Debt and Demand

LONDON – Former US Treasury Secretary Larry Summers recently caused a stir with his warning of sustained economic stagnation in the advanced economies. But, while many reject his suggestion of a secular trend, the data support him. Yes, economic growth has picked up in the United States and the United Kingdom, while the eurozone economy is no longer contracting and Japan shows some signs of responding to “Abenomics.” But the global recovery remains extremely weak, with most advanced economies still performing at 10-15% below pre-crisis growth trends.

It is not difficult to see why the recovery has been anemic. Excessive private-debt creation before the crisis and subsequent attempts at deleveraging have weakened demand considerably.

While fiscal deficits can help to offset deficient demand, they also result in rising public debt. Leverage has not gone away; it has simply shifted to the public sector – creating a debt overhang that may last for many years, or even decades. Eliminating it will likely require significant debt write-offs or permanent monetization.

But, as Summers noted, the party that preceded this severe post-crisis hangover was not, in terms of actual growth, all that exuberant. Credit volumes and asset prices soared, but labor markets did not overheat, real earnings remained flat in many advanced economies, and inflation rates were remarkably stable. Nominal demand grew at roughly 5% annually, despite annual credit growth of 10% or more.