In honour of our great Canadian central banker that is taking off to London, I thought I would highlight parts of his speeches. Carney understands global deleveraging more than most other central bankers, quoting Minsky along the way. He also understands that Canadians will one day have to go through this process as well….
Quotes from: Growth in the age of deleveraging
“Most fundamentally, current events mark a rupture. Advanced economies have steadily increased leverage for decades. That era is now decisively over. The direction may be clear, but the magnitude and abruptness of the process are not. It could be long and orderly or it could be sharp and chaotic. How we manage it will do much to determine our relative prosperity.”
“In general, the more that households and governments drive leverage, the less the productive capacity of the economy expands, and, the less sustainable the overall debt burden ultimately is.
“Another general lesson is that excessive private debts usually end up in the public sector one way or another. Private defaults often mean public rescues of banking sectors; recessions fed by deleveraging usually prompt expansionary fiscal policies. This means that the public debt of most advanced economies can be expected to rise above the 90 per cent threshold historically associated with slower economic growth.”
“While debt can fuel asset bubbles, it endures long after they have popped. It has to be rolled over, although markets are not always there. It can be spun into webs within the financial sector, to be unravelled during panics by their thinnest threads. In short, the central relationship between debt and financial stability means that too much of the former can result abruptly in too little of the latter. Hard experience has made it clear that financial markets are inherently subject to cycles of boom and bust and cannot always be relied upon to get debt levels right. This is part of the rationale for micro- and macroprudential regulation. ”
“As a result of deleveraging, the global economy risks entering a prolonged period of deficient demand. If mishandled, it could lead to debt deflation and disorderly defaults, potentially triggering large transfers of wealth and social unrest.”
“Austerity is a necessary condition for rebalancing, but it is seldom sufficient. There are really only three options to reduce debt: restructuring, inflation and
“Once leverage is high in one sector or region, it is very hard to reduce it without at least temporarily increasing it elsewhere.
In recent years, large fiscal expansions in the crisis economies have helped to sustain aggregate demand in the face of private deleveraging (Chart 8). However, the window for such Augustinian policy is rapidly closing. Few except the United States, by dint of its reserve currency status, can maintain it for much longer. “
“This will be hard to accomplish without co-operation. Major advanced economies with deficient demand cannot consolidate their fiscal positions and boost household savings without support from increased foreign demand. Meanwhile, emerging markets, seeing their growth decelerate because of sagging demand in advanced countries, are reluctant to abandon a strategy that has served them so well in the past, and are refusing to let their exchange rates materially adjust.”
“What It Means for Canada
Canada has distinguished itself through the debt super cycle (Chart 10), though there are some recent trends that bear watching. Over the past twenty years, our non-financial debt increased less than any other G-7 country. In particular, government indebtedness fell sharply, and corporate leverage is currently at a record low (Chart 11). “
“In the run-up to the crisis, Canada’s historically large reliance on foreign financing was also reduced to such an extent that our net external indebtedness was virtually eliminated.
Over the same period, Canadian households increased their borrowing significantly. Canadians have now collectively run a net financial deficit for more than a decade, in effect, demanding funds from the rest of the economy, rather than providing them, as had been the case since the Leafs last won the Cup. ”
” Unlike many others, we still have a risk-free rate and a well-functioning financial system to support our economy. ”
“First and foremost, that means reducing our economy’s reliance on debt-fuelled household expenditures. To this end, since 2008, the federal government has taken a series of prudent and timely measures to tighten mortgage insurance requirements in order to support the long-term stability of the Canadian housing market. Banks are also raising capital to comply with new regulations. Canadian authorities are co-operating closely and will continue to monitor the financial situation of the household sector.
To eliminate the household sector’s net financial deficit would leave a noticeable gap in the economy. Canadian households would need to reduce their net financing needs by about $37 billion per year, in aggregate. To compensate for such a reduction over two years could require an additional 3 percentage points of export growth, 4 percentage points of government spending growth or
7 percentage points of business investment growth. Any of these, in isolation, would be a tall order. Export markets will remain challenging. Government cannot be expected to fill the gap on a sustained basis.
But Canadian companies, with their balance sheets in historically rude health, have the means to act—and the incentives. Canadian firms should recognize four realities: they are not as productive as they could be; they are under-exposed to fast-growing emerging markets; those in the commodity sector can expect relatively elevated prices for some time; and they can all benefit from one of the most resilient financial systems in the world. In a world where deleveraging holds back demand in our traditional foreign markets, the imperative is for Canadian companies to invest in improving their productivity and to access fast- growing emerging markets.”
“Today, our demographics have turned, our productivity growth has slowed and the world is undergoing a competitive deleveraging.
We might appear to prosper for a while by consuming beyond our means. Markets may let us do so for longer than we should. But if we yield to this temptation, eventually we, too, will face painful adjustments.
It is better to rebalance now from a position of strength; to build the competitiveness and prosperity worthy of our nation. ”
I thought it would be good to look at the private household sector debt chart from the last post.
In short, Carney knows Canada is at risk despite its fiscal prudence and low corporate debt because the household private sector has accumulated leverage due to overconsumption. Carney would like Canada to avoid the situation where the public sector takes over the gap in aggregate demand caused by deleveraging and thus asks the corporate sector to step up. Exporting our way out of this isn’t an option as there is a game of competitive devaluation going on worldwide. Unfavourable demographics also come into play as a drag. Having said all this, Canada is still relatively in a better position although they haven’t even begun the deleveraging process and are therefore 3-4 years behind the game.
Carney also mentions that Canada still has a ‘risk-free rate’ which is a great point. The US has reached its zero-bound for interest rates, and as a result its economic cycle is closely related to trends in inflation. As Francois Trahan of Wolfe Trahan & Co. insists that “inflation is the new fed funds rate,”. In Canada we still have some maneuvering room