Martin Wolf: The World Economy in an Era of High Debt

and I don't know what people here will make but I had to certainly already stimulated me to think of several columns so that's very very I'm very happy I came I was old to talk about the global situation that was rather a big title for a speech lasting half an hour so I had to decide what it was going to be about and so I've just called it it's just going to be about what I think the world whether I think the world economy is today I've called it the world economy in an era of high debt that turned out to be go quite well with the previous discussion it's not really about monetary reform except at the very end and I'm going to do something which I don't normally do which might make it a bit stilted but I was advised that I should try and follow a script so I have notes and I'm gonna try and follow them so I will be standing here mostly but I hope to get through this in about 25 minutes and perhaps there can be some questions afterwards because otherwise I find it a bit depressing just hearing my own voice so um what am I going to talk about I'm very pedantic about these things so this is I'm gonna tell you what I'm going to talk about then I'm going to talk about them and then there will be some conclusions so I will focus on what's happened to the world economy since the financial crisis I'm not going to talk about what caused the financial crisis I'm not talking to talk about the history of financial crises as already pointed out there have been well there according to a well banked database there have been very far much over a hundred banking crises in the last 40 years and I'm certainly not going to talk about all those then I'm going to talk about where we are now particularly what's happened with monetary policy I'm not gonna make judgments here about whether the monetary policy were sensible or not we can discuss that asset prices in debt namely how did the authorities deal with the financial crisis and then I'll talk briefly very briefly about monetary reform that overlaps with a lot of what said so I won't add much on that so let's first start about with what's happened to the world economy since the crisis this is one of my favorite charts because it reflects very clearly the adjustment of the conventional wisdom IMF forecasts are perfect because they embody and create the the conventional wisdom that's obvious and each successive column shows the average growth expected these are at purchasing power parity I'm not going to go in to explain them that difference for this purpose the average growth of the respected the world the advanced economies the emerging economies or developing age expected over the succeeding five years starting with the fall 2011 or the autumn as we would say and ending with the most recent of autumn 2017 and there are four important points to make about this picture of the world economy some of which are very relevant to this call at this conference in some less the first is of course that emerging countries grow much faster than advanced countries and we were talking earlier about structural shifts in the digital economy but the rise of emerging economies relative to the advanced economies in my view is the single most important thing going on in the world this wasn't true until the 1990s it's a recent phenomenon it's a recent phenomenon of the last 25 years the second thing is that of course developing Asia has done consistently better and continues to do consistently better than emerging economies in general in fact they're driving most of the emerging me growth the relative rise of emerging countries is in fact restricted to emerging Asia and that doesn't really matter in the global picture because a major nature contains more than half of humanity everywhere else is the periphery we are the periphery temporarily by a freak of history Europe became the core this is getting rapidly over and the third point to make is there's been an absolutely consistent down grave of the future the future as I like to say is not what it used to be and despite the fact that fourth point the very last growth forecast for the first time shows a tiny uptick which is why we're all so elated right now because for once we not only do we have synchronised growth we have improving growth it's still far below what was hoped for four or five years ago so that's briefly where we are now second chart what has happened most of the rest focus on the developed countries simply because of lack of time and space I have much longer speeches which include the emerging countries I simply don't have the time to do so so this is what happened the two largest regions of the the Atlantic world which was the core of obviously the last furniture the reason we think this financial crisis is so big and important is that it happened as it were to us it's not supposed to happen to us it's supposed to happen to other people it even happen in Switzerland and if a financial crisis happens in Switzerland we must know it must be serious so the important points here are three Oh actually for the financial crisis was a devastating shock for developed countries their gdp s fell sharply in 2009 2008 and nine actually towards the end of 2008 and 9 something like that hadn't happened since the 30s so it was au special event the world economy as a whole by the way did not shrink but he didn't grow that was also new the u.s. started to recover from 2009 onwards and has recovered consistently through GDP per head but it is the weakest recovery the US is experienced on record the eurozone managed to have two crises because they had a eurozone crisis following the u.s. crisis and recovery started in 2013 in my view and because of the change in policy of the central bank and since 2013 GDP occurred in the eurozone as pretty well tracked that of the US but they lost six years and the result is essentially in average GDP per head the eurozone experienced a loss decayed roughly what's happened so that's this is a sort of picture we haven't seen since before the war and it's