Emerging Market Debt

via @IIF [Institute of International Finance] on Twitter today

"[Emerging Market] non-financial corporate indebtedness rose more than $1.6 trillion in H1 2016, surpassing $26 trillion"

The report this comes from is available to members only.

Note that corporate Saudi Arabia is currently accruing large amounts of debt. Not sure what is going on there!

A brief recap on what happens when the private sector gets over indebted. Business changes its behaviour from maximising profit to minimising debt. Rather than investing in growth, business seeks to minimise their interest payments. It's really the only rational thing to do. But it results in an economic slow down. Richard Koo calls this a balance sheet recession. He explains it well in this short video.

Richard Koo at INET

This video shows Richard Koo debating Ken Rogoff at the inaugural INET conference in 2010. Richard Koo makes a great deal of sense but he has yet to find mainstream support. Rogoff's ideas about debt have since been discredited by a graduate student. 

Koo's point that in a balance sheet recession things are different - our attitude to government debt must change. "The is a different disease!" His point is that with private debt levels so high there will be a continuing impact on demand - because the private sector are either paying off debt or saving, government must take up the slack to keep the economy going. Clearly austerity is doing the opposite and prolonging the recession.

Rogoff was one of the main proponents of focussing on government debt and cutting spending to bring it down. Now he and his colleague Carmen Reinhart are said to be "Furiously Away From Austerity Movement."

Japan has Seen it all Before, and We're Getting it Wrong

Nomura Research Institute's Richard Koo says that what the world is experiencing right now, a "balance sheet recession," is different from traditional recessions.

"This is no ordinary recession." 

Notes

"People were no longer maximising profits they were minimising debt. And even with zero interest rates people were paying down debt. And no economics text book or business school anywhere in the world has suggested that such a think should take place."

Corporate debt repayment occurred for 10 years. Equivalent to nett 6% of GDP for that period.

More debts than assets = bankrupt.  But can be bankrupt with cash-flow or without. Without cash-flow it's game over. With cash-flow the best thing to do is pay down debt. Best for all stakeholders: shares retain some value, banks get repaid, workers keep jobs. The right thing to do is to use cashflow to pay down det, and you'll eventually get back in business.

However when everyone does it the aggregate effect is that the economy shrinks. Even when interest rates are zero and people still don't borrow. Because if you are bankrupt "you are not going to borrow money at any interest rates; and no one is going to lend you money either!"

"The Great Depression in the US was exactly this pattern. US lost half of it's GDP in just 4 years... because everyone was paying down debt."

In Japan this continued for 10 years.

"In this type of situation monetary policy is largely dead in the water."

"The only thing the government can do is the opposite - borrow and spend."

"That's basically what we realised what was happening in Japan."

Govern stimulus improved things briefly, but then they cut the deficit and it crashed again--because the private sector was still deleveraging. And they repeated this cycle, for a full 15 years.

"And because this is not in the economic textbooks, because it's not supposed to happen, no one gave us the right direction, until we discovered it ourselves, that this is a different disease... fiscal stimulus was maintained we finally climbed out 2005, the whole thing took 15 years."