Opinion
COULD DEBT FORGIVENESS BE THE INTERIM SOLUTION FOR THE WORLD’ S ECONOMIC MALAISE?
By Steve Brice, Chief Investment Strategist, Wealth Management, Standard Chartered
There is a growing perception that monetary policy is losing its power to solve the world’ s economic problems. This may be misleading. What is probably true is that incremental policy easing is experiencing diminishing – and, possibly, negative- returns. Therefore, central banks – and governments- may need to get even more unconventional to reverse the tide. Japan appears to be closest to the tipping point in this regard, although there are few signs that it is winning the battle.
As the global economy faltered while recuperating from its longest recession since the Great Depression, central banks in the developed world moved from simply lowering interest rates – bringing them all the way down to zero- to issuing forward guidance with promises to keep interest rates low for a long pe riod …. to buying bonds, ultimately reducing rates to negative. The Euro area, Japan and some Scandinavian countries are notable examples.
The problem is the lack of sufficient growth and demand. Although the developed economies have recovered somewhat from the Great Recession, they are still not growing at their precrisis pace. This is not surprising given economic growth in the 40 years prior to the 2008-09 financial crisis was largely financed by debt. The emerging economies bucked this trend for a while, helped by the seemingly unending rise of China. However, in the aftermath of the financial crisis, China’ s boom also became increasingly debt-financed, with the result that attempts to deleverage have led to much slower growth in China and other emerging markets.
We are all taught as kids that we cannot forever spend beyond our means and that the chickens will ultimately come home to roost. So it is with countries and economies. With global debt levels very high, and rising, the world is likely to experience continued sluggish growth, at best, for years to come.
So how do we deal with this? In theory, there are several ways in which one can reduce debt financing concerns. 1) Cut funding costs 2) Pay off debts 3) Grow our way out of the debt 4) Write the debt off
There are problems with all four options. Let’ s take the first one- interest rates are already extremely low and it is difficult to cut funding costs much further.
In the second option, if everybody tries to pay off debt it would reduce spending and investment, undermining demand, corporate revenue There is a growing perception that monetary policy is losing its power to solve the world’ s economic problems. This may be misleading. What is probably true is that incremental policy easing is experiencing diminishing – and, possibly, negative- returns. Therefore, central banks – and governments- may need to get even more unconventional to reverse the tide. Japan appears to be closest to the tipping point in this regard, although there are few signs that it is winning the battle.
As the global economy faltered while recuperating from its longest recession since the Great Depression, central banks in the developed world moved from simply lowering interest rates – bringing them all the way down to zero- to issuing forward guidance with promises to keep interest rates low for a long peand economic growth. This can lead to a negative spiral, especially if it incurs deflation( or falling prices) which increases the debt burden of borrowers in inflation-adjusted terms.
The third route – through faster growth- is clearly the optimal outcome. Here, it is nominal growth that matters( real growth plus inflation). However, the high debt levels make this outcome difficult to achieve. As stated above, despite extraordi-
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