not very surprising to me that we're seeing pre-war politics emerging I mean that's pretty clearly what we're seeing we're seeing pre-war politics not thank God on the scale of the 30s but then the crisis was nothing like as big as the 30s because it was managed in different ways but we have a lot of very unhappy people that was an aggregate picture this is a picture which looks at a number of large developed countries so it's the g6 7 - Canada + Spain Canada is very boring for this purpose and the Spanish don't really understand why they aren't there because they're more important than Canada and the reason is there are too many Europeans already in the US had had enough of all these damned Europeans so they insisted on having another North American given the war that is now going on between the US and Canada on trade policy maybe the current president regrets that decision - but it was taken long before he got into power so the important point here is the enormous divergence of experience Richard would like this I think I think Germany exported its crisis but of course he will disagree violent with with that so let's park that for them and the important point is they all had bad crises they all did they all they have all now recovering but Germany recovered first and most strongly because of the strength of its export-led economy but even so by 2017 GDP per head was only ten percent above where it had been in 2007 which is pretty slow growth this is not fast growth of GDP per head but sort of decent Japan's done quite well a reasonable recovery by the way I don't accept this notion about Japan having a lost decade it had a loss to Cape but it has never lost 25 years GDP per head is doing quite well in Japan of course gee the heads are shrinking the heads are shrinking so and the workforce is shrinking productivity is doing great then there's the u.s. not done too badly we've already got that picture but you can see the other two developed countries has done even better than the US then below that you get France in the UK by very different means have ended up roughly in the same place France will pass the UK in the next couple of years we will put that down to another mistake it's called brexit ah and then you've got two really interesting cases of crisis hit countries Spain and Italy and Spain has made a remarkable recovery and has really had a Lost Decade a full loss decade and Italy is no where the gap between Germany and Italy is striking over this 10-year period GDP per head in Germany has risen relative to that in Italy by 20 percentage points roughly that's a massive massive shift and you might ask yourself whether the eurozone in the long run can sustain such massive divergences many big questions about that next chart I've stolen this from McKinsey they did the work it's plausible and I think it's a very interesting reflection of why lots and lots of people in our countries that already mentioned are really unhappy with what is going on I have focused on what I think of as relatively significant developed countries they basically did this work they asked themselves what proportion of households have experienced flat or falling real incomes from wages in capital and this was between 2005 and 14 and therefore expands the great majority that the crisis itself it would look a bit better if we went though succeeding two or three years but not actually vastly better because real disposable incomes have generally been moderately flat even the last two or three years so if you take a weighted average of 25 advanced economies about two-thirds of the households have experienced flat or falling real incomes and in a number of countries Italy in the u.s. also the UK Netherlands it's been significantly worse than that so a very high proportion of the population has experienced flat or falling real incomes over a decade and in societies where people have been told that rising living standards are the norm it's what ought to happen it seems to me that is one reason why people have got very unhappy the financial crisis isn't just something that happened to the financial system as I tried to explain in this it's very clearly something that has happened to the economy and also to the real incomes of people and they have noticed this and one of the ways they've noticed this and I could of course put many other charts on this I just don't have space to look at youth unemployment and so forth is that in a number of countries unemployment exploded after the crisis the only country where it didn't explode and it went up incredibly tiny amounts is Germany as the blue line and German unemployment has continued on down after a big spike in the US and UK unemployment game went down that's the Green Line of the black line but in the eurozone as a whole in France and Italy I don't put didn't put in Spain and Greece cuz it would make the whole scale look crazy because they're up there then peaked up in the close to 30% but unemployment soared it made people incredibly insecure and nervous it is now declining but in the eurozone as a whole it is still somewhat above where it was in the trough before the crisis which itself by the way was significantly above in the levels in the US and UK so unemployment also exploded and rising unemployment doesn't just affect the unemployed it makes everybody or many people very anxious because unemployment is a terrible condition in the modern world another thing that has happened which I don't want to link too closely to the financial crisis because I honestly think one of the many things economists don't really understand is productivity growth and the linked connections with the financial sector but this is a very interesting picture there could have been many many others which I've taken from Robert Gordon's work on the long history of productivity growth we heard earlier about the great technology revolution of our time I don't want to get into the debates about whether this is real or illusory and how real it is but all we can say for sure it's a very famous remark that the great