Monday, 16 July 2018

On mid-term ennui, and debt to GDP

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Anthony Peters asks: why all the yawns about the US elections?

Five weeks today America goes to the polls for the mid-term elections in which the entire House of Representatives and a third of the Senate are up for grabs. Although mid-terms never generate the same excitement as does the four yearly Presidentials – in which the House and a third of the Senate are also voted for – this particular election run seems to be generating less interest than any I can remember. That’s despite some big news such as the ousting of the Republican House majority Leader, Eric Cantor of Virginia, in the primaries by a Tea Party activist.

Might it be because of the loss of faith amongst Americans in their politicians after the budget and debt ceiling shenanigans? Might it be because of their loss of faith in the Presidency after six highly indifferent years of the O’Bama White House? Mind you, what else did they expect from a first term Senator who had only served four of his six-year senatorial period when he decided to storm 1600 Pennsylvania Avenue?

Or could it simply be that as it is, in the words of Bill Clinton ”..about the economy, stupid”. There is tacit understanding that the economy is in the hands of the Federal Reserve System and not in those of the politicians, irrespective of what hue?

Or might it be, behold, that the geo-political shifts which are visibly taking place around us are leaving even isolationist Americans with a sense of inevitability, whoever is in power? It will be a tightly-contested fight as little has changed in the past 20 or so years which have seen the country divided pretty much equally between the two main parties.

The final outcome might be defined by just one or two seats in the Senate which is currently as firmly in Democrat hands as the House is in those of the Republicans. As lame a duck as the President might now be, losing the Senate now would leave him for dead, and the country’s political system could fall into a persistent vegetative state. And yet, nobody seems to particularly care.

Perhaps once should rewrite Slick Willy and say “…it’s all about the central banks, stupid”.

Rising debt, slowing GDP

Of note is the 16th annual “Geneva Report” presented to us a couple of days ago by the International Center for Monetary and Banking Studies which paints a grim picture. It predicts that interest rates will have to remain low for a very, very long time in order to account for the rising debt at both public and private sector levels. It notes that households in the advanced economies have de-leveraged but that the public sector has done the opposite, and that household indebtedness in emerging economies has been building up drastically, mainly in China. It warns of a “poisonous combination of high and rising global debt and slowing nominal GDP, driven by both slowing real growth and falling inflation”.

The key observation is that global debt as a proportion of global GDP has risen from 160% in 2001 to 200% after the World Financial Crisis and, instead of falling from there, it has continued to rise to hit 215% by 2013.

Since Thomas Robert Malthus divined in 1798 that the world was going to die of hunger because the population was growing faster than food production, apocalyptic visions have abounded. I grew up under the threatening cloud of the Club of Rome’s 1972 book titled “The Limits of Growth” which forecast that population was outgrowing resources. Is the Geneva Report possibly just another “one of them”?

I broadly agree with the view that most of the recovery, in as much as we have seen it, has been funded by adding debt, and that there seems to be no strategy in place to repay it – cutting deficits as you know does not reduce debt, it just slows the build-up – but I have also lived through decades of calls that the system is about to hit the wall. So far it has not.

Debt to GDP means nothing. The relevant measure is the proportion of tax take which needs to be spent servicing outstanding debt and that, at this moment in time is very modest. Forget the cost to households of their mortgages. Imagine what happens if, as and when the cost of financing the US$17trn+ of the US national debt rises by, say, 200bp across the curve. That amounts to something in the region of US$350bn in extra cost or US$3,000 per tax payer. As much of the debt is not held in the US, the money is not simply recycled within the economy but it is gone. I could go on.

And yet, most of the worst case scenarios which I have encountered over the past 40 years since the Club of Rome report have not set in. I suspect that the same will apply again. This is not to say that things might not get tricky. Rates must and will rise and the sooner we can create a more balanced financial system with proper return on money invested, the better.

Adjustment will not be painless but then it never is. Then again, maybe Bill Gross will once again prove to have had the best long game with his bet that markets are too bearish on rates. In that context, do the mid-term elections really count?

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