Home > Economics > It’s the debt – stupid!

It’s the debt – stupid!

Some stats from the Swedish experience in early 90s. Bad loans 12% of GDP. Total loan losses 10%. GDP contraction 6% over 3 years. House prise fall 20%. Depreciation of SEK 30%. Unemployment in double digits. Stocksmarket halved. Consumer debt to GDP 40%.
Looks roughly like what we’re experiencing right now, with a couple of very important differences. 1) The crisis now is global, back then it was regional. Sweden could devalue and export itself out of a recession. 2) Consumer debt to GDP is now well above 100% in for example US & UK.

Now, loan losses will be greater, which means a Tier 1 ratio of 10 (4-5 was considered a safe level for a bank just 18 months ago) will go to zero and beyond, i.e. nationalisation or bust long before that. Don’t think banks can raise enough cash through rights issues anymore. In addition, governments are spending a lot more today (above 5-6% of GDP has been allocated in anglo-countries so far), than back then, in trying to save the banking system, with inefficient methods. Governments borrowing needs get out of control as a result, which forces central banks to print money, which in turn is inflationary, which devalues the currency.

We’ve already seen this happening, for instance in the UK this week with a failed government auction and Mr King warning about inflation (3.2%) and the state of the public finances. The US faces similar problems. Left is only to print more money or stop spending and deleverage.
Germany tried the first in the 1930s, which didn’t go to well. Stop spending and deleverage is likely to mean mass unemployment and depression for a long time.

Any of these options is likely to lead to markets questioning USD as the reserve currency. China has already expressed such thoughts. The current US government spending to bail out the banks and the economy is now more than $4.6 trillion. That is $4.600.000.000.000, or more than the Marshall Plan, Louisiana Purchase, Moonshot, S&L Crisis, Korean Was, The New Deal, Iraq War, Vietnam War and NASA’s all time budget put together. That is a lot of money. With spending programmes like that comes the inevitable question concerning the US’ AAA rating. Weaker USD is more than likely. For good old UK the situation looks if possible even worse, but that path is the same.

What to do? Well nationalisation is probably the cheapest option. It didn’t actually cost the Swedish taxpayer that much (or anything if you believe some studies) and it enabled banks to lend again.

Now, that’s the real problem, the debt level of consumers and corporations. That’s why this recession is likely to be longer and deeper than any other. We need a total change in people’s minds to debt. This will take a very long time. Now, having said that it doesn’t mean you can’t make money in stocks, commodities or bonds whilst the economy recovers. But if you’re long term and look for an absolute return it’s likely you have to have a very long term view.
I’m afraid a lost decade is definitely on the cards, but I hope that I’m wrong.

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