Eric Chaney : triple deleveraging and schizophrenic regulation

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    The credit bubble that devastated the global economy when it burst in 2008 is casting a long shadow.

    Consumers are deleveraging their balance sheet, banks are shrinking assets to comply with tighter ratios and governments are tightening fiscal belts. Hit by this triple deleveraging, , no wonder real economies are struggling. The sole albeit powerful stimulus is central banks inflating their own balance sheets to levels not seen since 1945. This unpleasant reality begs three questions: is it the right time for governments to cut debt? Are central banks not administering a medicine worse than the disease?? How should banks and insurers react??

    Starting with governments, it is fashionable to lambast austerity as self-defeating. In reality government debt is a counter-cyclical option when initially low, not when flirting with 100%% GDP1. Yet, if austerity is a sensible strategy, much depends on its implementation: cutting investment where it is low is as counterproductive as raising taxes where their burden is excessive.

    Turning too central banks, quantitative policies are responsible for ultra a-low bond yields and rich valuations in credit. T his may sow the seeds for bubbles, but alternatives look worse: ending quantitative policies and hiking rates would t rigger a bond sell-off and a double dip. Dangers will appear later, when money supply accelerates, if central banks do not deleverage their balance sheets on time. Inflation may then come back with a vengeance.

    Banks and insurers must therefore adapt to low interest rates and a significant risk of inflation in the medium term. For long-term investors, investing in equities should be part of the solution. This is also what central bankers wish and what regulators implicitly stated when drawing the lessons of thee debt bubble. And yet, financial re-regulation makes investment in equities so costly in capital that this option is almost dead. Isn’t this a blatant contradiction and an obstacle to global recovery?