David Rosenberg is known for his bearish outlook, and he has not yet seen anything in recent economic news that persuades him to change his tune. Contrary to prevailing “bullish complacency” and the widespread belief that central banking systems “have the answers to the ongoing global debt deleveraging cycle,” in the United States Rosenberg sees monumental deficits, flat growth, an underlying trend of deflation, and current fiscal policies that will limit future flexibility. In other words, trouble remains on the horizon.
Rosenberg, the chief economist for the Canadian money manager Gluskin Sheff, spoke at the Fortigent Winter Forum, held last week in Savannah, Georgia.
A key way Rosenberg differs from the optimists is in his belief that the current global deleveraging cycle is different than its predecessors. “This time around, we are seeing the biggest debt deleveraging in the global economy that we’ve ever seen before,” he said. “When you look at the global median debt-to-GDP ratio, it is up to 400% of total GDP.”
If Rosenberg is right, the full consequences of that deleveraging for the global economy still lie ahead.
Debt in the US and Europe
In the US and Europe, the problematic debt lies with the government sector, with the total government debt-to-GDP ratio beyond levels we have seen in a long time. After entering a global recession, virtually every country in the world radically increased its government spending. Instead of raising taxes – and risk driving their economies deeper into recession – the governments “tapped into the debt markets,” either spending on infrastructure, extending unemployment benefits, or instituting tax cuts.
Now, three years into recovery, the US has “monumental” deficits, with the difference between government spending and government revenue reaching heights unseen since World War II, Rosenberg said. Over the next year, he predicted that the debt-to-GDP ratio will rise above 100%. “Once you have crossed over 90% … you start to impair the private capital sector capital stock,” Rosenberg warned – presumably in reference to the research by Reinhart and Rogoff.
To measure the sustainability of government spending, Rosenberg looked at interest payments as a share of revenue. Over the next several years, this ratio will increase from 10% to 20%, “unless the problem is nipped in the bud quickly.” Given ageing demographics, healthcare needs, and current entitlement spending, Rosenberg predicted that interest payments as a percentage of revenues will double in the US, severely limiting the country’s future fiscal flexibility.
Rosenberg holds a similar view on Europe, arguing that over the next few years we will see significant changes in the eurozone – which he called a “failed experiment” – as more and more countries hit a “debt wall.” The eurozone depends on having a single interest rate, but that will prove untenable, he explained. “They might have a single policy rate, but what drives most economies is the bond market, the 10-year yield,” Rosenberg said. “When you take a look at history, you will see that a monetary union not coupled with the fiscal union fails.” He predicted that Greece will default first and Portugal will default next, leaving Italy as a looming question mark.
If the euro is going to survive, Rosenberg said, German taxpayers will need to bail out the weaker members of the eurozone. If they do not, these smaller countries – which did not have the economic infrastructure to join the eurozone in the first place – will return to their local currencies. Rosenberg predicted that a new, stronger euro area would most likely emerge at the end of this process.