economist Bob Solow made in 1987 which was that we can see the computers everywhere accepting the product accepting the GDP statistics has become even truer of the iPad so the the the what we see here is what's called total pact factor productivity growth which is the residual of growth over and above that we can readily explain under simplifying assumptions by the accumulation of capital and labor particularly improvements in labor so it is if you like pure innovation we had in a Gordon's view an exceptional period between 1920 in 1970 the u.s. is very relevant because it's been the frontier economy in technological terms either on its own or with one or two others for about a hundred and forty years so it's a it is the frontier we had this extraordinary period 72 94 was very poor there was a huge productivity growth slowdown after the oil shocks there was a big upswing or biggish up screen between nineteen ninety four in the middle of the last decade which most people associate explicitly with the introduction of the internet and the last decade has been really it goes up to 2014 it wouldn't have been changed if I'd included 2017 has been really really miserable at the frontier their evidence that productivity growth has seems to be extraordinarily slow at the moment the there is a big debate going on among economists about whether this is properly measured I'm going to put that to one side I think it is not the measurement problem is not fundamental here but it's part of it but the more interesting point is did it start before the financial crisis or was it started by the financial crisis my reading of the evidence is it did start before the financial crisis probably about 2005 or so but it can be the financial crisis made it much worse and it made it worse by impairing the financial sector in quite fundamental ways and impairing risk-taking and I think that's quite widely believed but like as I said our knowledge of this is limited another thing that clearly has associated with the financial crisis is the this is from Bank for International Settlements data there's been a cessation of globalization cross-border financial assets which are measured by the red line and world trade relative GDP measured by the Green Line have clearly stopped growing it's a significant factor you might well regard this and I do in the case of external financial assets as extremely attractive and desirable but it's a very significant change associated with the financial crisis globalization on these two fundamental measures trade and financial assets seems to have halted after a period of quite extraordinary growth by the way the red line of an ant global financial assets which is of course closely related to all the debt statistics we talked about earlier it's a subset of it it can be read off the left-hand scale and trade is on the right-hand scale so that very very briefly is what has happened to our economies focused on the developed world now let me turn quickly to policy asset prices and dead so just to remind you all I think this was already pointed out by you earlier central bank monetary policy has indeed been somewhat extraordinary so the these are are the central bank's policy rates of the four most significant developed countries central banks so it's the u.s. the Fed the Bank of England is red the ECB is green and the BOJ is blue and you can see that after the financial crisis with a temporary blip upwards by the ECB in 2011 which in my view went pretty damn badly the they they basically drove them down to zero the ECB and the Bank of Japan got into negative territory and only very recently right at the end after a period of about eight years has a policy rates began to rise and ism up to now that's almost entirely in the Fed and by historical standards if you look back the feds rates are still extremely extremely low the but I like to go back to 1990 because this is just shows you what how extraordinary this picture is and I'm not gonna make comment away has happened I think we covered this to some degree the Bank of Japan has had close to zero policy rates since the middle of the 1990s so we've had 23 years of near zero policy rates by the Bank of Japan and the main worry they have is that they can't raise inflation now you might think that these policies are crazy but it seems to me most economists prior to 1990 would have thought that's pretty well impossible that just shouldn't happen now but this is my single favorite chart I the the chart on monetary policy I most like because it's the only child I have I don't know why it's got caves in there that goes back to 1694 so this is the history of policy rates of the Bank of England which is I think the second oldest central bank in the world the oldest is the Swedish central bank and I don't know whether they have a comparable chart they probably do anyway this shows Bank of England policy rates Bank rate they've been called in the past base rate they've been called since 1694 and the basic point I wanted to make here is that in all those many many centuries prior to the recent past when we're going through the Napoleonic war and two world wars the Great Depression and God knows what else the rate never went below - never and it's now been half a percent or less let's back up for the last 10 years so this is an indication that we are in quite extraordinary monetary policy territory this is not something that happened forward I'd remind you that once upon a time the Bank of England was considered a rather sound and important central bank but this is not all that's happened indeed one person has already commented upon this I think was Larry who pointed to this out this is central bank balance sheets the Swiss central bank is the one I put at the top so the central bank balance sheet of Switzerland is now apparently 120 percent of GDP you know why that's happened so you betta got to 100% reserve banking congratulations all you need to do is raise a raise the reserve ratios to that level then you've done it this the story's over the Bank of Japan is getting