Green Shoots?

The other day I wrote that there are no green shoots of recovery. Perhaps that is unnecessarily dour. Like any living organism, the economy is continually growing and dying away at the same time. So at any given moment, there are green shoots, in the form of new businesses, new ideas, new innovations. At the same time, at any given moment someone is being laid off, a business is failing, and so on.

The phrase green shoots suggest that the winter of recession is over and the spring of recovery has begun. I don't think we're close to the recovery, because while the process of deleveraging is occurring, it's still incomplete. When household, corporate, and government debt burdens have been reduced to something like their historical levels, then I'd say the process of deleveraging has been completed. But we're far from that point now. Consider the graphs to the left. The top two show rapid rates of issuance of government debt securities, far in excess of economic growth rates. The third shows the escalation of debt within corporations, most of it led by the financial sector, which has made leverage into an art form. The last shows the debt burden among households. These last two show debt as a percentage of GDP, which corrects for increases in wealth, productivity, inflation, etc. What we see is basically a tripling of the relative debt burden of households, and even more of an increase in the corporate sector.

What must happen is a purging of bad debts. There is no way that all the debts that have been incurred by households, the various levels of government, and corporations will be repaid. That means lenders are in for a serious hit. The carnage we've seen in the financial sector (for example, look at the DJ Financial Services Index) is just the beginning. What is needed is a shift away from finance toward productive economic activity, a sort of de-financialization, to use a fancy term. (there's a nice post on this at Below the Crowd)

It's clear that massive bailouts to the financial sector will be costly failures. No amount of money creation can prevent de-financialization from occurring. If we test my thesis, it will only come at the expense of inflation. But high inflation would also threaten financial firms, for high inflation cuts into interest rates, lightening relative debt burdens in favor of the debtor, harming the creditor, making it more difficult to both borrow and lend. High inflation would also make nominal interest rates rise, encouraging further deleveraging.