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Animal spirits in the stockmarkets don’t add up to economic recovery in the real world

GraphThere is an extraordinary combination at the start of 2014 of souped-up credit markets and an anaemic economy. The urge to talk up the economic recovery after so many false starts has turned the heads not only of investors but also of the economic commentators who show the same herd instinct of prophesying long-term continuing growth on the back of minuscule readjustment of the ONS figures.

By contrast the factual evidence of what is actually now happening in both the credit markets and in the real economy makes for far more sobering conclusions. The prolonged period of low interest rates has prompted investors to take on greater credit risks or use additional financial leverage in order to reach for higher yield. This has produced highly frothy markets which ominously resemble the pre-crash situation of 2007.

There are several examples of this.

The issue of junk bonds rated triple C by credit rating agencies, the lowest possible designation which indicates substantial risks for investors, has surged as investors seek the highest-yielding bonds. The same jump can also be seen in leveraged loans and high-yield bonds as investors seek greater returns from riskier assets. Payment-in-kind bonds, which were popular in the boom years before the 2008 crisis and give borrowers the option to repay their lenders by issuing more debt – a classic path to perdition like Wonga in reverse – are now back in force. Loans that come with fewer protections for lenders – and thence called ‘covenant-lite’ – are surging and now account ominously for almost 60% of all new loans to companies. Collateralised loan obligations, which bundle together different business loans made to companies and which played a central part in triggering the 2008 crisis, have nearly surpassed their pre-crisis peak. And sales of commercial mortgage-backed bonds, a type of securitisation, have risen to their highest level since 2007. Collectively this adds up to several warning signals beginning to flash red.

That by itself is very worrying. But what is even more so is that all this flurry in the credit markets is not accompanied by any solid or sustainable recovery in the real economy. As with the pumping up of lending before 2007 which never produced an economic boom but which still managed to engineer an almighty crash, we now see extreme policies (£375bn of QE plus interest at near-zero for 4 years), together with wild over-excitement in financial markets, capable only of generating growth that is fragile and anaemic. The slowing pace of innovation and economic demand under neo-liberal capitalism which bedevilled Japan in the 1990s is now afflicting most of the West, including particularly the UK. Despite Osborne’s self-congratulatory hyperbole, the storm signals are flashing brighter.

2 Comments

  1. eric clyne says:

    Low interest rates cause in large inflows into equities which are inflated. New, hot and dirty money flows in from kleptocracies for real estate safe havens, pushing up high end property prices.

    This is insane but unfortunately, sustainable because raising interest rates is too scary as a couple of million mortgage holders live on the edge of broke.

    A serious mansion tax is urgently required to fund housebuilding.

  2. James Martin says:

    There is actually some underlying growth in a number of developed economies, hence the small fall in UK unemployment and even growing order books in some manufacturing businesses.

    However, the major reason for stock market growth is the continuation of money printing (i.e., ‘QE’) on an unprecedented scale. So far, and for a number of separate reasons, this has not triggered inflation, although inflation is the traditional method that governments have reduced debt, but it will at some stage increase the devaluation of currencies beyond a rational level.

    In the meantime capitalism will continue to limp on, as will the transfer of wealth from the producers to the owners…

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