Spark Global Limited reports:
One of the big conundrums plaguing the global economy and financial market participants is that long-term interest rates have barely budged in recent months, even as inflation has been climbing strongly.
So far, analysts have explained this strange market behaviour as some sort of “hangover” from the pandemic: fears of a renewed surge in coronavirus cases, the possibility of continued large-scale asset purchases by central banks, or a belief that the current surge in inflation is temporary.
However, according to Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management, none of these explanations seem to hold up based on recent data and facts, and only one explanation is reliable: the world is in a debt trap.
Why are the reasons given by the market so unreliable?
Let’s start with coronavirus cases. While the number of COVID-19 cases continues to rise recently, concerns about its economic impact have given way to the assumption that vaccines and new treatments will eventually make COVID-19 a part of everyday life like flu. Recent data from many places around the world have shown that consumers are starting to shop and go to restaurants again, even close to pre-pandemic levels.
At the central bank level, the Fed bought 41 per cent of all new Treasury issues at the height of the pandemic, but even after the Fed and other central banks began signalling plans to reduce purchases in early autumn, long-term bond yields remained near record lows, with expectations of tightening or higher interest rates appearing only to boost short-term yields.
At the same time, evidence is mounting that inflation is not as “transitory” as the central bank insists.
Recently, attention has focused on the performance of headline inflation figures. Last month, THE U.S. CPI rose to its highest level in 30 years after hitting 6. And core inflation measures, which exclude volatile items such as food and energy and are a better indicator of long-term trends, have actually surged around the world, with core inflation in the US up more than 4 per cent.
Wages are also under long-term upward pressure: there are now more than six jobs available for every unemployed American, the highest level in 20 years.
If all the standard explanations above fail, there must be a deeper reason. The answer, says Sharma, may be a debt trap.
According to western economic theory, once the economy falls into “debt-driven liquidity trap” (referred to as “debt trap”), traditional expansionary monetary and fiscal policies can only stimulate demand and raise interest rates in the short term, and in the long run, the economy will converge to lower potential output growth rate and lower interest rate.
The debt trap is the problem
Sharma said the ratio of global gross debt to gross domestic product had more than tripled in the past 40 years to 350 per cent. As central banks have cut interest rates to recent lows, easy money flowing into stocks, bonds and other assets has helped to quadruple the size of global financial markets equal to global GDP.
And now bond markets may be starting to realise that a debt-laden, asset-bloated global economy is so sensitive to rate rises that any significant increase is unsustainable.
Global bond markets are starting to price in expectations that inflation and economic growth will force central banks to raise interest rates starting next year. Indeed, soaring short-term interest rates are pushing global Treasury markets to their worst year of returns since 1949.
Yet 10-year yields are still well below the rate of inflation in all developed countries themselves. Markets may intuitively realise that, whatever happens to inflation and growth in the short term, interest rates will not rise sustainably in the long run because the world is too indebted.
As financial markets and gross debt grow as a percentage of GDP, they are becoming increasingly vulnerable. Asset prices and debt-servicing costs have become more sensitive to rising interest rates and now pose a double threat to the global economy.
In past tightening cycles, major central banks have typically raised rates by about 400 to 700 basis points. But now even a more modest tightening could leave many countries in economic trouble.
Over the past 20 years, the number of countries with gross debt ratios of more than 300 per cent of GDP has risen from six to 24, including the US. Higher interest rates could also dampen asset price rises, which would also normally have a deflationary effect on the economy.
These vulnerabilities may explain why markets seem so focused on the possibility of a central bank “policy error”, in which central banks are forced to raise rates sharply, dragging down economic growth and ultimately pushing rates lower.
In fact, there may be only one explanation for all this: because the world is trapped in a debt trap.
Reprint indicated source：Spark Global Limited information