Mark Carney on the difficulties of deleveraging

December 15, 2011 9:35 AM

Mark Carney: the man who speaks the truth. Toronto Globe and Mail columnist Jeffrey Simpson recommends a recent speech by Bank of Canada head Mark Carney. "Most fundamentally, current events mark a rupture. Advanced economies have steadily increased leverage [i.e. debt] 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."

The market cannot be solely relied upon to discipline leverage.

It is not just the stock of debt that matters, but rather, who holds it. Heavy reliance on cross-border flows, particularly when they fund consumption, usually proves unsustainable.

As a consequence of these errors, advanced economies are entering a prolonged period of deleveraging.

Central bank policy should be guided by a symmetric commitment to the inflation target. Central banks can only bridge real adjustments; they can’t make the adjustments themselves.

Rebalancing global growth is the best option to smooth deleveraging, but its prospects seem distant.

Canadians shouldn't be smug:

... 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.

Developments since 2008 have reduced our margin of manoeuvre. In an environment of low interest rates and a well functioning financial system, household debt has risen by another 13 percentage points, relative to income. Canadians are now more indebted than the Americans or the British. Our current account has also returned to deficit, meaning that foreign debt has begun to creep back up.

The funding for these current account deficits has been coming largely from foreign purchases of Canadian portfolio securities, particularly bonds. Moreover, much of the proceeds of these capital inflows seem to be largely, on net, going to fund Canadian household expenditures, rather than to build productive capacity in the real economy. If we can take one lesson from the crisis, it is the reminder that channelling cheap and easy capital into unsustainable increases in consumption is at best unwise.

... 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.

posted by russilwvong (10 comments total)

Toronto Globe and Mail

This is an interesting and (by finance wonk standards) very lucid piece and well worth reading, but could we not do this? It's the Globe & Mail. It's always been the Globe & Mail. I get cheques from them sometimes, I can attest the word Toronto only appears in their mailing address. It's not the Toronto Globe & Mail for the same reason it's not the London Guardian or the Melbourne Age or die Hamburger Zeit.

Just because American media convention insists on a geographic name in a newspaper's title does not mean that papers that have had none for more than a century have to pretend that they do.

Can we please not do this?

/pet peeve
posted by gompa at 10:06 AM on December 15, 2011 [4 favorites]

This is a great article. Thanks for posting it; I had missed Carney's speech.

I think the analysis is spot on. Reminded me to dig up this video on the European situation, which at least is a bit of a laugh.


and I don't want to really get the derail going, gompa, but growing up in Calgary the Globe and Mail was always referred to as a Toronto paper. I know it's not, but I suspect it's a bit of a western Canadian thing to do so.
posted by never used baby shoes at 10:40 AM on December 15, 2011 [1 favorite]

Canadians are always smug.
posted by clvrmnky at 11:15 AM on December 15, 2011

but growing up in Calgary the Globe and Mail was always referred to as a Toronto paper

Same in Edmonton.
posted by aramaic at 11:30 AM on December 15, 2011

...in effect, demanding funds from the rest of the economy, rather than providing them...

So, wait. Canadian incomes go down, just like in the US, so that working people have to rely more on debt than income, in order to get by...and that's considered "demanding funds"? Perhaps they should ask where the funds went in the first place?

much of the proceeds of these capital inflows seem to be largely, on net, going to fund Canadian household expenditures, rather than to build productive capacity in the real economy

I hate the idea of mixing up actual households with those who actually are supposed to be building productive capacity. Because, you know, if you're spending on your household, the products you're buying have to come from somewhere, and that part isn't really under your control.
posted by mittens at 12:12 PM on December 15, 2011

What it means, Mittens, is that Canada needs to export more products and services to other countries. Not resources, necessarily. Certainly not over the long term.
posted by anigbrowl at 12:28 PM on December 15, 2011

Canada needs to export more products and services to other countries.

Yeah, it is a bit alarming that Canada's balance of trade has gone into deficit despite the country being a major exporter of oil and many other things. Looks like the largest factors are decline in exports of machinery and equipment, and motor vehicles. Exports are down by a whole lot more than imports are up, compared to pre-crisis.
posted by sfenders at 5:15 PM on December 15, 2011

It's not the Toronto Globe & Mail for the same reason it's not the London Guardian

Its not the London Guardian because its the Manchester Guardian.
posted by devious truculent and unreliable at 6:45 AM on December 16, 2011

Canada needs to export more products and services to other countries.

I'm not sure what we can export, especially since some of the exporting we had was pegged on a low dollar relative to the US- for example out sourcing call centres here makes sense when we can offer workers indistinguishable from Americans for less money, but makes less sense when we cost the same and the US employer can rely on collapsing auto plants and the like to spit out mature adults who will motor through lava to feed their families while these are "student" jobs that you quit after a month.
posted by Phalene at 7:29 PM on December 16, 2011

anigbrowl: Canada needs to export more products and services to other countries.

Actually, what Carney is saying is that Canada needs to shift spending from household consumption to business investment. (Canada's traditional export markets, like the US, are also going through deleveraging.)

The Bank of Canada can't do this directly. It can control overall spending ("aggregate demand") by raising or lowering interest rates--but it can't control the mix between household consumption and business investment. Carney can only encourage households to be more cautious about spending, and businesses to be more bold about investing.

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.

This would be good for Canadian companies and good for Canada. Indeed, it is the only sustainable option available. A virtuous circle of increased investment and increased productivity would increase the debt-carrying capacity of all, through higher wages, greater profits and higher government revenues. This should be our common focus.

posted by russilwvong at 6:40 PM on December 17, 2011