Satyajit Das: World economy is addicted to credit and the markets seem oblivious

Midweek View: A debt write-off would result in a significant loss of wealth for lenders and trigger an economic contraction
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The Independent Online

Financial market indicators suggest that the global economy's condition is brighter than an examination of the real economy would suggest. Following the seizure in 2007/2008, liberal injections of taxpayer cash avoided catastrophic failure, assisting a modest recovery. Governments ran large budget deficits. Interest rates around the world were reduced. Balance sheets of central banks have increased from $6 trillion to $18 trillion, 30 per cent of global gross domestic product (GDP). The global economy is now addicted to monetary heroin.

The US is in marginally better condition than others – the "cleanest dirty shirt". But despite a $1 trillion annual budget deficit (6 per cent of GDP) and expansionary monetary policy, growth is a tepid 2 per cent.

The US housing market's rate of descent has slowed, but prices remain 30 to 60 per cent below highs. New housing starts have stabilised, at half peak levels. Benefiting from a weaker dollar, manufacturing has improved. Lower oil and natural gas prices have benefited the economy.

Employment remains weak. Consumer spending remains patchy. Job insecurity, lack of earnings and wealth losses are causing households to cut spending and repay debt.

Record corporate profits have been achieved mainly through cost reductions. Investment is weak due to the lack of demand. Bank lending is sluggish due to lower demand for credit and problems of financial institutions.

Federal public finances remain unsustainable. Cuts in spending, mandated under the 2011 increase in the national debt ceiling, would improve deficits, but adversely affect growth. State and municipal finances are under severe stress.

Europe remains trapped by high debt levels, budget and trade deficits, social spending inconsistent with tax revenues, poor industrial competitiveness, a rigid monetary system and inflexible currency arrangements. This is compounded by the weaknesses of the European banking system with large exposure to sovereign bonds issued by peripheral nations.

Europeans believe stabilisation and recovery can be achieved through greater integration. Even if issues of national sovereignty can be overcome, integration will not work. The arithmetic of European debt problems is that the EU and Germany, its main banker, does not have enough funds to rescue the beleaguered eurozone members.

Austerity dooms Europe to recession as the debt burden is worked off. The alternative, a debt write-off, would result in significant loss of wealth for lenders, triggering an economic contraction and stagnation.

Japan is in a state of advanced atrophy. Its primary investment merit is that almost all possible man-made and natural disasters have happened and the worst is factored in.

The Bric nations (Brazil, Russia, India, China) are unlikely to be able to offset weakness in more developed economies. China's growth is slowing rapidly. India and Brazil have also lost momentum, with growth weakening. Russia is dependent on high energy prices.

Bric weakness is a function of lower demand from developed countries, reducing exports, and weaker commodity prices. The withdrawal of European banks, historically major lenders to emerging markets, has decreased the flow of money to countries needing foreign investment.

Emerging markets show signs of the developed world credit virus. A rapid expansion of domestic credit in China, Brazil, Eastern Europe, Turkey and India will result in banking system problems. The combination of external and internal weaknesses threatens emerging economies, naturally prone to serial crises. Most importantly, necessary structural changes have simply not occurred. Borrowing levels remain unsustainable. Debt levels for 11 major nations have increased from 381 per cent of GDP in 2007 to 417 per cent of GDP in 2012. Debt has increased in Canada, Germany, Greece, France, Ireland, Italy, Japan, Spain, Portugal, the UK and the US.

The global economy has a serious chronic condition with limited prospects of a full cure. It exists in an impaired no or low growth state. The threat of a sudden life-threatening seizure cannot be discounted.

Financial markets and investors seem strangely oblivious to the reality and risks. Perhaps they have taken the rock star Steven Tyler's advice: "Fake it until you make it".

Satyajit Das is a former banker and author of 'Extreme Money' and 'Traders Guns & Money'

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