We live in remarkable times | Economist

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Jay Shah

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Sep 13, 2012, 7:37:45 AM9/13/12

Economics and markets

We live in remarkable times

Sep 4th 2012, 11:04 by Buttonwood

IT IS worth pausing from time to time to reflect on the remarkable features of the modern economy. As Deutsche Bank points out in its long-term asset return study, the longest series of bond yield data is for the Netherlands dating back all the way to 1517. In June, those yields reached a record low. Not just any old record, then, but a 500-year nadir. In America, yields go back only to 1790 but they too have been at all-time lows. The Bank of England was founded in 1694 but never felt the need to push base rates down so low; not in two world wars or a Great Depression. Nor did the Bank ever feel the need to expand its balance sheet to such a great extent (although Deutsche only has data back to 1830); currently it is around 25% of GDP.

Another statistic highlighted by Deutsche is the innate tendency of developed world countries to run a budget deficit. America has run a deficit for 40 of the last 44 years; Britain for 51 out of 60 and Spain for 45 out of 49. France has not balanced its budget since 1978; Italy since 1960. Efforts to balance the budget in many European countries are currently associated with recessions. There is an orthodox Keynesian explanation for this, of course, but perhaps there is something about the structure of the modern welfare state, with its elaborate system of transfer payments, that simply makes it difficult to trim. (The latest column muses on democracy and debt.)

Given this combination of economic circumstances, Deutsche is surely right to say that

Anyone predicting the endgame is speculating outside the historical dataset

Perhaps we will see hyperinflation as central banks suffer the "ketchup" problem; they create so much money that eventually it splurges out of the bottle. Or perhaps monetary policy has reached its limit, and we are in for a long period of Japanese-style stagnation. But perhaps a long period of stagnation is not feasible as it will exhaust the patience of either voters or creditors and lead to rapid default.

One other point from the Deutsche study (sorry, this is an investment bank research note and I can't link to it) is that despite all this unprecedented fiscal and monetary policy action, we have not made much progress in deleveraging economies. Deutsche looks at 16 countries and finds that only two - America and Australia - have total debt-to-GDP ratios that are lower than they were in 2007. At 345%, America's ratio is down from the peak of 366%, but barely below 2007's 348%. Some might say that is a good thing; that modern economies can't cope with shrinking credit.

But if they can't cope with shrinking credit, balanced budgets or higher interest rates, then modern economies have truly entered a new, and not very appealing, era.