SINCE the global financial crisis in 2008 and the ensuing Great Recession, innumerable reports on the world economy have appeared from official bodies such as the International Monetary Fund, the World Bank and the OECD, as well as academic institutions, seeking to ascertain when a ‘recovery’ might begin.
Released this week, the 16th annual Geneva Report, commissioned by the International Centre for Monetary and Banking Studies, and written by prominent economists, differs in one major respect.
Earlier studies, while pointing to the ongoing problems of the world economy, have tried to find at least one ‘bright spot’. This report finds none. In fact, its basic theme is that any number of economic scenarios in one or other region could set off another financial disaster.
The report’s main focus is what the authors call ‘debt dynamics.’ Contrary to the widely-held belief that debt has come down since the global financial crisis, they point out that the overall world debt (public and private) ratio to GDP has reached new highs. Excluding financial sector debt, it has risen by 38 percentage points since 2008 and now stands at 212pc of GDP.
The US Fed’s quantitative easing and its low-interest rate regime has encouraged the corporate sector to take on more debt to build up cash buffers, lift dividends and buy back stocks
The authors point to a ‘poisonous combination’ of lower world growth and lower inflation. When inflation is relatively high, debt burdens are easier to pay off because the real value of money is lower. In today’s world of lower inflation and even outright deflation, however, deleveraging becomes much more difficult. At the same time, debt reduction lowers growth, setting in motion a ‘vicious loop.’
The report also notes that potential output growth in the developed economies had been on the decline already since the 1980s. The financial crisis “has caused a further, permanent, decline in both the level and growth rate of output.”
The report casts a critical eye over the US economy. “[C]ontrary to the widespread perception and self-congratulations of public officials,” it remains heavily indebted as a consequence of the near 38 percentage point increase in federal debt relative to GDP. Much of the increase in public debt resulted from financial bailouts.
The most striking result of state intervention to prop up the US financial system is the expansion of the balance sheet of the Federal Reserve. Its holdings of financial assets have gone from less than 6pc of GDP in 2007 to 25pc today.
The Fed’s increase in asset purchases, known as quantitative easing, coupled with its low-interest rate regime, has encouraged the non-financial corporate sector to take on more debt. This borrowing has not been used for real investment and increased production but to build up cash buffers, lift dividends and buy back stock to boost share values.
Keeping interest rates low made investors ‘stretch for yield,’ the report states. “In effect, the Fed has been ‘recruiting’ investors to purchase risky assets. The problem is that not all investors may appreciate the extent of the risk they acquire in the bargain.”
Surveying the European economy, the report says that on the “current projection for inflation and potential output growth, the eurozone finds itself in a situation of great fragility.”
China is “one of the candidates for the next episode of the debt crises that have plagued the world since the early 1990s.”
The path for ‘successful’ debt reduction ‘looks quite narrow, and “there is a high likelihood of either a prolonged policy of very low growth or even another global crisis.”