Recessions vs de-leveraging
0The current recovery is playing out differently than past ones because a de-leveraging cycle is at its heart different than a typical Central Bank-controlled cycle.
A typical recession is an economic contraction that is typically due to a contraction in private sector capital (i.e., debt and equity) arising from tight central bank policy (usually to fight inflation), which ends when the central bank eases.
Recessions end when central banks lower interest rates and increase the supply of money enough to stimulate demand for goods and services and credit growth because lower interest rates
1) reduce existing debt service costs;
2) lower monthly payments (de-facto, the costs) of new items bought on credit, which stimulates the demand for them; and
3) raise the prices of income-producing assets like stocks, bonds and real estate through the present value effect of discounting their expected cash flows at the lower interest rates, producing a “wealth effect” on spending.
However, this cycle was not really caused by significant Central Bank tightening, but rather by the pricking of a debt bubble.
A product of the debt bubble was an over-levered financial system along with an over-levered consumer.
De-leveragings cannot be rectified by the Central Bank changing the cost of money.
The lingering impact of the de-leveraging and the policy reaction to it will be a significant driver of markets and the economy for the next decade.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
