In keeping with his affinity for the world view of the dour economist, Magnus depicts our current credit crunch as a Minsky moment and sees the outcome as dependent on whether investors take up central bankers’ interest rate cuts.
Excerpted from the Financial Times:
Hypothetical scenarios revolve around whether declines in interest rates will spur a new round of risk-taking and debt, or whether we will be left pushing on that wretched piece of string. If the former, it will give longevity to the economic expansion, culminating in 2008 in the revival of higher inflation and interest rate fears. If the latter, we may at best face slow growth and higher unemployment until 2009, with interest rates declining in most places through next year.
In my view, two main propositions define the outlook. First, the flight from debt in this downswing may be as potent as the rush towards it was on the upswing. In the US, the credit share of gross domestic product rose from 270 per cent in 2000 to 340 per cent in early 2007, mainly as households and financial institutions relied on borrowed money or leverage to increase spending on goods and services and assets. It is most likely that the reduced availability of cheap credit is going to lead to a sharp reverse in spending.
Second, current credit cycle concerns are about solvency, not liquidity per se as was the case in 1998, after which the world economy recovered quite promptly. This time the problem is about solvency among homeowners, builders, mortgage providers and financial institutions. Despite the fact that aggregate corporate balance sheets are in reasonably good shape, the rapid deterioration in financial conditions and rising cost of capital will almost certainly lead to higher default rates. Currently, most people are focused on the availability of capital. But in due course the price of capital will become more significant and tend to depress borrowing, capital raising and capital spending and employment.