There’s nothing like two weeks of cricket to clear the head. As I watched Michael Clarke’s accumulation of a triple century last week it occurred to me that the financial world hasn’t the patience for a five-day Test match, let alone a once-in-a-lifetime deleveraging cycle.
The Big Bash of the debt crisis looks to be over and we are now in the long grind of debt reduction and low growth. But the language of crisis will probably continue since media and commission brokers (the volatility junkies) will always conspire to cultivate fear and activity.
Mind you, there will be plenty of fuel for that this year, what with $US7.6 trillion worth of debt maturing among the world’s leading economies in 2012, according to Bloomberg.
That may be hard to get away, since the borrowers that are safe hardly pay any interest, and those that pay interest aren’t safe. And there is always the possibility of mass panic (buy or sell), since markets sometimes adjust in jerks to gradual changes in the economic environment.
But underlying it all is a grinding Test match on a flat pitch. Growth is slowing in the US, Europe, Japan and China — how could it be otherwise when governments and households are trying to reduce debt at the same time and lenders can’t make money from money anyway? Without an expansion of credit there cannot be growth, and without growth deleveraging will be a long and painful process.
Monetary expansion — ECB bond buying and guarantees in Europe and QE3 in the US — might temporarily lift share prices during 2012 but it will worsen the underlying economy by also raising commodity prices and doing nothing to reduce debt.
The best insight on what’s happening came from Bill Gross of Pimco, published in Business Spectator on Friday. He pointed out that developed economies have not, in fact, deleveraged since 2008 thanks to “multitudes” of quantitative easings, or money printing, in the US, UK and Japan. Now it seems a “gigantic tidal wave” of QE is being generated in Europe, thinly disguised as a three-year, long-term refinancing operation, which Gross describes as QE by any definition and “near ponzi” by another.
But Gross’s most important insight is that near zero interest rates in the developed world are actually depressing their economies, not boosting them. That’s because the flat yield curve, coupled with “zero bound” money, is creating no incentive for the financial system to expand credit.
There are no profitable outlets for the credit that financiers create by taking deposits and making loans. When the return on money is less than 100 basis points, the expensive infrastructure of banks and money market funds makes it unprofitable to be in business, so the system delevers.
The likelihood that cash interest rates will stay near zero “for an extended period of time”, plus the flight to safety, has reduced the long-term interest rate, flattening the yield curve.
In Australia the yield curve is inverted, with cash at 4.25%, five-year bonds at 3.34% and 10-year bonds at 3.8%. But at least there is the prospect of capital gains on bonds, which is why money is rushing into Aussie bonds from overseas and keeping the currency above parity, and there is money still to be made lending to households and businesses because credit risk here is still relatively low.
So credit is still expanding in Australia, but even here it’s at the slowest rate for more than three decades.
Elsewhere, 2012 will be characterised by system-wide deleveraging because the business of making money no longer makes money, or as Bill Gross puts it, the financial system can no longer find profitable outlets for the credit it is creating.
The big question is whether the big three central banks — the ECB, Bank of England and the Fed — can reinvigorate animal spirits through QE, or money printing. Gross says: “We shall see.”
In the meantime investors need to lower their return expectations to 2-5% for stocks, bonds and commodities, in a world where substantial price appreciation is “getting close to mathematically improbable”, and prepare for “bimodal” outcomes.
And businesses will have to lower their growth expectations. Even if the US escapes another recession, growth is likely to be in the range of 1-2%. Europe and Japan probably won’t escape recessions. Growth in China is also slowing as it deals with slowing exports and a domestic property boom (bubble?), although not yet to recessionary levels (that is, below 7%).
*This article was originally published at Business Spectator