Sunday, April 26, 2015

Rogoff, debt cycles, and optimism

The name Ken Rogoff ring a bell? How about Reinhart and Rogoff? Or maybe you remember the notion that once central government debt reaches 90% of GDP, economic growth falls off -- you remember that one, right? And the name Thomas Herndon too, maybe?

Reinhart and Rogoff, Growth in a Time of Debt:

Our main result is that ... median growth rates for countries with public debt over roughly 90 percent of GDP are about one percent lower than otherwise; average (mean) growth rates are several percent lower.

You might expect Ken Rogoff to be a man of principle (not a man of science). You might expect his economic analysis always to come up heads for the right and tails for the left. If so, you might be surprised by his recent article at VOX. Rogoff writes:

... there has been far too much focus on orthodox policy responses and not enough on heterodox responses that might have been better suited to a crisis greatly amplified by financial market breakdown. In particular, policymakers should have more vigorously pursued debt write-downs ...

That's downright Arthurian.

From Rogoff's article:
Has the world sunk into ‘secular stagnation’, with a long future of much lower per capita income growth driven significantly by a chronic deficiency in global demand? Or does weak post-Crisis growth reflect the post-financial crisis phase of a debt supercycle where, after deleveraging and borrowing headwinds subside, expected growth trends might prove higher than simple extrapolations of recent performance might suggest?

I will argue that the financial crisis/debt supercycle view provides a much more accurate and useful framework for understanding what has transpired and what is likely to come next.

All in all, the debt supercycle and secular stagnation view of today’s global economy may be two different views of the same phenomenon, but they are not equal. The debt supercycle model matches up with a couple of hundred years of experience of similar financial crises. The secular stagnation view does not capture the heart attack the global economy experienced; slow-moving demographics do not explain sharp housing price bubbles and collapses.

It's an important topic. And because I think in terms of debt-as-cause-of-problem and problem-that-fits-a-cycle-of-civilization, Rogoff's "debt supercycle" catches my eye.

In the introductory paragraph above Rogoff's VOX article, we read:

Unlike secular stagnation, a debt supercycle is not forever.

I like the clarity in that. "Secular stagnation" is long term stagnation. By contrast, we expect a "cycle" to have its ups and downs.

The introductory continues:

After deleveraging and borrowing headwinds subside, expected growth trends might prove higher than simple extrapolations of recent performance might suggest.

So if we think in terms of a cycle, or no, but if the economy actually moves in a cyclic pattern of sorts, then we have reason for optimism, Rogoff says, simply because of the cyclical pattern: Good times are bound to return.

Secular (unexplained) stagnation offers no reason for optimism. Unexplained? Yes. Rogoff observes "the view that the world is suffering from long-term secular stagnation due to a chronic shortfall of demand." Well that's circular, for sure. A shortfall of demand *IS* stagnation.

But if the problem is a debt supercycle it's the pattern that's circular, not the argument. And if it is a debt supercycle, then we can be pretty sure the problem arose with debt -- with "overall economy-wide debt", to use Rogoff's phrase. He's knocking at my door.

But one doesn't adopt cyclical thoughts because they allow for optimism. Good grief!

Have we reason for optimism? "Again," Rogoff writes,

the US appears to be near the tail end of its leverage cycle

Near the end of the leverage cycle? I don't think so. Look at the start- and end-levels for the previous (blue) and current (red) depression-scale peaks of private debt on this graph:

Graph #1: Comparison of Debt Growth around the 1929 and 2008 Debt Peaks
See my Decline from Peak Debt (2015 Update) spreadsheet on Google Drive.
Previous version of this graph: 17 December 2012
Private debt rose much more quickly in the 2000s than in the 1920s. But the deleverage was much less in the recent period. This time, private debt has been reduced almost not at all.

It's not that the period of deleveraging is almost over. It's that the deleveraging never really got under way. That leaves little room for baseless optimism.

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