there too that's the red line though it's slowing a little but you've got two significant central banks with absolutely extraordinary balance sheets and they make the others look rather small so I've got a separate chart for the others the US eurozone UK and I put Sweden in and you can see particularly for the US and UK the ECB already started with quite a large balance sheet there have also been very very large increases in their balance sheets that the US is now beginning to tail off downwards very very very very slowly so we now have and it's very important extraordinary large reserves in the banking balance sheet so if you want to increase the reserve rate ratios of the banking sector even not 100 percent just get them up a long way to to constrain credit creation and directly well all you have to do is to take the current reserve ratios and make them compulsory and it's done by accident as it were we've ended up in this extraordinary position of course the amos has been pointed out of all this extraordinary policy was to keep inflation up this is core consumer price inflation so this is in a exclude excludes a basically excludes energy and food that's the major exclusion it doesn't include taxes which is why the Japanese rate suddenly shoots up a couple of years ago because they increased it consumption taxes but the main point to make and here I've got the US Japan Germany the UK and eurozone is we've had this staggeringly expansion monetary policy on the face of it I'm not going to go into the question of whether Milton Friedman would have agreed was expansion I think would have said it wasn't but that because money aggregates have not been growing very rapidly that's the whole point because the credit system is broken that's why that have happened but the interesting thing is the exception of the UK which shoots up to the right at the end and that's virtually entirely I think due to the brexit induced fall of sterling all these central banks have failed to hit their targets they they've tried very very hard with exceptional monetary expansion and they've consistently failed to hit their targets of course hyperinflation begins next year some people think hyperinflation is always about to start next year and I would not rule it out because my confidence about next year is limited but it hasn't happened so far this is an extraordinary combination of monetary expansion and weak inflation and Japan is a particularly a remarkable case is the blue line you can see core inflation has been for very long periods in the negative or near zero level despite this massively on the face of it expansionary monetary policy as a red this is just one measure the point has already been made debt these are domestic credit for the financial sector to the private sector essentially of the major developed countries and you can see with the exception of the UK and to a small degree Spain there it's been absolutely no deleveraging at all it's not just the figures that correspond to bills thing these come from the World Bank I'm sure there are better sources but it's a nice simple for me to use source and they only go to 2015 it would not look better if we went to 2017 it would look worse so there has been no private sector deleveraging even in Germany though private sector debt is relatively modest there as it is in in France and of course the public sectors as have been mentioned already have leveraged up in all major developed countries with the exception of Germany I haven't gone into the emerging economies simply for lack of time and and to do this and in some countries Spain is a very interesting example Spain went into the crisis with really very little public that far less than Germany and it's ended up with public debt gross public tax a hundred percent of GDP which reinforced a proposition which I personally have long believed is correct and is even a fundamental law is that in after huge financial crises private sex sector debt transforms into public sector debt it does so not so much because of the direct refinancing of the banking sector by the state though that's important but much much more because the collapse in demand from the private sector that follows a crisis leads almost instantaneously well instantaneously to huge increases in the government's deficit as revenue collapses and cyclical spending on unemployment insurance and so forth Rises and you get enormous fiscal deficits which were in the neighborhood of 10 percent of GDP for quite a number of crisis hit countries including the US the UK in Spain and of course then the debt starts exploding extremely rapidly so financial crises lead pretty well instantaneously to rapid rises in fiscal deficits and debt as we are seeing and the final thing in looking at where we are now I think it's almost the fight not quite I'm sorry I'm over reaching is I said that we would talk about asset prices there are three - asset prices that are relevant government bonds and and stocks and as you can see these are thirty-year government bonds have very long term yields up till the early part of this year long-term bond yields fell to just unbelievably low levels completely inconsistent with any normal view of inflation expectations term risk premia and real interest rates so the highest rate on the 30-year bond of these countries was 2% so if you think they were gonna hit their inflation target that meant the real interest rate was zero in a number of countries real interest rates were clearly highly negative there's been a small bounce-back recently as we get more confident about the recovery and therefore the expected rise in short rates but even today real interest rates are astonishingly low the implications of these real interest rates if they hit their inflation targets is that they are between minus 1 and 1 percent that's the that's the real rate so that our historical standards is extremely high bond prices this is a measure of the stock market in the US the Shiller so-called cyclically adjusted price earnings ratio it's a measure of the underlying revenue