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Got those Great Recession blues

November 10, 2010

Given the amount of money central banks have been pumping into the global economy you’d be forgiven for thinking we should be getting a pretty decent recovery right now. And whilst that seems true for emerging markets, market participants and consumers just can’t rid themselves of the feeling that there is another shoe yet to drop.

Citi’s Matt King encapsulated this general nervousness in his presentation at the CFA Institute’s European Investment Conference in Copenhagen on Tuesday. And according to King, there are some very good reasons why corporates and households just can’t bring themselves to load up on more debt.

“We’ve had the worst recession since the 1930s, but it doesn’t feel like it, because we haven’t taken all the pain yet,” he said. “We’ve simply shuffled the debt around – that’s why markets are still so volatile and correlations are so elevated.”

King argued that if this is a normal cycle, corporates will soon come under pressure from shareholders to start borrowing again in order to invest and expand. “The risk is this is not a normal cycle, but something different,” he said. 

He pointed to the lesson of Japan, where even when interest rates were cut to zero, corporates didn’t want to borrow because they had taken on too much debt in the boom years. He sees a similar problem in the West today where although banks are willing to lend, corporates and consumers have no appetite for more borrowing.

With austerity now the order of the day, King said it was difficult to see where growth would come from. In the past when governments have cut spending it was because that was the heart of the problem. But today it is corporates and households that have too much debt on their balance sheets.

“So if the government cuts back on the spending that has been propping up the economy, it could drive the economy back into recession. That’s what’s happening in Spain and possibly some of the other peripheral eurozone countries,” he said. “You can’t have an economy in which all three sectors are saving at the same time.”

The risk is that some states won’t be able to grow out of their difficulties and will need to be rescued or will end up defaulting. “For some European peripherals it’s already too late,” he said.

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