While market watchers fixated on the debt ceiling in the United States, as the clock for raising the ceiling was again reset by Congress, debt issues in China likely pose a more significant threat to the global economy. It’s a risk not lost on Chinese policymakers, who are adopting new practices in order to wean their economy off dept dependence before the worst happens. But with the current levels of debt, economic imbalances and perhaps most importantly high debt inefficiency that clock is ticking. And unlike the U.S. Congress’ debt clock, this Chinese one is not going to be reset by a simple vote of politicians to borrow more. It is imbalances such as these not so easily addressed that pose the real threat to the stock market.
The Three Bears Economy has seen us move through the doctom bubble of corporate debt, the real estate bubble of consumer debt and now we are deep into the government bubble of debt. Previously people got rich oftentimes only on paper from dotcom stocks before they fell and then many saw their wealth on paper rise and fall with their home values. Now we are well into the era of people making money from government, including paper millionaires—retirees with million plus dollar government retirement plans. Pension millionaires include the ex-police chief of Stockton California, who after two years as chief, retired with an annual pension of over $200,000. Add in benefits and on paper you get to over a million dollars in payouts pretty quickly. But the government largesse the ex-chief and many Americans to a lesser extent are growing accustomed to will turn out to be as solid as pets.com stock or sky high real estate values, because it is built on unsustainable debt. In the case of Stockton the city is already in bankruptcy, and in the case of the global economy the clock is ticking on how much longer government spending will prop up living standards.
The balance sheets of the major central banks of the world are in a dangerous state. In the United States, the European Union and Japan they have basically printed money to buy debt, counting the debt securities purchased as an asset and the money paid for them in the liability column. Despite many mistakenly believing China’s central bank must be in good shape with all the U.S. government debt held in its asset column, this overlooks its liability column. Reviewing the magnitude of central bank liabilities, the implications on future policy and potential economic challenges, arguments can be made that central bankers are either wisely learning from history or the equivalent of fools playing with matches in pools of gasoline of their own pouring. Unfortunately their lackluster track record argues more for the latter than the former.
With the media focused on the political circus around the debt ceiling, not much attention was paid outside of financial circles to the newest GDP data announced late in July. But it is likely of more concern than the government’s self imposed borrowing limit. The first six months of 2011 were estimated to be the weakest in terms of economic growth since the recovery began. The first quarter is now estimated to have posted annualized growth of just 0.4 percent with the second delivering an uptick of only 1.3 percent. As a result economic forecasts are being lowered for future growth.
There has been a lot of worrying in financial markets over the past few months. In fact quite a long list of looming disasters has been assembled. Will destabilization in the Middle East, especially if unrest reaches Saudi Arabia, send oil prices skyrocketing and the global economy spiraling? Could this wave of unrest spread to China? Will the earthquake in Japan trigger a financial crisis in that country, as more debt is added to an already formidable mountain of debt? Is Bill Gross signaling a debt crisis in the U.S. is eminent, as he pilots the world’s largest bond fund out of U.S. Treasuries? Irrespective of the U.S. Treasury market is a wave of defaults on its way in the municipal bond market? And what about real estate—are we now on our way to a second bottom with prices headed for a 20 percent or greater decline?