By Mark Carney, Bank of Canada Governor, 12-December 2011
Link: http://www.bankofcanada.ca/2011/12/speeches/growth-in-the-age-of-deleveraging/
Link: http://www.bankofcanada.ca/2011/12/speeches/growth-in-the-age-of-deleveraging/
Introduction
These are trying times.
In our largest trading partner, households are undergoing a long process of balance-sheet repair. Partly as a consequence, American demand for Canadian exports is $30 billion lower than normal.
In Europe, a renewed crisis is underway. An increasing number of countries are being forced to pay unsustainable rates on their borrowings. With a vicious deleveraging process taking hold in its banking sector, the euro area is sinking into recession. Given ties of trade, finance and confidence, the rest of the world is beginning to feel the effects.
Most fundamentally, current events mark a rupture. Advanced economies have steadily increased leverage for decades. That era is now decisively over. The direction may be clear, but the magnitude and abruptness of the process are not. It could be long and orderly or it could be sharp and chaotic. How we manage it will do much to determine our relative prosperity.
This is my subject today: how Canada can grow in this environment of global deleveraging.
How We Got Here: Debt Supercycle
First, it is important to get a sense of the scale of the challenge.
Accumulating the mountain of debt now weighing on advanced economies has been the work of a generation. Across G-7 countries, total non-financial debt has doubled since 1980 to 300 per cent of GDP. Global public debt to global GDP is almost at 80 per cent, equivalent to levels that have historically been associated with widespread sovereign defaults.
The debt super cycle has manifested itself in different ways in different countries. In Japan and Italy, for example, increases in government borrowing have led the way. In the United States and United Kingdom, increases in household debt have been more significant, at least until recently. For the most part, increases in non-financial corporate debt have been modest to negative over the past thirty years.
In general, the more that households and governments drive leverage, the less the productive capacity of the economy expands, and, the less sustainable the overall debt burden ultimately is.
Another general lesson is that excessive private debts usually end up in the public sector one way or another. Private defaults often mean public rescues of banking sectors; recessions fed by deleveraging usually prompt expansionary fiscal policies. This means that the public debt of most advanced economies can be expected to rise above 90 percent threshold historically associated with slower economic growth.
The cases of Europe and the United States are instructive.
Today, American aggregate non-financial debt is at levels similar to those last seen in the midst of the Great Depression. At 250 per cent of GDP, that debt burden is equivalent to almost US$120,000 for every American. (Chart 1)
Several factors drove a massive increase in American household leverage. Demographics have played a role, with the shape of the debt cycle tracking the progression of baby boomers through the workforce.
The stagnation of middle-class real wages (itself the product of technology and globalisation) meant households had to borrow if they wanted to maintain consumption growth.
Financial innovation made it easier to do so. And the ready supply of foreign capital from the global savings glut made it cheaper.
Most importantly, complacency among individuals and institutions, fed by a long period of macroeconomic stability and rising asset prices, made this remorseless borrowing seem sensible.
From an aggregate perspective, the euro area’s debt metrics do not look as daunting. Its aggregate public debt burden is lower than that of the United States and Japan. The euro area’s current account with the rest of the world is roughly balanced, as it has been for some time. But these aggregate measures mask large internal imbalances. As so often with debt, distribution matters. (Chart 2)
Europe’s problems are partly a product of the initial success of the single currency. After its launch, cross-border lending exploded. Easy money fed booms, which flattered government fiscal positions and supported bank balance sheets.
Over time, competitiveness eroded. Euro-wide price stability masked large differences in national inflation rates. Unit labour costs in peripheral countries shot up relative to the core economies, particularly Germany. The resulting deterioration in competitiveness has made the continuation of past trends unsustainable Growth models across Europe must radically change (Chart 3)
