the bondholders are:
In an article ‘The Fall of Greece May Topple Us All’ Damien Kiberd, Business, P6, Sun Times, 02/05/10, Kiberd makes the following points:
‘Greece owes its creditors €300bn in sovereign debt. The equivalent of €135 bn is owed to German banks, with two thirds owed to German and French banks alone.’
‘Portugal owes €240bn, much of it to French and German banks. But the Portuguese also owe the equivalent of €80 bn to Spanish banks.’
‘A Spanish default would be breathtaking in scale, it owes $850 bn to sovereign creditors.’
Kiberd echoes the information around at the moment that Ireland’s fiscal deficit at 14.3% is technically worse than Greece’s. Also ‘cancellation of May’s debt auction by our own NTMA is not a good omen’.
‘The fear that, in due course, Greece will exit the eurozone, devalue its new currency and seek a 50% write-off!’
Is the above becoming clear? Ok, so here’s the deal. German banks have been getting a good deal from the euro by lending cheap money to PIIGS. In turn, just as many clients of Anglo squandered the loans and acted without due diligence, German bondholders have hosed this money around the eurozone without due diligence.
Their answer to this problem at the moment is to kick the can down the road, lend out more money to countries who a) can’t afford it b) don’t know how to spend it well because of an abundance of cute hoor gombeenism. There is the chance more profits can he had from these gombeens if their economies improve and they get to pay back big lenders. The Armegeddon alternative, it would appear, is to restructure the eurozone and have these indentured countries default at great cost to their lenders of first call, German bond holders.
Don’t believe the stability of the euro is at stake, or the right to proper social services and lower taxes, what is at stake is the profits to be made from taxpayers across Europe by German bondholder banks.
Finally, don’t believe there is much salvation in sovereign default or the complete break up of the eurozone in favour of a triumphant dollar. Currently the American middle class is being decimated by Wall Street. The rich are becoming richer and the poor are becoming poorer.
The banks want their hands on dollars and euros funding social services, education/health care, from the world, north and south, redirected as profit/interest on their bonds. In search of that purpose, neither currencies, governments, wars, right or wrong, will stand in their way. Watch the markets, the shorts!
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