The political elites and many in the economic community warned of dire consequences should Britain vote to leave the European Union. Immediately following the announcement of the vote equity markets worldwide drop significantly. However, one week later they have rebounded and are about back to where they started.
The action of the equities markets suggest either the predicted dire consequences were severely exaggerated, or as an alternative, equity markets with the assistance of continuous central banker interventions no longer believe that stock valuations can go down. Neither is very comforting.
How the UK’s exit from the EU will affect the world economy remains to be seen. The Daily Reckoning suggests that political elite Progressives will take a play out of Obama associate Rahm Emanuel strategy book, who infamously said: “You never want a serious crisis to go to waste.” Using this strategy, they will use the Brexit vote as an excuse for more central bank spending and interventions into the economy. Why not, that strategy has failed for the last eight years so let’s double up on it.
The Daily Reckoning reports that since 2009 central banks have printed over $12 trillion. In addition, they have made 654 interest cuts worldwide. This has succeeded in creating equity bottles that have made the wealthy wealthier.
The Daily Reckoning expects more Quantitative Easing, QE 4, and an even more radical policy called “helicopter money” where the Fed basically froze money to the masses. These radical steps are not taken out of stupidity. Instead, they are an acknowledgment by central banks that we are reaching the end game. Without continuous and more aggressive interventions, the rebalancing of the economy will begin and it will be painful. Irrespective of the central banks’ actions, that rebalancing will occur. It is only a matter of time.
The Wall Street Journal reported on Monday that bond rating service, Fitch Ratings, downgraded Japan’s credit rating by a notch from A-plus to A. According to Fitch, the downgrade was made due Japan’s deteriorating financial condition. This is highlighted by the fact that Japan’s debt to GDP ratio is now over 200% and projected to grow next year to over 240%. This would be the highest debt to GDP ratio for any foreign bonds rated by Fitch.
Japan’s sovereign finances are an example of the race to the bottom. Countries throughout the world have used public spending and low interest rate policies in an effort to stimulate growth. However, Japan has been in a 30 year period of stagnation, the poster child for the failure of these governmental interventions. It is likely that these interventions they inhibited real economic growth and recovery, leading not only to long-term problems in Japan, but also in other economies worldwide.
Under normal times Japan’s economic situation would cause substantial turmoil in financial markets. But these are not normal times. While Japan’s economic policies have failed and resulted in its significant sovereign debt, other countries are also running up debt to unprecedented levels. As a result the bond markets have not decided who to punish for imprudent economic policies. This equivocation has given countries like Japan some breathing space. However, economic markets always revert to the mean. Ultimately countries with bad finances will be punished by the markets. When this occurs it will likely come quickly and with little warning causing significant economic turmoil worldwide, a repeat of the economic turmoil that occurred in 2008.
This Blog has often referred to the real and potential problems associated with the growing debt in the United States and Western Europe. However, the unsustainable growth of debt is a worldwide phenomenon that includes the fastest-growing major economy, China.
The Wall Street Journal reported on China’s growing debt. According to the International Monetary Fund, China’s debt is growing quicker than that of Japan, who has a debt to GDP ratio of over 200%. It is also growing faster than the debt of the United States and South Korea.
A significant portion of China’s debt is being created by local governments who borrow to finance projects in their areas. The Journal reports that these local governments have accounted for 25% of China’s total debt since 2008 and in 2013 reached 36% of GDP, double the rate of five years earlier. At this rate it is estimated that local borrowing will increase to 52% of GDP by 2019.
Incredibly, there are approximately 8,000 local quasi-government finance organizations throughout China. This huge number and the large amount of debt lend themselves towards corruption and inefficient usage of the debt. Also, since these finance organizations are related to the government, they are able to sell bonds with high risk at subsidize rates as lenders incorrectly believe that default is not possible.
This lose money policy in China lends itself to financing ventures that do not make economic sense, thereby increasing the likelihood of defaults. This is eerily reminiscent of the lose money policies of the West and the United States in particular that led to the economic meltdown of 2008. It is likely that China’s flawed financing practices will lead to similar results in that country. Given the size of the Chinese economy, that will lead to contagion in economies worldwide.