Normal business cycles are self-correcting. De-leveraging cycles are self-reinforcing because the destruction of debts and assets feed on one another until excess leverage has been eliminated. The current de-leveraging is unleashing two major deflationary forces. First, the re-capitalisation of banks, and the restructuring of their balance sheets. Second, the long overdue correction of household balance sheets, especially in the US and UK, but also elsewhere where personal debt levels have risen rapidly. If we don't see the full effects of de-leveraging immediately in economic data, it is probably because economic decisions made by banks and households take much longer to affect the economy than in the case of businesses, which have to make production and employment decisions quickly. This de-leveraging downturn, therefore, will last a long time, perhaps until 2010.Today, significant securitised asset losses have already been recognised and over $200bn of new capital has been raised. But more losses, especially on residential, commercial, home equity, and consumer loans will come to light with weak or negative growth. More capital will have to be injected into financial institutions for both operational and regulatory reasons, and bank balance sheets will shrink in size and in terms of risk. According to a UBS research report, a 1 per cent rise in Tier 1 capital ratios in 2009, for example, could result in a 10 per cent decline in banks' risk-weighted assets, assuming no new capital injections. We should expect, therefore, both a larger re-capitalisation, and some contraction in assets. This hardly augurs well for an early end to the economic downturn.Households in the US and some other countries have to de-leverage for the simple reason that highly indebted households will no longer have adequate or cheap access to credit - especially housing based credit - to fund the gap between income and consumption growth. The savings rates in the US, UK and some other countries are now at historic lows at a time when credit is less accessible, real incomes are being squeezed, and unemployment is starting to increase. De-leveraging is likely to drive a downturn which is easier to define in terms of duration (measured in years rather than months) than precise depth. Monetary conditions will remain restrictive, irrespective of the level of official rates, discretionary consumption will stagnate at best, and the output gap will widen.
First, the re-capitalisation of banks, and the restructuring of their balance sheets. Second, the long overdue correction of household balance sheets, especially in the US and UK, but also elsewhere where personal debt levels have risen rapidly.
If we don't see the full effects of de-leveraging immediately in economic data, it is probably because economic decisions made by banks and households take much longer to affect the economy than in the case of businesses, which have to make production and employment decisions quickly. This de-leveraging downturn, therefore, will last a long time, perhaps until 2010.
Today, significant securitised asset losses have already been recognised and over $200bn of new capital has been raised. But more losses, especially on residential, commercial, home equity, and consumer loans will come to light with weak or negative growth. More capital will have to be injected into financial institutions for both operational and regulatory reasons, and bank balance sheets will shrink in size and in terms of risk.
According to a UBS research report, a 1 per cent rise in Tier 1 capital ratios in 2009, for example, could result in a 10 per cent decline in banks' risk-weighted assets, assuming no new capital injections. We should expect, therefore, both a larger re-capitalisation, and some contraction in assets. This hardly augurs well for an early end to the economic downturn.
Households in the US and some other countries have to de-leverage for the simple reason that highly indebted households will no longer have adequate or cheap access to credit - especially housing based credit - to fund the gap between income and consumption growth.
The savings rates in the US, UK and some other countries are now at historic lows at a time when credit is less accessible, real incomes are being squeezed, and unemployment is starting to increase.
De-leveraging is likely to drive a downturn which is easier to define in terms of duration (measured in years rather than months) than precise depth. Monetary conditions will remain restrictive, irrespective of the level of official rates, discretionary consumption will stagnate at best, and the output gap will widen.
Normal business cycles are self-correcting. De-leveraging cycles are self-reinforcing because the destruction of debts and assets feed on one another until excess leverage has been eliminated. The current de-leveraging is unleashing two major deflationary forces.
What are they talking about? Business cycles are de-leveraging cycles. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes
