After the massive stimulus provided to global economies there will inevitably be a hangover, and there are “no easy exits” from the current financial crisis, says Professor Niall Ferguson, the Laurence A Tisch Professor of History at Harvard University and the William Ziegler Professor at Harvard Business School.
In a 30-minute video presentation prepared exclusively for the Portfolio Construction Forum Conference in Sydney, Ferguson said we are “at the end of the road” when it comes to any further credible efforts to provide stimulus to ailing economies.
“After any stimulus, and you may have noticed this yourself on a Sunday morning, there is often a hangover,” he says.
“The hangover in the case of monetary policy took the form of a dramatic surge in commodity prices. The hangover in the case of fiscal policy began in Greece, as well as Portugal and Ireland, as it became clear that governments were running deficits that they couldn’t possibly finance on the bond market.
“The third, most interesting, hangover is the one that’s brewing here in China, where it may just be that the residential property bubble sparked by the monetary and banking stimulus of 2008 and 2009, is coming to what could be a painful and dramatic end.
“Where are we now? I think we’ve reached the end of the road when it comes to stimulus. We’ve reached the point where there no longer is any quantitative easing that can credibly keep the global economy going. We’ve reached the point where no country, not even the United States, with its extraordinary record … can carry on running deficits of 10 per cent of GDP.
‘In other words, there are no easy exits from the great problem of leverage that blew up over the last 40 years’
“And we’ve reached the point where the Chinese economy really can’t credibly keep growing at 10 per cent per annum; not on the basis of massive credit expansion – which, by the way, has as its counterpart a very rapidly growing burden of local authority debt.
“And we have reached the point where excessive debt can no longer be wished away. It’s there on household balance sheets in the Western economies, it’s become an enormous problem on public-sector balance sheets throughout most of the Western world, and it’s a growing problem even in China today.”
Ferguson says the big problem now is “how to get rid of these excessive debt burdens”.
He says total debt – public and private combined – in the US, for example, is about 350 per cent of GDP, and getting it down from that level “is a very painful process”.
“Deleveraging. That is what’s slowing down consumption; that is what makes households cautious; and, of course, what makes banks and businesses pessimistic,” he says.
“How can we speed that process up? There are two possible ways of doing it. The easy way would be inflation. But I remain sceptical that we will easily leap to the kind of inflation that reduced debt burdens, in real terms, in the 1920s and again in the 1970s. There are too many things stacked against an easy inflationary exit.
“So what’s the alternative? Well, when private-sector institutions, when corporations are excessively indebted, there’s a relatively smooth process called ‘bankruptcy’ for dealing with that problem. Unfortunately, that’s not the case when it comes to sovereigns. Most sovereign bankruptcies – think Argentina – are disorderly things. What we see in Europe today is an almost insoluble problem where countries that were wed together in a monetary union are struggling to default without blowing that union part.
“In other words, there are no easy exits from the great problem of leverage that blew up over the last 40 years. Not through inflation and not, in my view, through some kind of collective bankruptcy – the kind of ‘jubilee’ that the Old Testament recommends that society should experience every few years or so.
“For that reason, when I step back from the trees and try to take a look at the woods, or rather to take a look at the burning forest, my outlook is a relatively pessimistic one. I do not see an easy exit for us now. We managed to buy ourselves some time with stimulus, in 2009 and 2010, but now the hangover is upon us.
“Whichever tree you’re looking at, try not to lose sight of the forest fire that I’m describing. It appears to make it very hard indeed for us to achieve any exit from the dark wood we find ourselves in.”
To understand why a solution is likely to be so painful, one needs to understand how this situation arose in the first place. Ferguson says he’s reluctant to pin the blame solely on deregulation, or on the greed of bankers. Both are simplistic, in isolation. Even when markets were much more highly regulated than they are now, there were still recessions, and bouts of stagflation, he says. And bankers have always been greedy.
“Something very specific must have happened,” Ferguson says. “Or rather, six very specific things had to happen together to produce the biggest financial crisis since the 1930s, and the biggest macro-economic shock to the world since the 1970s.”
Number one is excessive leverage on bank balance sheets (not only in the US, but in Europe as well), driven by the pursuit of high returns on equity. Number two were the conflicts that existed in the ratings business, where rating agencies were being paid to rate the products issued by the people paying them. Ferguson says that on the eve of the GFC there were only 12 corporations in the world with a AAA rating on their bonds; there were 64,000 structured financial products with a AAA rating. Ratings agencies issued very high ratings on what was later shown to be junk – or worse – and the highly-leveraged banks bought them because the banks were regulated on the basis of the risk-weighting of their assets.
