Why has the post-crisis recovery been so disappointing? Are we stuck in a world of diminished prospects and subdued demand?
These were the key questions Lord Adair Turner, chairman of the Institute for New Economic Thinking and author of Between Debt and the Devil, sought to answer in his wide-ranging keynote address at the 2016 Middle East Investment Conference in Bahrain. And his responses, while nuanced, offered some hope — and potential solutions — for the global economy in the years ahead.
Of course, to cure the world economy of its prolonged malaise, the causes must first be diagnosed, and for Turner, it comes down to one key factor: debt.
“Debt has become unsustainable across the world,” Turner explained, pointing to “the growth of debt in the advanced economies, not just over the few years before 2008, but over an entire half century.”
His assessment, that global debt has become unsustainable, was shared by roughly 62% of participants in an audience poll conducted prior to his session.
Turner has a unique vantage point from which to make such an assessment. As a key policy maker at the height of the financial crisis, he experienced the catastrophe firsthand. He was named chairman of the United Kingdom’s Financial Services Authority (FSA) in September 2008, just five days after Lehman Brothers collapsed. It was, Turner recalled, “rather like being appointed captain of the Titanic after you’ve hit the iceberg but before you’ve actually sunk.”
As he and other officials worked to stabilize the economy, Turner became convinced they were only skimming the surface of why 2008 had occurred — and why the recovery, both then and now, has been so weak.
That’s where Turner came to the debt situation. In 1950, he explained, household and corporate debt as a percent of GDP across all the advanced economies together, was roughly 50%. By 2008, that figure had ballooned to 170%, growing pretty much every year from 1950 to 2007 and accelerating in the early 1990s.
But it wasn’t that looming credit overhang alone that was the issue, it was what that debt was financing. It wasn’t going towards productive enterprises, like machinery, staff, or the components that generally drive economic growth.
“In the advanced economies, banks primarily lend money not for new investment but for the purchase of assets that already exist and in particular for the purchase of real estate assets that already exist,” Turner said. “The big picture here is that from about 1870 through to about 1950 or 1960, banks lent about a third of their money against real estate and the rest to non-real estate finance. But after about 1950, that relentlessly grew to reach 60% by 2007, and this actually understates the case because this is primarily residential real estate. There’s quite a lot of commercial real estate on top.”
So why is that important?
“It matters because one of the features of real estate in advanced rich economies is that it is locationally specific,” said Turner. “Location matters enormously in real estate and it is difficult to create rapidly new attractive locations. Locationally specific real estate is an inelastic supply. And that has a very particular consequence, which is that if you lend money as a banking system against something which is an inelastic supply, the only thing that tends to give is the price.”
So more credit is extended against real estate. Prices go up. Borrowers and lenders believe prices will go up further and in turn borrow and lend more money.
“The cycle goes round and round and round until there is a crack of confidence,” said Turner, “and then it goes round and round in the other direction.”
These cycles of credit and real estate lending are not just part of the story of instability in advanced economies, according to Turner. They are the whole story.
“The trouble is,” Turner explained, “once we have these cycles of credit, asset prices, more credit, if we then get a swing from the exuberant upswing to the depressive downswing, if we get that when leverage is already high, we seem to enter an environment where the leverage never actually goes away. All it does is move around the economy.”
Debt is never paid down, in other words. It’s only shifted: from corporate debt to public sector debt, from advanced economies to emerging markets, and so on.
To support his case, Turner pointed to China.
“The growth of Chinese debt from something like 140% of GDP in 2007 to maybe 240% in 2016 — that isn’t just a coincidence,” he said. “That increase in Chinese debt was a direct consequence of deleveraging in the advanced economies.”
As US households tightened their belts to pay down their debts, China’s leaders feared reduced demand for Chinese exports and lower employment.
“And to offset that,” Turner said, “the Chinese authorities unleashed the biggest credit-fueled construction boom that the world has ever seen.”
In four years, China poured more concrete than the United States had used in the whole of the 20th century.
“So we live in a world in which having created an enormous amount of debt. The debt doesn’t go away, it simply moves around within developed economies from the private to the public sector, and it moves around across the world.” said Turner.
Fiscal and monetary policy have all had a stimulative effect. But they create negative cycles of their own. As worries increase about the rise in public debt, austerity programs are implemented — just as the private sector is still deleveraging, creating more negative pressure on growth.
Ultra loose monetary policy leads to low or even negative interest rates. But that creates increasingly diminishing returns. “The transmission mechanism to the real economy isn’t very effective,” Turner explained, “because if companies and households are already over-leveraged, they’re not very sensitive to further cuts in interest rates.”
Currency mechanisms are no solution either, according to Turner. They may be able work for one country, but not all nations together.
“So we seem to be stuck,” said Turner. “All our classic policy levers to keep demand growing are blocked.”
The question becomes whether we are stuck in a low-growth, low-demand environment for the foreseeable future. Do governments and central banks have anything left in their arsenal?
“Governments and central banks together never run out of ammunition,” said Turner.
So what’s his solution?
Citing both Milton Friedman and Ben Bernanke, Turner proposed “helicopter money,” or what he prefers to call “overt monetary finance of increased fiscal expenditure.”
“You can use central bank money to finance tax cuts or expenditure increases in a fashion that does not require the government to borrow money,” he explained. “Or you can monetize existing government bonds. Central banks can buy existing government bonds and simply write them off, which frees up the government to run larger fiscal deficits in future.”
Turner acknowledged that the prescription may strike some as rather unorthodox. “When you say that, and if you’re a respectable member of society, people think you’ve gone a bit crazy.”
But Turner suggests that given the current economic stagnation, now is not the time for half measures.
“We may need to think about some very radical options.”
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Photo courtesy of George Raphel.