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Wednesday, January 09, 2008


the debt supercycle

i used to read the bank credit analyst religiously, and have long thought highly of it. so i am interested to have picked up a september bulletin regarding their view of the credit crunch, which is optimistic.

There will be an end point to the Debt Supercycle, but we are not there yet. Market turmoil will likely persist a while longer, but the authorities still have policy ammunition, and a new round of reflation will kick start the system again. If this cycle follows the pattern of previous episodes, then a reflationary response to current problems will set the scene for a whole new round of excesses later on.

the entire paper is well worth reading. their view is that the supercycle will not end until the united states experiences foreign capital flight. i must admit that, while we have seen some signs of reluctance on the heels of new dollar lows, nothing like a wholesale collapse of foreign interest is now evident. indeed, as bank credit contracts and deflationary tendencies manifest, the dollar is set to rally and offer foreign investors some exchange rate compensation.

i'm puzzled at some of their assertions.

The risks in the current environment are also lowered by the fact that U.S. commerical banks are in much better financial shape than ahead of previous crisis periods. For example, the equity capital ratio and return on equity are extremely high by historical standards, while loan delinquency rates are low. Loan problems will clearly grow, but will remain far below the levels reached in the early 1990s crisis, when more than 6% of loans were delinquent (by value).

but the BCA predicts a reprise of the RTC (which bailed out the savings and loan debacle) in an effort to address solvency concerns, while paying less than face value in order to allay fears of moral hazard. they also anticipate direct aid to homeowners, and feel (contra my stated view) american federal government finances can sustain such operations without undue stress.

Inevitably, there is a widespread concern that reflationary policies may not work this time around. Household indebtedness is at a record and there seems little scope to boost leverage further in that sector. Meanwhile, mortgage lenders will be cautious for the foreseeable future, and housing faces a long period of adjustment. We agree that the consumer sector faces a period of retrenchment that will keep U.S. economic growth at a modest pace for some time to come. And a recession is likely at some point in the next few years. But that is different from saying that the Debt Supercycle is about to end.

this recession, the BCA anticipates, will be more severe than that of 2001 and more along the lines of 1990-1.

they further speculate that the next round of reflation will concentrate on corporate spending, as american corporations are sitting on healthy balance sheets with quite a lot of cash. moreover, their longstanding suspicion is that the final aspect of the supercycle will involve a speculative mania in emerging market shares, which may be the next beneficiary of reflation.

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