Look forward to a new mediocre for the world economy. Five years after the great recession, growth remains sluggish – conforming to the pattern of previous financial crises – but some countries suffer more than others. The U.S. has broken out of this malaise to the benefit of equities, but growth is lackluster because of a lack of re-leveraging. U.S. consumers continue to pay down debt and shy away from new debt even though mortgage yields have fallen to record lows. U.S. corporate sector leverage has risen somewhat, but companies have borrowed largely to retire stocks rather than fund new growth.
The trend of slow credit creation is global. Credit growth in Europe and the emerging markets continues to contract. Banks are reluctant to lend and businesses and consumers are loath to borrow. Globally, total private sector credit growth is poor.
- Liquidity conditions, driven by the European Central Bank (ECB) and the Bank of Japan (BoJ), will remain easy over the next year
- Even the end of the Fed’s Quantitative Easing program does not imply a tightening of liquidity conditions because
- The Fed will raise rates before it shrinks the balance sheet
- The combined expansion of the ECB and BoJ balance sheets could amount to an additional $2 trillion (equivalent to about 45% of the Fed’s balance sheet)
Policymakers around the world are “all in”, determined to keep liquidity conditions flush and protect the banking system until economic activity is strong. This environment ferments asset bubbles!…oil being the most recent example.
The U.S. economy has re-emerged as a growth leader, while the rest of the global economy is sub-trend. Skeptics have been amazed by the chronically distrusted, yet durable, U.S. economy and corporate profit expansion. The U.S. was written off in 2008, yet recovered – it survived the greatest banking crisis since the 1930s, fiscal cliffs and political paralysis and, up until 2011, an overshoot in oil and commodity prices – with no assistance from the global economy, which has been a persistent source of drag. In Europe, the specter of a double-dip recession has given way to the prospect of protracted stagnation. In Japan, nominal growth has stalled, but another dose of stimulus is sustaining reflationary momentum. In China, the cyclical progress in the economy is two steps forward, one step back, with the authorities simultaneously juggling reforms and growth.
It will be a long and halting rehabilitation process before businesses and consumers lever up their balance sheets again, even with central banks around the world encouraging borrow and spend by keeping rates at zero. An unleveraged economic expansion could define the future global business cycle in three ways:
- Over-saving. Europe has seen the largest surge in excess savings; Japan’s excess savings are shrinking, but still sizeable; the U.S., which has been a chronic undersaver, has saved more since 2008; China’s domestic savings rate remains at around 50%.
- Increased likelihood of a long economic cycle. Unleveraged growth means the developed world is unlikely to move into a boom which also means it is unlikely to fall into bust or recession. Without borrowing, the aggregate GDP growth of an economy will be confined by its natural rate of income growth, about 1%-2.5% for a developed country.
- A lack of leverage implies a “balanced” world. Low leverage comes with huge costs; export countries have run down their fiscal surpluses because they can no longer sell according to their productive capacity, while net importers save more and spend less, thus reducing their imports.
Too many goods produced and low demand; this backdrop is clearly deflationary.
Michael Ashley Schulman, CFA
Hollencrest Capital Management