If you ask economists or Wall Street analyst to describe what’s happening in financial markets right now, they’ll probably say “deleveraging.” Both consumers and financial insitutions are clearing bad debt off their balance sheets, and as soon as they do, the theory goes, we can get back to business.
The problem, according to Yves Smith at naked capitalism, is that, as a per cent of GDP, credit is still far higher than it has ever been. Smith offers this graph, comparing the current crisis with the 1920s and everything since:
The March 31 level was 350% of GDP. The previous peak occurred in 1933, during the Great Depression, at just under 270% of GDP. Note that the peak was reached due to the start of the rapid fall in GDP taking hold faster than debts were written off, a dynamic not in operation now. So the comparable level to our situation is in fact lower than the 270% peak.
An additional bit of cheery news comes from reader Bjomar: Japan’s total debt to GDP in 1990 was roughly 250% (it took some triangulating among this, this, and this source, his interpolation of corporate debt at 100-140% of GDP, household at 65%, and government at 60%). And unlike us, Japan had a very high saving rate, so its net debt would have been less alarming.
Smith goes on to cite economist Frank Veneroso, who argues that the financial system is due to come crashing down (and the economy with it). Veneroso, analysing the above graph, claims that because it charts an “economic ratio,” things must eventually revert to the mean:
This chart shows something that has gone vertical, something that is on a moon shot. If it were the GDP of Argentina in pesos I would agree that the moon shot could go on and on. But it is not the Argentine economy in domestic money terms. It is a macroeconomic ratio of total debt to GDP. Macroeconomic ratios cannot go on unending moon shots. They are basically mean reverting series.
The implication is that the financial system is due for a massive deleveraging that will make the current crisis look like a picnic. Let’s hope it’s different this time.
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