“Those who expect a swift return to the business-as-usual of 2006 are fantasists. A slow and difficult recovery, dominated by de-leveraging and deflationary risks, is the most likely prospect.” (Martin Wolff)
As most readers of this blog know, I have my own timeline for p2p-induced transformations. It goes roughly like this: given that 2008 was a systemic shock of the same nature as the crisis in the 1890’s and 1930’s, we should expect 8 to 15 years of deep crisis, i.e. the time for the excess debt of the system to be processed, i.e. the time for deleveraging or ‘debt deflation’. Not being an economist, I simply draw this inference from the past historical experiences, showing that such recovery processes were never quick. (after this period of recovery, I expect a new Kondratieff long wave cycle, but complicated by the structural crisis the earth is facing due to climate change and resource depletion).
But what if we could calculate this period more precisely?
Australian-based economist Steve Keen thinks we can do this, by calculating the debt to GDP ratio of the start of the crisis, and positing a 4 to 8% deleveraging rate, 4% being the natural rate and 8% the rate that can be reached through smart policies (“where however that “policy” was an arms race during a global military conflict”).
Important is that we are starting from a much higher debt to GDP ratio than in previous crisis, instead of the 100% of the 1890’s and the 50% of the 1930’s, we started from a high point of 165% in March 2008. (figures are from Australia)
OK, here are the shockers, based on calculating the Australian case:
“Taking 50% of GDP as a level at which normal economic activity might resume (higher than the 40% level that applied in the 1920s and 25% level of the 40s-60s), this implies that deleveraging could take anywhere between 15 years (at the accelerated 8% rate) and 30 years (at the “natural maximum” 4% rate).
We are currently deleveraging at the 4% rate, and debt has fallen from 165% of GDP in March 2008 to 159% today–a 6% fall as a percentage of GDP, as noted above. At this rate, debt will not fall below 50% of GDP until 2038, and the annual reduction in debt will be equivalent to 3% of GDP until 2028.
Even the worst rate of 1930s deleveraging (including WWII) only just compares to the impact of deleveraging today at the 4% rate–because the debt ratio in 2008 peaked at 2.2 times the peak level in the 1930s. And throughout the 1930s, deleveraging never subtracted more than 3% from GDP–again because debt was so much lower then than it is now.
If we rely upon the “natural maximum” process of deleveraging, we face a 30 year period in which changes in debt will cut at least 3% from the growth potential of the economy.”
Here’s is the conclusion of the article:
“This is why I propose a far more radical policy to deal with the crisis than the government stimulus package that Australia and other OECD nations have followed to date. These policies are attempting to address a crisis caused by irresponsible private lending, yet they involve continuing to respect this debt. They attempt to counteract private deleveraging by running up public debt instead. And they drastically underestimate the impact of deleveraging: rather than achieving a return to growth by 2010, these policies alone are likely to result in zero or sub-zero growth for most of the next decade.
That private debt does not deserve respect. It was irresponsibly lent in the first place, and the financial institutions that lent it should pay the price–not the public nor the public purse–via deliberate debt reduction. This of course would bankrupt those financial institutions, but as should be obvious from the US experience, these institutions are effectively bankrupt already.”