Monday, 1 April 2013

Super Cycles.. not the end, perhaps the beginning of the end

David Stockman has written a piece in the NYT  ahead of the launch of his latest book,   The Great Deformation: Capitalism Corrupted which is out tomorrow. There has been plenty of fuss and he's succeeded in annoying Paul Krugman amongst others.

Mr Stockman blames crony capitalism, badly designed fiscal stimulus, financial bailouts and easy money for the woes of the US.  And of course, he predicts than when the next bubble bursts, the US will be left defenceless and the effects will be awful. Cue a decent Easter debate (that's the polite term) in the press, and on social media.

Away from the rhetoric and the politics, there's at least a core of truth in some of what he writes. Anyone interested in the subject really ought to start by studying the work of the Bank Credit Analyst and you could do worse than google the term 'debt super-cycle'.  Since the end of the Volcker era at the Federal Reserve, the US has seen a long-term downtrend in both nominal and real interest rates. That's the reward for the defeat of (consumer price) inflation, in turn helped by Mr Volcker but also thanks to the benign effects of globalisation.

What the Fed has done, is use the freedom created by subdued CPI, to adopt incredibly easy monetary policy at the first sign of danger, and keep rates very low regardless of the effect on other parts of the US economy. They started in the early 1990s, when the Fed cut rates to 3% in response to the S&L crisis. The denouement in 1994 and onwards, was fine for the US but catastrophic for many countries which had tied their currencies to the dollar. Some of you may say 'so what?' but it was hardly great global leadership. In 1998, the Fed cut rates far too quickly after the LTCM 'crisis' and was too slow to raise them, starting the housing bubble which lasted a decade and lighting the fuse for the dotcom bubble. And after a very mild recession at the turn of the Millennium, a period of crazy monetary policy was as much the cause of the credit bubble which ended with the 'Great Recession' as lax bank supervision and greedy bankers.

In 2008, I thought the debt super-cycle had ended.  It seemed obvious that households and companies would reduce their leverage and that the financial sector would be forced by regulators and natural caution to lend less, and build up more defensive balance sheets. What I hadn't reckoned on, was that the public sector could take over so much of the debt and that the Fed would respond by adopting even easier monetary policy. The asset bubble whose explosion triggered the recession, was caused by negative real interest rates. Economic recovery is being built on even more negative real interest rates, which have indeed triggered a recovery in asset prices from equities to housing.

I've learnt to be wary of saying that the Fed is out of bullets. QE and ZIRP are working. There is collateral damage in the form of increased economic inequality and in terms of overvalued exchange rates in some emerging economies, but the US is going to out-grow most other developed economies in the next few years. And since ZIRP, QE and the dollar's reserve currency status all combine to allow the US to borrow money at deeply negative real yields, I don't even see why the government wouldn't go on postponing sensible fiscal policies. If I could borrow 10-year money at less than 2% per annum to invest in an economy growing at 4 1/2% in nominal terms, I would. And after all, political gridlock in Washington doesn't look that bad when you compare it to the synchronised fiscal masochism in Europe.

I wouldn't rule out a longer period than many expect when US bond yields can stay below nominal GDP growth, continuing to support asset prices; when globalisation keeps on keeping wage growth down and CPI inflation under control; and the US can give a very decent impression of being in the early stages of an OK economic recovery. The rest of us, wearing our hair shirts and struggling to get out debt levels under control in the face of recession, will be thankful for any growth we can import from the US.

That's where I disagree with Mr Stockman. 2008 didn't signal the last 'mini-cycle' of the debt super-cycle; maybe it didn't even signal the last-but-one. The  philosophical rights and wrongs of mad money and ever-rising public sector debt levels, can fuel debate but when Ben goes and Janet takes over, the policy recipe could just stay the same. So Mr Stockman may find that he is an awful lot older before he is ever proved right in his warnings of doom...

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