Deutsche Bank: "We Think Something Structurally Changed Since The Great Financial Crisis"

Tyler Durden's picture

The topic of whether central banks have destroyed the global business cycle to the point where all we have is phase jumps from one bubble to another (with an intervening depression in the interim) where central banks inject record amounts of new debt-created liquidity to cover up the credit excesses of the most recent bubble, has gained prominence following the recent comments by none other than the almost-Fed head Larry Summers who advocated the creation of an even bigger asset bubble to push the economy onward and upward. Below we present some much more sober and rational thoughts on this topic by Deutsche Bank's Jim Reid.

Do we need bubbles for growth?

The worrying feature of the DM economy over the last decade or so (and perhaps longer) is that it seems that we’ve needed to pursue ever looser policy to enable us to hang on to what has actually been lower and lower trend growth. However the consequence appears to be that markets have moved from bubble to bubble. On the slowing growth front, Figure 7 tracks real GDP growth by decade for the G7. It’s quite clear that growth has been on a declining trend now for several decades with this century’s growth being very disappointing across the board in spite of very accommodative monetary and fiscal policies and the inflating of at least two major asset bubbles around the globe.

Since 2000, the US has outperformed all but Canada across its G7 peers but has averaged only 1.9% real growth. As for the rest of the G7, the average growth rate over the same period has been 2.2%, 1.7%, 1.3%, 1.2%, 1.0% and 0.3% for Canada, UK, Germany, France, Japan and Italy respectively.

Even though the US is the relative star performer in this cohort (ex Canada) this remains one of the weakest US recoveries on record and one that continues to disappoint to the downside. As regular readers know we like to monitor nominal GDP in this cycle due to the requirement to erode the still substantial debt burden. On this measure this is the second-weakest US recovery since our data begins in the early 1920s (Figure 8). The weakest was the rebound after the 1929 crash that turned into the Great Depression. Figure 9 then shows that this slowdown is a global problem. The 5-year rolling nominal GDP growth number is now at its lowest level for 80 years.

Are we now finally going to revert back to pre-crisis levels of growth or are we going to appreciate that a) the trend rate of growth for DM economies has slowed markedly (perhaps due to demographics and other structural issues), b) that current inflation is becoming dangerously low but financial market liquidity dangerously high and that c) current policies are not having as big an impact on growth as hoped or expected (i.e. we’re possibly in a liquidity trap).

We think that something structurally has changed since the GFC, a change that seems destined to continue to hold back growth in the near-term and more worryingly has lowered the longer-term trend rate of growth. In the absence of structural reforms, a lack of appetite for debt restructuring and no ability to pursue more aggressive fiscal policy, the temptation will be strong globally to continue to throw liquidity at the problem which is likely to continue to have more impact on asset prices than the actual economy. Bubbles could easily form which could ultimately be the catalyst for the imbalances that will likely lead to the next recession or crisis. So to avoid bubbles we possibly need the US and global economy to have a stronger year and for activity to withstand the impact of tapering and the inevitable higher yields that this combination would bring. The jury is still out as to whether this can happen though and it might be that the US needs very low yields by historic standards to maintain a recovery. It might also be the case that the rest of the world needs low US yields too. 2014 will be a test of this.

Our base case is that the world needs low yields and high liquidity given the huge amount of outstanding debt that we’re still left with post the leverage bubble and the GFC. There’s still too much leverage for us to believe that accidents won’t happen with the removal of too much stimulus. If we’re correct, we may see a reaction somewhere to tapering and this in turn may force the Fed into a much slower tapering path than it wants.