Despite efforts of central banks, global economy will remain perilous for years, advisers warn

As Japan’s stagnant economy lurches toward another fiscal crisis, experts say it could take decades for the world’s largest economies to address deficit and debt ...
Jim Gilliland, head of fixed income at Leith Wheeler Investment Counsel: debt issues will slow global economic growth

Investors and business leaders should brace for several more years of economic uncertainty as the global financial crisis continues to undermine stability.

Jim Gilliland, head of fixed income at Vancouver’s Leith Wheeler Investment Counsel, noted that most governments of developed nations will spend the next few years eliminating deficits and cutting debt levels, which will impede economic growth globally.

Thus far this year, the International Monetary Fund (IMF) has downgraded its global economic forecast three times. In its latest quarterly forecast in October, it projected growth at 3.3% in 2012 and 3.6% in 2013, down from 3.5% in 2012 and 4.1% in 2013 in its April outlook report.

Government deleveraging and a struggling global financial system are the key culprits for the slowdown, which has continued to affect key global markets, such as China, as well as other emerging markets.

Central banks around the world have been trying to bolster private-sector growth by lowering interest rates and other major bond-buying programs. So far in October, the central banks of South Korea, Brazil and Australia have cut their interest rates by 0.25%. Those changes come a month after the U.S. Federal Reserve, the European Central Bank and the Bank of Japan announced their own government bond- buying programs to further bolster their respective economies.

The initiatives have given stock markets a temporary boost but will still take time to have a lasting impact in the economy.

“One of the services we work with has counted over 250 instances of easing monetary policy globally over the last 12 months,” said Gilliland. “You’ve seen rate cuts in Brazil, India, and for some countries like the U.K. and the U.S. that are still in the midst of deleveraging, it’s less clear [such moves] will have an immediate impact. It comes with a lag, which tends to be 12 to 18 months.”

The fed’s latest moves are likely to help bolster the U.S. housing market by keeping mortgage rates low for years (see “Why Canadians are bullish on U.S. economy” – BIV issue 1200; October 23-29). But even if the European sovereign debt crisis does get resolved over the next few years without the breakup of the euro, Japan’s fiscal crisis looms large.

“Japan is a huge looming risk on the horizon,” said Christine Hughes, president of OtterWood Capital Management, who was in Vancouver on a recent speaking tour. “Their debt to GDP ratio eclipses anyone else’s, and they’ve been able to pull it off because they are running on fumes. But that will run out.”

Since 2008, Japan’s debt-to-GDP ratio has risen to 230% in 2011 from 192% (see graph). But the IMF projects Japan’s national debt to rise to 237% of GDP this year and to 245% in 2013 as the country struggles to breathe life into a stagnant economy with a rapidly shrinking workforce and aging population.

By comparison, Greece’s debt to GDP ratio was 144% in 2010 when it was forced to request its first bailout from the European Union and is expected to rise to 171% this year after its third bailout.

Until now, Japan has managed to pay for its government deficits by selling government bonds primarily to investors within the country, and despite its financial and economic challenges, the country is still seen as a global safe haven for capital, as illustrated by its persistently high currency. But if Japan is unable to deal with its fiscal crisis, the market will react and generate another round of global economic havoc.

Hughes said that while foreigners own only 9% of Japan’s bonds, the country’s bond market remains the second largest in the world.

“When it [collapses], people are going to be rushing out of the yen and into U.S. dollars, which will create a massive shortage of dollars that will affect the global economy,” she said.

“It’s not today’s story, but history tells us these sovereign debt crises happen in clusters, and the domino effects play out. I do expect Japan to be hit with the bug; I’m just not sure exactly when. We’re watching for it.”

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