Why Deleveraging Is The True Culprit Weighing On Global Growth
Fears over “secular stagnation” appear to be overdone
Persistent low and negative interest rates have prompted fears that the global economy has entered a period of chronic weak demand, famously described by former U.S. Treasury Secretary Larry Summers as “secular stagnation.” It is easy to see why people are concerned: Since the 2007–2008 global financial crisis (GFC), monetary policy has been continuously loosened to prop up growth—with disappointing results. The proximity of policy rates to the lower bound also means there is little policy space should we encounter a negative demand shock, leaving central banks with a major headache.
I do not believe that the primary cause of the sluggish growth over the past decade is secular stagnation. Rather, the unprecedented low rates of recent years are, in my view, the product of a protracted deleveraging process that is likely to reverse at some point. As such, I think that the global economy is probably in better shape than the proponents of secular stagnation would have us believe.
The Four Phases of Postcrisis Deleveraging
The deleveraging since the GFC has come in four phases: the acute phase of the financial crisis, which kicked off the deleveraging of the U.S. balance sheets; the eurozone sovereign crisis, which started the deleveraging process in Europe; the taper tantrum, which mainly affected ex China emerging market countries; and most recent, the deleveraging of the Chinese economy. These phases of deleveraging have applied a series of powerful brakes to the global economy, one after the other, over the past 11 years. Typically, postcrisis periods of deleveraging last for a few years; the longevity and breadth of the current one shows the extent to which macro imbalances accumulated before, and during, the GFC.
What were these imbalances? I think there were three main ones. First, in the years preceding the financial crisis, loose financial conditions facilitated an enormous construction boom. This imbalance, most pronounced in the United States and the troubled economies in the south of Europe, left the world with an inventory backlog that we have been working to reduce ever since. Second, shocks to housing caused more damage to household balance sheets than shocks to the financial markets. Housing is the prime store of wealth for most families, whereas stock investing is the privilege of the elites only. In combination with more prudent lending standards, the impairment of households’ balance sheets has frustrated households’ access to credit. Third, in response to the financial crisis, fiscal deficits ballooned and emerging markets, which entered the crisis with pristine private sector balance sheets, promoted a rapid expansion of credit to the private sector.
The deleveraging process has diverged across regions. In the U.S., while households have aggressively brought down their debt levels, the nonfinancial corporate sector has substantially increased its borrowing. The borrowing by the nonfinancial corporate sector has been mainly used for financial engineering (stock repurchases, dividend payments, acquisitions), which, unlike capital formation, does not support growth. In Europe and Japan, deleveraging has been multifaceted, but there has been a strong impulse to reign in the fiscal deficits that ballooned during the great financial/Eurozone sovereign crisis. The deleveraging process in China has been orchestrated by a decisive swing in the policy priority from growth to financial stability and has been concentrated in the non‑household sector.
What happens when everybody wants to deleverage—i.e., save—at the same time? Deficient final demand drives down growth and a surplus of loanable funds drives down interest rates. However, it would be a mistake to believe that there is anything “natural” about a secular state of deleveraging. In any economy with a growing population, household debt should be an increasing share of aggregate income as growth in the number of households requires growth in the stock of available housing. In turn, this requires someone to take on a mortgage—either the household or the landlord.
Lower Debt, Smaller Recession
One consequence of the deleveraging process is that it has left the global economy with very few macro imbalances: We do not experience capex or consumption booms in economies that deleverage. Most recessions emerge in response to excesses; therefore, seen through a macro prism, the global economy finds itself in an unusually resilient state given the already long‑lived expansion. So while there will inevitably be a correction at some point, the absence of a real economy macro imbalance should lessen its severity.
Are we too cavalier about the rising debt levels of the U.S. nonfinancial corporate sector? This is clearly a financial fragility that, most likely, will play a prominent role in the next recession. However, as this debt has not found its way into the real economy in the form of a capex boom, it has likely not created much of a macro distortion.
What will it take for consumers and businesses to begin to borrow again and trigger growth? That is a more difficult question. Beyond completing the inventory adjustment in construction/housing, taking on debt requires a certain amount of confidence in the future, of which stable politics is a key component. The past few years, however, have given us the on‑off U.S.‑China trade dispute, the prolonged saga of Brexit, and the rise of populist, antiestablishment political parties in many countries. A degree of political stability may need to return before households and firms begin spending again.
We will explore the likely timing of any return to leveraging in a separate article. For now, we reemphasize the point that the chronically low demand and low level of interest rates that we have experienced over the past decade seem to be, more likely, the result of a deleveraging process instigated by a large buildup of macro imbalances prior to the global financial crisis and not to secular stagnation. As such, the global economy is likely in much better shape than the proponents of secular stagnation argue.
This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.
Australia—Issued in Australia by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 50, Governor Phillip Tower, 1 Farrer Place, Suite 50B, Sydney, NSW 2000, Australia. For Wholesale Clients only.
Brunei—This material can only be delivered to certain specific institutional investors for informational purpose upon request only. The strategy and/or any products associated with the strategy has not been authorised for distribution in Brunei. No distribution of this material to any member of the public in Brunei is permitted.
Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to Accredited Investors as defined under National Instrument 45-106. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.
China—This material is provided to specific qualified domestic institutional investor or sovereign wealth fund on a one-on-one basis. No invitation to offer, or offer for, or sale of, the shares will be made in the People’s Republic of China (“PRC”) (which, for such purpose, does not include the Hong Kong or Macau Special Administrative Regions or Taiwan) or by any means that would be deemed public under the laws of the PRC. The information relating to the strategy contained in this material has not been submitted to or approved by the China Securities Regulatory Commission or any other relevant governmental authority in the PRC. The strategy and/or any product associated with the strategy may only be offered or sold to investors in the PRC that are expressly authorized under the laws and regulations of the PRC to buy and sell securities denominated in a currency other than the Renminbi (or RMB), which is the official currency of the PRC. Potential investors who are resident in the PRC are responsible for obtaining the required approvals from all relevant government authorities in the PRC, including, but not limited to, the State Administration of Foreign Exchange, before purchasing the shares. This document further does not constitute any securities or investment advice to citizens of the PRC, or nationals with permanent residence in the PRC, or to any corporation, partnership, or other entity incorporated or established in the PRC.
DIFC—Issued in the Dubai International Financial Centre by T. Rowe Price International Ltd. This material is communicated on behalf of T. Rowe Price International Ltd. by its representative office which is regulated by the Dubai Financial Services Authority. For Professional Clients only.
EEA ex-UK—Unless indicated otherwise this material is issued and approved by T. Rowe Price (Luxembourg) Management S.à r.l. 35 Boulevard du Prince Henri L-1724 Luxembourg which is authorised and regulated by the Luxembourg Commission de Surveillance du Secteur Financier. For Professional Clients only.
Hong Kong—Issued in Hong Kong by T. Rowe Price Hong Kong Limited, 6/F, Chater House, 8 Connaught Road Central, Hong Kong. T. Rowe Price Hong Kong Limited is licensed and regulated by the Securities & Futures Commission. For Professional Investors only.
Indonesia—This material is intended to be used only by the designated recipient to whom T. Rowe Price delivered; it is for institutional use only. Under no circumstances should the material, in whole or in part, be copied, redistributed or shared, in any medium, without prior written consent from T. Rowe Price. No distribution of this material to members of the public in any jurisdiction is permitted.
Korea—This material is intended only to Qualified Professional Investors upon specific and unsolicited request and may not be reproduced in whole or in part nor can they be transmitted to any other person in the Republic of Korea.
Malaysia—This material can only be delivered to specific institutional investor upon specific and unsolicited request. The strategy and/or any products associated with the strategy has not been authorised for distribution in Malaysia. This material is solely for institutional use and for informational purposes only. This material does not provide investment advice or an offering to make, or an inducement or attempted inducement of any person to enter into or to offer to enter into, an agreement for or with a view to acquiring, disposing of, subscribing for or underwriting securities. Nothing in this material shall be considered a making available of, solicitation to buy, an offering for subscription or purchase or an invitation to subscribe for or purchase any securities, or any other product or service, to any person in any jurisdiction where such offer, solicitation, purchase or sale would be unlawful under the laws of Malaysia.
New Zealand—Issued in New Zealand by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 50, Governor Phillip Tower, 1 Farrer Place, Suite 50B, Sydney, NSW 2000, Australia. No Interests are offered to the public. Accordingly, the Interests may not, directly or indirectly, be offered, sold or delivered in New Zealand, nor may any offering document or advertisement in relation to any offer of the Interests be distributed in New Zealand, other than in circumstances where there is no contravention of the Financial Markets Conduct Act 2013.
Philippines—THE STRATEGY AND/ OR ANY SECURITIES ASSOCIATED WITH THE STRATEGY BEING OFFERED OR SOLD HEREIN HAVE NOT BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION UNDER THE SECURITIES REGULATION CODE. ANY FUTURE OFFER OR SALE OF THE STRATEGY AND/ OR ANY SECURITIES IS SUBJECT TO REGISTRATION REQUIREMENTS UNDER THE CODE, UNLESS SUCH OFFER OR SALE QUALIFIES AS AN EXEMPT TRANSACTION.
Singapore—Issued in Singapore by T. Rowe Price Singapore Private Ltd., No. 501 Orchard Rd, #10-02 Wheelock Place, Singapore 238880. T. Rowe Price Singapore Private Ltd. is licensed and regulated by the Monetary Authority of Singapore. For Institutional and Accredited Investors only.
South Africa—T. Rowe Price International Ltd (“TRPIL”) is an authorised financial services provider under the Financial Advisory and Intermediary Services Act, 2002 (FSP Licence Number 31935), authorised to provide “intermediary services” to South African investors.
Switzerland—Issued in Switzerland by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland. For Qualified Investors only.
Taiwan—This does not provide investment advice or recommendations. Nothing in this material shall be considered a solicitation to buy, or an offer to sell, a security, or any other product or service, to any person in the Republic of China.
Thailand—This material has not been and will not be filed with or approved by the Securities Exchange Commission of Thailand or any other regulatory authority in Thailand. The material is provided solely to “institutional investors” as defined under relevant Thai laws and regulations. No distribution of this material to any member of the public in Thailand is permitted. Nothing in this material shall be considered a provision of service, or a solicitation to buy, or an offer to sell, a security, or any other product or service, to any person where such provision, offer, solicitation, purchase or sale would be unlawful under relevant Thai laws and regulations.
UK—This material is issued and approved by T. Rowe Price International Ltd, 60 Queen Victoria Street, London, EC4N 4TZ which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.
USA—Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.
© 2020 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc.