Low Growth And High Debt: Financial Repression Is Here To Stay

In case we needed to be reminded, the IMF’s latest World Economic Outlook included a section on the rather dismal long-run outlook for economic growth. Trends in demographics and productivity are expected to deliver average potential growth of only 1.6% a year in the advanced economies during the remainder of the decade. Such measly growth will make it very difficult for governments to lower current high debt-to-GDP ratios.

In this Special Report, BCA’s Chief Economist, Martin Barnes, explains why debt burdens are more likely to rise than fall over the short and long run given demographic trends and the low odds of another economic boom. If governments cannot easily bring debt ratios down to more sustainable levels, then the obvious solution is to make high debt levels easier to live with. This can be done be keeping real borrowing costs down and by regulatory pressures that encourage financial institutions to hold more government securities. In other words, financial repression is the inevitable result of a world of low growth and stubbornly high debt.

Martin argues that central banks are not overt supporters of financial repression, but they certainly are enablers because they have no other options other than to keep rates depressed if they cannot meet their growth and/or inflation targets. A world of financial repression is an uncomfortable world for investors as it implies continued distortions in asset prices, and it is bound to breed excesses that ultimately will threaten financial stability.

For the full report and investment implications, please see Low Growth And High Debt: Financial Repression Is Here To Stay.

The Spike In German Bund Yields Will Not Last

The recent selloff in German bunds has been driven by two factors. First, Grexit risks have abated. Second, and more importantly, euro area growth continues to surprise on the upside.

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The IMF reckons that the lagged effect of a weaker euro alone should boost real GDP by a cumulative 1.7 percentage points by early next year, with lower oil prices contributing another 0.3 points. In addition, we estimate that increased government spending could boost growth by a further 0.3 points this year, while the shift from negative to modestly positive credit growth could add a full percentage point.
This is a lot of extra growth in a very short period of time, and so it is not surprising that investors have begun to reconsider their view that the ECB will keep rates on hold for many years to come. However, while the euro area economy is likely to fare well over the coming few quarters, the party will not last far into 2016. Please see the next Insight, (Part II) The Spike In German Bunds Will Not Last.