Positive economic statistics, and a solution to the Greek debt crisis, have been the driving force behind the stock markets gain over the last few days. But, according to chief economist David Rosenberg, creating new sovereign borrowing to finance another thriftless consumer binge and more asset bubbles is no way to achieve sustainable growth.
“Unless immediately addressed, the excess of sovereign debt will be the next chapter in the credit crisis.”
“Crisis what crisis? Have a read of Hedge Fund Pay Roars Back in the NYT and see how one fund manager is boasting about how he “bet on the country’s revival.” Sure, on the back of the most aggressive intervention ever by the government to prop up asset prices by burning the short sellers, who actually got the call right in terms of identifying which institutions were, in fact, insolvent,” chief economist David Rosenberg at Gluskin Sheff writes in his latest market commentary.
“It is nice to know that the government efforts to save the system nicely padded the pocketbooks of the hedge fund community even though we still have on our hands the poorest recovery in final sales, organic wage-based income and employment ever recorded,” he adds.
“The fund manager cited above (see Hedge Fund Pay Roars Back on page B1 of the NYT) who claimed brilliance because he believed that the government would go all-in on saving banks, home-builders and automakers and preventing the consumer from daring to raise its savings rate, should consider that governments do not create income or wealth but merely redistributing it.”
“While they can borrow their way towards achieving their objectives in the short- and intermediate-term, there is a piper that will have to inevitably get paid. Those who think that the road ahead is going to be paved with riches just because of the success these hedge fund PMs had in terms of placing “bets” on government intervention may want to have a read of the well thought-out column by David Roche on page 22 of the FT (Watch Out For Sovereign Black Holes in the Credit Universe).”
“The markets are very likely not taking into account the extent of the fiscal tightening that is going to be required over the next three to five years.”
• Once government debt-to-GDP ratios break above a 60-90% range, more government spending actually takes on classic ‘Ricardian equivalence’ characteristics and leads to lower economic activity (Rogoff & Reinhardt). In general, risk assets are not pricing this in this stylized fact. Further to this assertion of how the government is now achieving fewer results with greater taxpayer funds, have a look at the editorial section of today’s WSJ (The Permanent Mortgage Crisis).
• It would take fiscal tightening in the order of 8-10% of GDP annually for the U.S., the U.K. and Japan over the next five years just to bring their government debt-to-GDP ratios to the levels prevailing in 2007 (from the Bank of International Settlements).
• Budget deficits in OECD countries now absorb 50% of the combined savings pool (Roche).
Conclusion: “Creating new sovereign borrowing to finance another thriftless consumer binge and more asset bubbles is no way to achieve sustainable growth. Unless immediately addressed, the excess of sovereign debt will be the next chapter in the credit crisis.”
“In other words, the markets are very likely not taking into account the extent of the fiscal tightening that is going to be required over the next three to five years, which will undoubtedly have a dampening effect on everything from income, to spending, to output, to profits, to inflation. Investors seem to be have been lulled into this false sense of security that the governments are equipped with the resources, or even have the willingness, to embark on another ‘too big to fail’ strategy once the next crisis hits,” Mr. Rosenberg concludes.
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