Article / 26 September 2014 at 11:00 GMT

Surely not this old chestnut – again?

Chief Economist & CIO / Saxo Bank
Denmark
  • Dearth of policy options as 'pretend and extend' continues to dominate
  • US growth stubbornly stuck at 2.0%/year growth levels
  • China's rebalancing efforts set against backdrop of alarming debt

By Steen Jakobsen


‘Interest on debt grows without rain’ – Yiddish proverb


This proverb explains most of what goes on in policy circles these days. We are now watching Extend-and-Pretend, Episode VI: Promises for improvement amid ever growing debt levels.

In brief, we’re still working with the same dog-eared script we were introduced to all of five years ago, when markets had stabilised in the wake of the financial crisis: maintain sufficiently low interest rates to service the debt burden.

In other words, pretend to have a credible plan, but never address the structural problems and simply buy more time. But while we were able to get away with this theme for an awfully long time, the dynamic is now changing as the risk of low inflation (and even deflation) is a brick wall for the extend-and-pretend meme. Yes, interest does grow without rain, and the cost of maintaining and servicing debt grows especially fast in a deflationary regime.

Mads Koefoed, Saxo Bank’s macro economist, projects US growth at around 2.0% for all of 2014. That will be the sixth year with US growth near 2.0%, so despite lower unemployment and a record high S&P500, the economy has a hard time escaping that 2.0% level.

b  The US may be getting back to work, but why are growth rates
so stubbornly stuck at the 2.0% mark? Photo: Thinkstock
 

Any talk of higher interest rates is hard to take seriously when US growth is going nowhere and world growth is considerable weaker than was expected back in January (or as recently as July, for that matter). It seems everyone has forgotten that even the US is a part of the global economy.

The fourth quarter is always the most politically interesting time of year. Countries need to get their new budgets in order. The EU, IMF and World Bank will need to pretend they agree or accept the weaker data, which has to mean bigger deficits.

It’s a tiresome exercise to watch denial-in-action as EU governments and other policymakers try to make something so obviously unpalatable go down easy in their internal reporting. '

It’s obvious that buying more time (extending) is always the number one priority, followed by projecting (pretending) that forward looking growth will reach an ever-higher trajectory in order to make the budget fit within the supposed constraints. Or in France’s case, the recent unilateral abandonment of meeting budget targets for the next two years is already a fait accompli. Who’s next?


Such behaviour would cost you your job in the private sector, but in the economic model of 2014, which reminds us more of the Soviet Union than a market based economy, it’s par for the course. But, many would protest, it would be even worse if we hadn’t done so much to “save the system”, right?

Well maybe, except for the fact that those economies where the belief in State Capitalism is strongest – Russia, China and France – are all at the end of the line. Time has caught up.

Negative productivity, capital flight and a system built on protecting the elite is failing.

France is now moving from recession to depression. China is moving quickly from denial towards a mandate for change, Russia’s future has not looked this bleak since the late 1990s. Meanwhile, the US continues at a sluggish 2.0% rate of growth. Investors and pundits seem to have forgotten that we were promised 2014 would be the end of the crisis.

x

 China's efforts to build a better, more prosperous society has led to a rethink
of its economic policies in the last 12 months. Photo: Thinkstock

 

Instead, we are speeding towards the inflection point at which debt becomes harder to service because pretend-and-extend policy making has created a depression in investment and consumption.

The public debt loads continue to inflate across Europe: Portugal’s public debt has ramped up to a staggering 130% of GDP, up from about 70% in 2007. Greece’s public debt load, even after the restructuring of Greek debt a few years ago, has swelled to 175% of GDP. The EU now has far more systemic risk than it did at the beginning of the crisis. 

With zero growth or as our economist Mads sees it, 0.6% with the arrow pointing down, debt levels continue to rise relative to GDP. And most importantly, the current flirt with deflation will make servicing the growing debt even more expensive.

The nightmare for both the European Central Bank and the world is deflation, as it’s a tax on debtors and a boon to net savers. The new reality is that we currently stand face-to-face with the very deflation risk that just about everyone denied could ever happen when Q1 outlooks were written.

