Fiscal stimulus not monetary policy will jump start economy
Fiscal stimulus is what is required to break the cycle of excessive borrowing, and allow the private sector to begin paying off large accumulated debts, Marshall Gittler, Chief Strategists - International at Deutsche Bank’s Private Wealth Management, said during a media roundtable held today.
Gittler, who focused on global macro-economic trends, said that the world is experiencing today a “balance sheet recession”, which unfolded as a result of low and falling interest rates which encouraged excessive borrowing, and resulted in large accumulated debt as asset prices fell.
“This creates balance sheet problems, and as more borrowers default, central banks step in and try to solve the problem by easing monetary policy. This doesn’t work, since fewer and fewer people want to borrow and even a smaller number of banks are willing to lend,” Gittler said.
Under these circumstances, governments need to increase both spending and borrowing. Spending on projects supports demand, while borrowing keeps the money supply growing as the private sector pays its debt. Expansionary fiscal policies will prevent deflation.
An expert on Japan, having both lived and worked in the country when it went through its economic crisis in the nineties, Gittler drew parallels between the current global crisis, and the Japanese experience.
“There are five lessons that need to be learned from Japan: first, governments can soften business cycles not eliminate them; real-estate markets reach bottom when demand starts rising. Second, an economic downturn following asset deflation can cause a second-wave crisis, as the line of causation goes from a bad economy to bad loans, not just the other way around. Third, capital injections into banks are necessary but not sufficient. Fourth, growth is essential as it is the only way that governments can pay off their debt. And finally, the effectiveness of a reflationary policy is uncertain. Japan had almost zero interest rates for 13 years and still had deflation.”
On the outlook for growth, Gittler said that economic conditions are likely to improve in the second half of 2009, with the US being the first to emerge from the recession. Emerging markets will follow; while both Eastern and Western Europe are likely to emerge last.
The concerns about the deepening economic downturn in Europe and the deteriorating debt problems of smaller Euro countries and Eastern Europe will keep investors from aggressively buying the Euro, thus benefiting the US dollar despite it being weakened recently by the Fed’s shift to quantitative easing.
Gold is at risk of becoming a crowded trade but will continue to outperform due to flight-to-safety and fears about fiat currencies (USD, JPY or CHF) in general.
“Outlook for the global stock markets remains volatile,” said Gittler, and added that “a sustained rebound in the US stock markets would ultimately result is a recovery in some emerging markets namely in Mexico and Asia.”
The bond markets are benefiting from the flight-to-safety, but yields are expected to remain low.
Gittler however cautioned against extreme pessimism. “One crucial lesson from the great depression was that it eventually ended. The current crisis is by no measure as severe as that of the Great depression. We are at an advantage this time around, since our starting point in much stronger and the policy response faster and better-conceived.”
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