We are plunged deep into the biggest credit-business cycle in world history. Many cycles have been worldwide, but this one dwarfs all others, including the Great Depression. An ocean of money and credit flooded every corner of the globe. The culture of easy wealth worked its way into the smallest economies from Norway to Chile, from Iceland to Mongolia. Economies built on commodities exports, even energy exporters, have felt its impact. The inevitable bust sent the world into economic decline wiping out trillions of dollars of wealth. Built largely on credit, the resulting debt is now being liquidated causing worldwide deflation.
Business and credit cycles are always created by central banks and this one is no different. While we can blame the greed of Wall Street and London's City, capitalists are just players on a stage where greed always exists. It takes something more than greed to create massive cycles like these, and that something is the creation of money and credit out of thin air, something only central banks and governments can do.
The question we face now is: how has the playing field for our economy changed and how will those changes affect our future? The answer to these questions will determine the future of the world's economies.
The economic world has changed. There are new trends, megatrends if you will, now at work in our economy. They are "mega" trends because they overarch and impact everything else in the economy and will do so for quite a while. There are other major trends at work as well, but they have been operating as a part of the basic framework of our economy for decades. These megatrends have emerged from the credit cycle because people change their behaviors in response to a crisis, and it would be foolish to assume that everything will just go back to the way things were before.
These aren't predictions of the future, because circumstances change. No economist can accurately predict the future, at least in the detail many economists claim they can do. There is just too much data from the millions of decisions that our fellow citizens make every day to know enough to predict with any accuracy. How many economists predicted this crisis? Very, very few. Think of these megatrends more as chalk marks on the playing field that will guide human economic behavior for some years.
Megatrend No.1. The culture of consumption is broken and won't return to former levels. This is the key to everything.
For the last 30 years our economy has been based on personal consumption. From 1980 to 2007, personal consumption went from 54.4% of GDP to 77.3%. We went on a spending spree financed by borrowing, reduced savings, and asset inflation. Most obvious was the rapid rise in home prices. We came to think of our homes as an ATM, and kept pushing those buttons. We felt rich: our homes appreciated, our 401(k)s appreciated, and, who needs savings?
From the high of 2007 our net worth has plunged 20% (nominal), from $62.591 trillion to $50.377 trillion as of Q1 2009. Down $12 trillion, or about equal to one year's GDP. That has dire implications for consumer spending. During the boom, debt as a percentage of spendable income went from 68% in 1980 to 138% in 2007. We are now in the process of paying it back. And, since our main assets, homes and stocks, have declined, the bank wants its money back.
There is nothing like fear and an uncertain future to prompt people to save. As the savings rate has increased, consumer credit continues to decline, wages are decreasing, and unemployment is rising. It will take consumers a long time to reduce their debt. If incomes don't grow from current levels, it will take a savings rate of 5% to achieve a 5% annual reduction in the household debt-to-income ratio, according to a McKinsey Global Institute study. At this rate it would take about 7 years for this ratio to return to levels seen in 2000 (101% then, vs.138% today). If incomes grow by 2%, then it would take a savings rate of 2.3% to achieve a 5% reduction in the ratio. Every percentage point of savings reduces consumption by about $100 billion per year.
This doesn't mean people won't spend; it means they will spend less and save more. In an economy of which 70+% is based on consumption, this represents massive change. It means that GDP will remain subdued for a substantial period of time.
The one caveat? Inflation would tend to result in quicker debt paydowns as old debt would be cheaper to pay off with inflated dollars. Inflation would cause people to buy things as they dump depreciating dollars for appreciating goods. But inflation has its own problems.
David Fuller's view Jeff Harding makes some very good points but they are mainly US centric. They do apply to the UK but generally less so for other OECD countries. They are not applicable to Asia, where savings rates remain high and very little credit is utilised by households. Moreover wealth creation in this region remains a boon for private consumption.
I maintain that debt reduction and higher savings rates are in the long-term interests of any country but clearly the US and UK transition, to the extent that it occurs, lowers medium-term economic prospects. However people with no debt who also have job security are unlikely to reduce spending.
Megatrend 2 is a concern for the US and a number of other western economies, and a further reason for them to lag emerging (progressing) market GDP growth.
Megatrend 3 overstates China's export dependence in my opinion. Yes, exports remain important but China exports to countries all over the world. Today, much of what the west produces needs to be manufactured in China, to remain competitive (see also yesterday's Comment). Few commentators predicted the extent of China's GDP growth over the last decade and factors inhibiting western growth mentioned in these megatrends should ensure that both China and the Asian region continue to grow much more rapidly than OECD countries.
Megatrend 4 is also mainly applicable to OECD countries. Inflation is a problem throughout the Asia Pacific region, due to stronger GDP growth and higher commodity prices. Quantitative easing has sown the seeds of future inflation which will increase, led by commodity prices, as the global economy continues to recover. This will co-exist with the deflationary pressures and slower growth mentioned by Jeff Harding, mainly in OECD countries. We are likely to hear more about stagflation in the west.
Megatrend 5 seems logical for the US.
Megatrend 6 is informative, if somewhat controversial. What I believe we are seeing in the US is a trend away from red-blooded capitalism towards a more socialistic European model, including wealth redistribution. We can argue all day about whether or not this is a fairer and more compassionate society, but it is not a recipe for strong economic growth.
Megatrend 7 - I fear he is right.
Jeff Harding's concluding summary is informative. Subscribers are unlikely to be surprised by these forecasts but probably find them sobering. However, we can already see where our partial protection lies. Corporations have responded rapidly to the changes and profits are booming. While productivity increases due to reducing employment overheads are finite and cannot be repeated to the same extent anytime soon, successful companies will continue to flourish more often than not. This is reflected by the US stock market's strong relative performance this year. Information technology, not surprisingly, is leading this advance and there are many opportunities in international markets. The US remains the world leader in information technology and a number of other American multinational companies are influential participants on the global stage.