The recent G8 meeting confirmed that OECD governments are in denial. They are trying to stave off the impact of private sector deleveraging by adding to their own debt. This won’t work and is merely creating new problems that will emerge farther down the road.
Government debt will weigh heavily on sustained economic growth because of wasted expenditure and rising tax burdens to pay for it.
The servicing of government debt will mean higher government bond yields and a lower dollar, along with lower-than-average returns on productive assets. And that means the same for most financial assets.
One of my key themes in past columns has been that the huge rise in asset prices since 2002 had been made possible by a massive increase in debt, particularly in new forms of money beyond traditional areas of credit such as bank lending. These new forms (securitized debt and the derivatives based on it) must now shrink. And bank credit must shrink and bank leverage be reduced permanently before sustained economic growth can be resumed in a world based more on thrift than credit.
If that is the measure of when we can expect the global economy to start to recover, then we are not there yet.