(By Claus Vistesen) The debate is on! Are we in a liquidity trap and if so what should we do? Why is the financial system depleted of collateral and what does this mean? Should policy makers and central banks be even more "irresponsible" (1) and conduct more monitised deficit spending? What does a lack of triple A rated/safe haven securities mean and is it real?
All these questions and more have recently gotten a fascinating treatment in the economics debate courtesy, mainly, of this piece by Credit Suisse. FT Alphaville has been giventhe question extensive and brilliant coverage and now even the IMF has pitched in. I think the issues raised are not only important but likely to form a substantial part of framework for the next decade's worth of research on macroeconomics, monetary policy and financial markets.
So yes my dear reader. This is no time to shy back. Dig in, and dig in hard! In this first post of a series of 3-5 posts, I try to present the building blocks of the argument as I see them an answer the question of why the traditional view on the liquidity trap does not apply in the current situation.
Let me begin with the following key premises for my argument and the state of the global economy and financial system post 2008/09. I will try to develop each of these statements in the posts that follows.
- The crisis of 2008/09 has ushered in what is likely to be a period of severe stress in global sovereign fixed income markets. Sovereign debt distress and defaults are messy and costly affairs and take a long time to deal with. We have now entered a period where the next 10-20 years will see several developed economies default on their sovereign debt. Ageing populations, too low growth and insufficient future income/consumption to push forward mean that the OECD is now at an inflection point. For global financial markets this means that an unprecedented and systemic share of the global fixed income market is likely to be in distress at any given point in time over the next 10-20 years.
- There is an accute shortage of liquid triple A rated government securities. This shortage is structural and capital deepening in emerging economies is too slow and insufficient in size to take up the slack. Pension funds, insurance companies and big real money managagers are now essentially unable to construct their portfolios in such a way to match their future liabilities with a satisfactory (or perhaps even promised) yield. In addition, this leads to mispricings in remaining assets considered the last safe havens. US government bonds, UK Gilts, German Bunds, Danish Mortage Backed Securities etc.
- Central banks are now acting as international clearing houses for the banking system. This is mainly seen in Europe where the ECB has been forced into taking up slack for an interbank market which has essentially been broken.