Wednesday, 8 October 2014

The IMF gives more poor advice

The IMF have made some interesting pronouncements over the last few years – having missed the credit crunch and the “great recession” that followed they at first endorsed the UKs plan A and then decried it just as it was starting to work – so we shouldn’t hold up too much hope that the Fund will have anything sensible to say on the matter of European recovery.  No one was too interested when they published their World Economic Outlook, which is normally like a school report – “the UK could try harder”, “France needs to apply herself and complete home work on time” – you get the picture.  But this time round it was a bit more specific and surprisingly so; normally the IMF is reasonably hawkish, looking to solve problems through monetary policy (what would expect, it’s a bank) but in this report the IMF suggest substantially increased public spending on infrastructure investment, and across much of the world.   It asserts that when unemployment is high and interest rates are low, the benefits will be greater if investment is paid for by increased borrowing, rather than cutting other spending or raising taxes. Most interestingly, the IMF declares that good infrastructure investment will reduce rather than increase government debt burdens as public infrastructure investments pay for themselves.  Confusingly the whole 44 page synopsis of the WEO highlights a number of risks to the world economy – political risk in Russia, property bubbles, shortages of natural gas, etc;  but report hardly mentions the debts run up by governments and leverage in the banking system - convenient eh!
Christine Lagarde Head of the IMF points the way forward

In stark contrast and a world away from Washington, where the IMF is based, the Geneva based Centre for Economic Policy Research has published an interesting paper on the evils of debt and the world inability to do without leverage.  The paper titled “Deleverage, What Deleverage” concludes that the world and the advanced world in particular is hooked on debt and tells us -  “The world has not yet begun to de-lever and global debt ratios are breaking new highs. At the same time, in a poisonous combination, world underlying growth and inflation are also lower than previously expected, reducing global debt capacity”.  In short hand – we have never been so indebted and low growth and deflation could make this extremely dangerous.
On one hand we have the IMF egged on by Larry Summers and Paul Krugman imploring governments to spend more to drive growth and inflation, whilst the CEPR point out that world debt is now over 200% of global GDP – and that despite the great recession and all that we have not started on the road to redemption.

Debts are generally higher in the advanced economies and likely to by weighted to public debt rather than private debt which is the main component in emerging markets.  The chart below shows that government debts are still rising in the advanced economies some 5 years after the Lehman’s bust.

The basis for the IMF advice to the advanced economies to borrow more to fund “infrastructure” investments is - money is cheap and maybe labour is cheap and some countries have lousy infrastructure and Government debt is only 25% of the whole debt problem (total debts including financials are around 400% of GDP in the advanced economies) so what could go wrong.  Well the problem is that investors generally aren’t Keynesian economists they tend to be hard-nosed people who prefer is see their savings dwindle rather than face a total loss due to a sovereign default.  So there we have it; governments might try to simulate growth but borrowing to fund infrastructure projects but any small net benefit would be wiped out by the negative effect this will have on private borrowers  (75% of all debt) they will be scared off and overall investment will plummet.  So short of sending all rich people, bankers and business people on a Keynesian indoctrination we should start to de-leverage and and quickly confidence will return to the private sector who will have confidence in the markets that they are investing into.  And if you want some proof for this the UK is an example of how this con trick can work.  In 2013 just as the IMF suggested that plan A would not work (too much deleverage) there was a great in flow of overseas investment as confidence grew that we were serious about tackling debt and the rest is history!

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