Central Banks and the Borrowing Addiction: Romain Hatchuel
http://online.wsj.com/article/SB10001424127887324688404578541822549510286.html?mod=WSJ_Opinion_LEADTop
Have financial markets become a giant crack house? Investors have certainly been acting like a bunch of junkies lately.
Any hint that their main dealer—otherwise known as Federal Reserve Chairman Ben Bernanke—might start cutting down his generous supply of cash sets them off in a frenzy. Mr. Bernanke’s latest comments on Wednesday, signaling a sooner-than-previously anticipated tapering off of the Fed’s monetary easing, triggered a sharp global selloff in practically every asset class.
Japan, the world’s most central-bank-driven market at the moment, recently has been at the forefront of this commotion. After rallying 50% from the beginning of the year until May 22, the Nikkei 225 index lost more than 13% in a matter of days due to fears of the Fed reducing its asset purchases, and contradictory statements made by Bank of Japan 8301.JA -3.68% chief Haruhiko Kuroda about the targeted level of interest rates. It has fallen another 4% since the end of May, putting it close to bear market territory. This growing dependence on central bank liquidity is only the latest stage of a long process of addiction that began decades ago.
Drug addicts turn to dangerous and potentially lethal substances in order to find happiness, or at least some comfort, that their sober lives can’t provide. Getting high is a way for them to live in a falsely enhanced reality. That is exactly what most developed nations have been doing for the past 30 years—artificially stimulating their economies by abusing a toxic substance called debt.
From 1980 to 2010, the average amount of household, nonfinancial corporate and government debt as a percentage of gross domestic product in G-7 countries (the seven most industrialized economies, excluding China) grew to 303% from 177%, a 71% jump. Over that same period, real GDP in these seven countries increased by 88% on average. When considering these two statistics, it’s hard not to infer that a heavy reliance on debt had something to do with the economic happiness the world’s richest nations enjoyed during those years.
A closer look at the United States over a longer period provides an even clearer picture. From 1950 to 1980, the world’s largest economy soared by 191% in inflation-adjusted terms, while the combination of household, corporate (including financial) and government debt increased by a mere 12%. In the following three decades, from 1980 to 2010, the U.S. GDP grew a more moderate 124%, yet total debt rose by an almost identical 125%.
Although one needs to be careful when drawing conclusions from such data, it is obvious that surging debt—whether public or private, household or corporate—contributed massively to the advanced world’s economic expansion. Our prosperity was, if not stolen, at least borrowed from the future. Well, the future is now, and payback time is nearing.
Major central banks in late 2008 and 2009 engaged in unprecedented monetary easing conducted to avoid a full-fledged financial meltdown. In doing so, they have postponed the adjustments required to stabilize let alone bring down, aggregate levels of debt in the world’s largest economies. The Fed and its counterparts from England, the euro zone, Switzerland, Japan and China, have printed an astounding $10 trillion since 2007, tripling the size of their combined balance sheets.
By flooding the world with liquidity and keeping interest rates at rock-bottom levels, they have exempted many fiscally challenged nations from having to deal with their debt addiction. These policies have also provided artificial support to household wealth and spending, as well as corporate balance sheets.
Why get off the drugs if Mr. Bernanke and other members of the international central-bank cartel are providing a seemingly infinite fix? For a good reason: The risk of a global overdose is probably as high as it has ever been.
Asset prices look bubbly across the board, resulting in erratic price movements that extend way beyond Japanese borders. U.S. 10-year Treasurys, which are among the least volatile securities, posted their worst monthly performance since December 2010, losing 3.5% of their value in May (and another 2% since then).
Few serious money managers will tell you that they still see compelling investment opportunities out there. The more optimistic ones usually put forward the same lame reason: liquidity, liquidity, liquidity. In other words, cheap money should continue to drive up asset prices.
Austerity-bashers agree that the party must go on. One of their most outspoken leaders, New York Times columnist Paul Krugman, has been arguing for years that austerity simply “doesn’t work.” But his criticism fails to address the issue properly, since it ignores the fact that austerity—a combination of spending cuts and tax increases—is not a policy intended to stimulate growth. If anything, austerity initially hinders economic activity (as several peripheral European countries are now experiencing), and may even interfere with deficit- and debt-reduction efforts. Rehabilitation is not designed to provide short-term relief to drug addicts. It is always a long and painful process.
Most of those against austerity concede that some sort of fiscal consolidation—deficit and debt reduction—is needed, but not in times of economic hardship. This theory takes no account of the considerable risks that the global economy still faces. These threats require immediate fiscal action—delaying such action undermines confidence and could create self-fulfilling prophecies.
How long will markets continue to give credit to debt-addicted nations? Would any of us lend money to a junkie? This “spend more, worry later” approach is also a waste of the historic momentum that the crisis created for fiscal discipline and reform—momentum that is now fading due to asset reflation.
Austerity is not a choice, nor is it an alternative to some other economic policy. It is a life-or-death obligation meant to prevent the world from an otherwise inevitable debt overdose. Unlike what some would like to believe, there is no painless recovery from a crisis that follows 30 years of stolen growth through heavy debt abuse.
Mr. Hatchuel is managing partner of Square Advisors, LLC, a New York-based asset management firm.
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