George Magnus of UBS on the "Great De-leveraging"
George Magnus, former chief economist and now senior economic adviser to UBS, recently penned a must-read note tying together a lot of the major political and economic developments the world has witnessed in the wake of the 2008 financial crisis, aptly titled, "The Convulsions of Political Economy."
To quote the introduction, "During the last several months, we have seen a succession of such challenges in the Eurozone, the US, and even, in embryonic form, in China. The recent skittishness in financial markets and increase in risk premiums reflect not only a rise in anxiety about the deteriorating health of the global economy, but the draining of confidence that political elites are up to the task of addressing it."
We spoke with Magnus on Benzinga Radio about some of the ideas and policy prescriptions put forth in his piece. Here is what he had to say.
On the Great De-leveraging:
George Magnus: "It's a painful process, it's a very long process, and we shouldn't expect our economy--certainly in the West--to perform the way that we've been brought up to expect over the last thirty, forty, fifty years. The de-leveraging really is about getting rid of debt--either paying it off, or liquidating it, or restructuring it, or whatever we do with it--but we can't really resume normal spending patterns until that's happened."
On prevailing--yet wholly inappropriate--policy prescriptions for dealing with sub-par economic growth:
George Magnus: "Clearly, interest rates have been reduced down to the lowest levels that we've seen in a generation or more. These low interest rates, which traditionally would have stimulated credit demand, clearly aren't. That is one of our policy tools that has basically gone absent."
"The political climate in the United States is now obviously quite different from what it was two or three years ago in terms of what government could or might be able to do in the economy. The same is true in Europe, by the way. But of course, before that, we tried to do things like cut taxes--income taxes, sales tax, or where we gave certain types of tax breaks to people--but people aren't spending the windfalls that they get.
"So, those kinds of normal tools that we would use in a normal business cycle just aren't accepted nowadays. We have to think a little bit innovatively about different kinds of policy prescriptions. Not only that, but we probably have got to, I think, eventually reverse some of the decisions that we have taken on both sides of the pond to basically take government out of the equation in terms of economic management."
"That way, I think we will be headed for much more serious times ahead because there simply isn't enough demand in the private sector at the moment to be able to give us sustainable growth--not big growth, but not even any growth, perhaps. Obviously, as we talk now, clearly everybody's concerned about another economic contraction at some point in the next few months."
On obstacles in today's political climate to acting on bold policy ideas:
George Magnus: "They have embraced this idea that austerity is the new religion--that if only we could reduce deficits, cut debt tomorrow, get government out of the way, that this would spontaneously bring new confidence to companies and to households and they will start spending again."
"My contention, really, is that that is premature, to say the least. When the private sector really is going through a very difficult process of reducing its debt and consolidating its income, that we basically have to do different things. Otherwise, we could find ourselves drifting quite easily into the kind of debt trap which Japan got into over the last twenty years."
On which are the most important factors saddling the economy and what could be done to address them:
George Magnus: "We need to try to do something to get people back to work, because more people at work means more income, more consumption, more savings. If we basically just don't pay attention to this--for example, by cutting payroll taxes, perhaps even thinking about ways in which the government could encourage private firms, small and medium-sized enterprises, for example, to take on more workers--if we don't do things like that, I don't really see how the economy can find its sea legs."
"I think it's very difficult to be optimistic that these kinds of initiatives will gain traction at the moment. But if and when politicians recognize that the debt crisis is basically the single most important economic issue we face, then it happens once every generation or once every other generation that we do extraordinary things that normally would be unpalatable or even unthinkable."
"There are proposals. There are think tanks and professors at universities and so on who are thinking about and trying to come up with ideas that might, for example, in the case of the household sector, mean that eligible homeowners may have a certain part of their mortgage obligations either cancelled or suspended in deference to capital gains in the future on their properties which would then accrue to the lenders, the providers of the mortgages."
"Normally, we would never think about doing this. Socially, it's a very difficult issue because people who have already had their homes foreclosed obviously missed the boat, in a way, because they've already fallen victim to the housing crisis. It's a difficult issue, but there are certainly precedents in the past for the kinds of schemes in which certain types of debt forgiveness or deference could certainly be envisaged."
"In the same way, as sovereign nations have to have their debt restructured, i.e. longer maturities of servicing the debt and reduced interest rates--this is something which the European countries in the eurozone recently agreed to in the case of Greece, and I suspect it will become a template for other sovereign debtors in the eurozone as well. These kinds of debt restructuring or arrangements to basically lighten the burden of debt, I think, will become more common as we find it increasingly difficult to generate enough growth in demand."
On innovative monetary policy:
George Magnus: "There is a certain economic theory--and it's one that the Japanese thought about a lot during the late 1990s before they actually embarked on their version of quantitative easing--which is basically that even if you've got nominal interest rates at zero or close to zero, that the real rate of interest may be too high, despite record low nominal rates."
"The way that you can essentially accommodate that is by creating a little bit of inflation. At the moment, I think that politically, that would be something very difficult to pull off. I think, given the kind of political pressure which the Federal Reserve and the Bank of England are under, for example, it would be difficult for them to embrace this."
"If you look at some of the work which Ben Bernanke, for example, has spoken and written about in the past that relates to the Japanese situation, you can see that there are limits to monetary policy, to be sure, but we haven't reached those limits yet. There may be ways in which the central bank can basically encourage a little bit of additional inflation, particularly if the economy were to lapse back into a contraction again, which might help."
"I don't think anybody can say beforehand, 'This is a slam dunk, this is going to work.' We don't know that, but it's worth having a bash at doing some rather different things if we're worried that the nominal world--the nominal environment for income and GDP--is going to be stagnant or even contract."
"This is the situation the Japanese have found themselves in, where the nominal level of GDP in Japan, measured in yen, is significantly lower now than it was in 1991. That is an extraordinarily difficult environment for companies to make money and for employment to be created. So, all I'm suggesting is that rather than maybe raise or increase or have an inflation target as such, that actually central banks could target monetary value of GDP, which combines both real economic growth and obviously a certain degree of inflation. We might have to be tolerant of a little bit more inflation--perhaps even encourage it a bit, under circumstances where maybe the nominal GDP basically stalls, which it's close to doing now."
On the reality of further easing from the Federal Reserve and Bernanke's upcoming Jackson Hole speech:
George Magnus: "People don't expect that QE3 could actually achieve very much, because once you've got treasury yield on the ten-year maturity down at 2%, and that's not really having an effect, then lowering those yields by another 20, 40, 50 basis points probably isn't going to have much of an effect either. So, just doing asset purchases is probably not the answer."
"[The Fed will act] quite cautiously, I think, not least because obviously there are doves and a handful of hawks on the committee, which makes it very difficult for the chairman to say anything of imminent relevance or substance."
"Of course, the Federal Reserve normally has a sort of public function in the sense of trying to keep people reasonably cheerful and to give a relatively upbeat assessment about the balance of risks. Privately, of course, one has to imagine that the chairman and several others on the FOMC probably share concerns that the economy has not only lost a lot of momentum in the first half of this year, but may lose more, particularly when strains on federal spending come into effect, and perhaps even before then if the extended unemployment benefit scheme and the employee payroll tax reductions are not renewed at the end of this year when they are due to expire."
"So, the balance of risks, I think, is one of the things that people will pay a lot of attention to. If the Federal Reserve and if Ben Bernanke basically seems to be shifting his position in terms of the balance of risks, I think people would take that as code that the Fed may be in the position of having to discuss and think about additional policy initiatives over and above those that they have just taken."