income earning streams that support stock prices that's the red line the blue line is the bond yield which is very similar to it's the long-term 10-year bond yield which is very similar to what I've just shown you and if you look at my red line this goes back to 1880 you will see that the current valuation of US stocks relative to the cyclically adjusted earnings there are measuring critiques you can make of this measure but it's an it's a has proved in the past quite a good indicator of prospective returns that is they when the price is very high the subsequent real returns on stocks are very low you will see that at current this is the very ladies last Friday I think so not the very late because it's follow me then but at the current valuations the US stock market is valued more highly than in any year since 1880 except 1929 1998 1999 and 2000 in other words asset prices have been driven to extremely high levels as a result of the attempt to control - to cope with the crisis so bond yields are very low therefore bond prices are very high and equity prices are very high there's also evidence by the way that housing markets are recovering quite fast in a number of countries but I won't go into that this cyclically adjusted earnings yield is not so easy to compute for other countries going back so far here you can see this I've converted it inverted it into the earnings yield instead of a price earnings yield is just a reciprocal for the US Germany UK and Japan you can see the US has is strikingly low but its historical standards that's the Purple Line is it really very remarkably low except in the end of the 1990s it's less extreme elsewhere particularly in the UK nonetheless evaluations are pretty high elsewhere and with that background that immense monetary policy effort those effects on asset prices we are now getting a pretty decent recovery with consistent upgrades to expectations on growth in major developed countries the US UK Japan eurozone Germany France Italy in Spain if you compare the consensus of for cars in January 2017 for this year with the consensus of focus in January 2018 or a year later you can see that there is only one country in which expectations have not got vastly more optimistic than they were a year ago we are now in a boom everybody is delighted until it busts and the exception is the UK and that's because of our own self-inflicted wounds so let me just conclude if I may by saying that it is reasonable to worry about the possible interactions in the future of rising inflation rising interest rates high leverage and high asset prices this is not a comfortable position to be in we appear at the world economy level and in the developed countries I think it's true for the world economy as a whole but I haven't been able to go to to into that it's been mental for on a debt treadmill the debt treadmill turns financial for fragility into a permanent feature of our economies it's not entirely due to the monetary system but the debt driven monetary system has to be a big part of it I think in this underlines what was said in the previous session fundamentally a highly leveraged banking system that bares credit quality interest rate and maturity risk is also a source of systemic risk in other words it tends to lead to massive financial crises and of course as has already been mentioned the liabilities of the bank make up the vast bulk of the contemporary money supply and they're created essentially in the way richard has described I believe that the state is inescapably involved in the supply of money one could imagine a different world but I don't think it's a world we're going to live in because of the systemic risks created by the private sectors supply of money and the role of the state has guaranteeing this essential public good the but the the the soundness of the monetary system the state backs the privates this financial system via the central bank and also in extremis via the fiscal budget but of course this state backing of the private financial system because the privates its financial system creates most of our money increases moral hazard and inevitably therefore the fragility of the banking and financial systems my friend Andy Hall Dane has described this as the ultimate Red Queen's ray it's it's an infirm alice-in-wonderland separating the creation of money from private banking institutions is one way of reducing this fragility there are many others which have been discussed and this would return senior age to the state where in my view it properly belongs but of course we can have a very vigorous debate about this but what I think the main clusion and I failed utterly to get to be quick enough to give you time to ask me what I think we I have done is to show you that we have had an extraordinary deep and costly crisis has had big political consequences because of its economic effects on normal people and their loss of confidence in our financial economic and political arrangements and you can see signs of that across all developed countries in elections who's in power and this is very very dangerous the central banks in my view have had no alternative but to do the apparently crazy things they've done that's a point of difference to try and get the system going again but it means that we are emerging into this happier world of stronger growth with even more fragility in our economic system in my view in the financial sector and also public debt that we went into it with so I'm not at all optimistic about the stability of the future and all this I think justifies very strongly the analysis of and the enthusiasm for fundamental reforms because the system we now have is clearly and on this I think all the previous speakers agree whatever their particular views is the system we now have doesn't work

Channel: Monetary Institute

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Keywords: Martin Wolf, Financial Times, Monetary Institute, money creation, monetary policy, monetary reform

Id: SYS60iPur3g

Length: 37min 41sec (2261 seconds)

Published: Tue Apr 24 2018