Two other global threats (or time bombs, if you will) outside of the EU are risks from the growing costs of servicing debt in China and the US. In China, the governments – national and local – have piled up considerable debt, but it is the overall debt service costs in all of China that are the real concern, which have only grown so large with the dangerous assumption by Chinese banks, companies and citizens that they can count on a public bailout. 

According to a Societe Generale analyst, total debt service costs (including maturing debt and roll overs) in China are at nearly 39% of GDP. Compare that with the closer to 25% of GDP for the US in 2007.

In the US, interest on US government debt cost over 6% of budget outlays in 2013. This is relatively down from its worst levels when interest rates were much higher, but only because the Federal Open Market Committee has so drastically lowered the costs for the US government to issue debt with a zero interest rate policy.

And now the debt load is vastly larger than it was before the financial crisis, at 80% of GDP (net debt according to IMF) versus 45% of GDP a mere 10 years ago.

So are we actually to believe that the Federal Reserve can lift the entire front-end of the curve from 0-1% (current rates out to three years) to 2-4% over the next two years without adding massive further stress onto the deficit, and only adding to the debt? 

Servicing 2% interest when growth is 2% means you are doing worse than standing in place if you also have a budget deficit.

Whatever the timing, the US, China and Europe are all headed for another Minsky moment: the point in debt inflation where the cash generated by assets is insufficient to service the debt taken on to acquire the asset. Productivity growth in the US last year was +0.36%. The real growth per capita was about 1.5%. 

Anything which is not productivity is consumption of capital. So, the only way to grow an economy without productivity growth is to do so temporarily through the use of debt – about 75% debt and 25% productivity growth, in this case.

Since the 1970s, US productivity growth rates have fallen by 81% – the move onto the internet has ironically made us bigger consumers and less productive. Had we remained at pre-1970s productivity, the US GDP would have been 55% higher and the outstanding debt to GDP would be easily fundable.

Anecdotally, and by way of conclusion, I just returned from Singapore on business.

Singapore, to me, used to be the most rational business model around. Its founder Lee Kuan Yew was one of the greatest statesmen in history. Now, productivity is collapsing in Singapore. They are, like us, becoming the Monaco of the world — an economy based on consumption and not on productivity and growth. 

The developed economies are growing old in demographic terms, but we’re still not wise enough to realise that our current model is a Ponzi scheme rushing toward its inevitable Minsky moment. No serious policymaker or central banker is talking about the truth told by simple maths and hoping that things turn out well. Hope is not good policy and it belongs in church, not in the real economy.

c

 Bastion of forward -thrusting, aggressive capitalism Singapore has recently witnessed
a collapse in productivity that epitomises the global malaise. Photo: Thinkstock

 

-- Edited by Martin O'Rourke


Steen Jakobsen is chief economist and CIO at Saxo Bank

3y
ChrisandAmber North ChrisandAmber North
It would be nice if CNBC would link to this article the interview says the piece is called "Debt the elephant in the room" , but I see it is called "Surely not this old chestnut – again?" http://www.cnbc.com/id/102035634
3y
Wizof0z Wizof0z
Since all fossil-fuel-enabled productivity is only temporary, it is safe to state to permanently-sustainable world productivity hasn't really grown for decades, if not centuries. There are relevant opinions which can comfortably state that the world's ecological systems could not sustain more than a billion people. For now we are called crazies, but what will be called in, say, 25 years? Ohh, and there is no such thing as a 'safe' level of radiation; All gamma rays damage organic tissues.
3y
Wizof0z Wizof0z
Typo" it is safe 'to state that'
3y
Wizof0z Wizof0z
Would you like some tuna with your caesium-137?
3y
BILLWILLIAM FOULKES BILLWILLIAM FOULKES
Why should EUR-USD go up once the foolish market realizes we are a 2%, not 3% while Europe
is on the brink like Cary Grant in North by Northwest?
3y
Solidus Solidus
What to do when we blow up? I hoarded cash which causes lower inflation - liquidity trap. Maybe Steen exaggerate and we get nice deleveraging according to Ray Dalios' machine theory.
Relevant articles for you

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Tradingfloor.com permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Tradingfloor.com and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Tradingfloor.com is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Tradingfloor.com or as a result of the use of the Tradingfloor.com. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through Tradingfloor.com your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. Tradingfloor.com does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer
- 沪ICP备13028953号-1

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail