24th September 2013
Ashmore’s head of research Jan Dehn has warned that the US debt of 405% of GDP explains why the US recovery is flagging.
Dehn says: “To us, the debate whether the tapering U-turn is a policy mistake or not misses a more important question, namely why the US economy once again has failed to perform in line with the bullish expectations of analysts and the Fed. The weakness that prompted the tapering U-turn took place against a backdrop of improving manufacturing, cashed up corporate balance sheets, a fully re-capitalised banking system, and major progress in household deleveraging.
“We think the fundamental reason for the many bad forecasts is that most analysts ignore the enormous debt stock in the US. Total US debt is 405% of GDP, twice as much as in 1980. Even the government’s debt of about 100% of GDP is unsustainable, according to the latest IMF Article IV report. Growth is, and will likely continue to be anaemic because the economy is drowning in debt. If interest rates rise, the debt burden could move from tolerable to unbearable. Yet no one talks about debt. Why? The reason is that almost everyone with a direct stake in developed fixed income markets has strong incentives to ignore or belittle the problem.”
He has offered several explanations as to why people are ignoring the issue. These are as follows
• The Fed cannot blame the debt for its poor forecasts, because if it acknowledged the debt problem it would have to enter into a discussion about how the debt stock can be reduced. The only feasible solution is inflation, but inflation would conflict with its mandate as a central bank
• Ratings agencies and regulators are silent on the subject because the entire regulatory system rests on the notion of risk free bonds with zero capital requirements. When Standards & Poor’s downgraded the US in 2011 it did so with reference to political dysfunction, not to the debt dynamics
• The US Administration is silent because it is impotent. It has neither the stomach for nor means to undertake fiscal reform
• Banks are silent, because long-term problems like debt do not generate daily trading volume
• The media knows that debt does not produce ‘news’ until it results in crisis
• Emerging Markets central banks are hugely exposed to the developed market debt, especially US treasuries, but see no alternative investment destinations with comparable liquidity
“The Fed’s decision not to taper smashed the consensus view that the US is on track to strong recovery and materially higher real rates. Still, most market participants and policy makers are unlikely to grasp the reasons for the US economy’s weak performance until they acknowledge the role played by the 405% debt burden. Total US debt is 405% of GDP, twice as much as in 1980, and most analysts ignore this enormous debt stock,” he says.
Dehn also repeats his view that the market was wrong to punish emerging markets in the supposed run up to Federal tapering. He says: “The effects were almost identical to similar events in the past. Firstly, EM asset prices massively over-reacted to the global shock as banks, cross-over investors and hedge funds once again found themselves unable to resist the urge to dump EM assets. Secondly, EM fundamentals defied all the hysterically calamitous predictions of an ‘EM crisis’; they were far more resilient than the moves in asset prices would suggest.
The note adds: “The actual fall-out from three months of severe outflows, currency volatility, sovereign spread widening, rising domestic bond yields, monetary policy tightening and fiscal retrenchment can be summarised as follows –
· No Emerging Markets government defaulted or even came close to serious sovereign funding problems. Instead, a number of new countries entered the main benchmark indices and unloved Indonesia was able to issue with great success amidst the worst of the anti-EM sentiment
· No Emerging Markets central banks ran out of reserves or had to seek IMF support or lost control of their currency, even Turkey, Brazil, and Indonesia that were singled out for special punishment because of external deficits. In fact, at no point did the cumulative intervention by Asian central banks exceed $20bn (Asian central banks ex-China have firepower of more than $2trn of FX reserves)
· No banking system in Emerging Markets faced serious stress which could challenge the capacity of central banks and fiscal authorities, despite very large moves in FX and rates. Central banks only stepped in to provide liquidity support in a few selected cases. In the most publicised case, that of China, the motivation to intervene was to manage a specific regulatory arbitrage case, not to alleviate stresses arising higher global rates
· As of yet no EM corporate has defaulted due to tighter global financial conditions.