hsbc stephen king recession

8/9/2019 HSBC Stephen King Recession

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The world economy is like an ocean

liner without lifeboats

If another recession hits…

…it could be a truly titanic struggle for

policymakers

Remarkably enough, it has been six years since the trough of

the last US recession. If history is any guide, we are probably

now closer to the next one. Yet whereas previous recoveries

have enabled monetary and fiscal policymakers to replenish

their ammunition, this recovery – both in the US and

elsewhere – has been distinguished by a persistent munitions

shortage. This is a major problem. In all recessions since the

1970s, the US Fed funds rate has fallen by a minimum of

5 percentage points. That kind of traditional stimulus is now

completely ruled out. Meanwhile, budget deficits are still

uncomfortably large and debt levels uncomfortably high:

while the US fiscal position has improved, it remains

structurally weak.

We investigate the options for policymakers given thisshortage of traditional ammunition, including: (i) reducing the

risk of recession; (ii) reverting to quantitative easing;

(iii) moving away from inflation targeting; (iv) using fiscal

policy to replace monetary policy; (v) using fiscal and

monetary policy together in a bid to introduce so-called

“helicopter money”; and (vi) pushing interest rates higher

through structural reforms designed to lower excess savings,

most obviously via increases in retirement age. We conclude

that only the final option is likely to lead to economic success.

Politically, however, it seems implausible. As a result, we arefaced with a serious shortage of effective policy lifeboats.

As for plausible recession triggers, we highlight four major

risks: a rise in US wages which leads to a falling profit share

and a major equity decline; a series of systemic failures

within the non-bank financial sector; a major weakening of

the Chinese economy, sending shockwaves around the world;

and a premature attempt by the Federal Reserve to normalise

monetary policy, in a repeat of the mistakes made by the

Bank of Japan in 2000 and, more recently, by the European

Central Bank in 2011.

Economics

Global

The worldeconomy’s titanic problemCoping with the next recession

without policy lifeboats

13 May 2015

Stephen King

Chief Economist

HSBC Bank plc

+44 20 7991 6700 [email protected]

View HSBC Global Research at: http://www.research.hsbc.com

Issuer of report: HSBC Bank plc

Disclaimer & DisclosuresThis report must be read with thedisclosures and the analyst certificationsin the Disclosure appendix, and with theDisclaimer, which forms part of it

mailto:[email protected]://www.research.hsbc.com/https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=WcFy86QWeB&n=461009.HTMhttp://www.research.hsbc.com/mailto:[email protected]


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Not quite a return to normality

In most economic cycles, the recovery phase has not just marked a return to economic growth. It has also,

eventually, marked a return to policy “normality”. Interest rates have risen. Tax revenues have rebounded.

Welfare payments have shrunk. Budget deficits have declined – and, on some occasions, have even turned

into surpluses. Put another way, a return to economic growth typically allows policymakers to rebuild their

stocks of ammunition, providing them with room to fight the next economic battle.

This latest economic cycle is, to date, fundamentally different. According to the National Bureau of

Economic Research, the last trough in US economic activity was reached in June 2009. Almost six years

into recovery, official short-term interest rates haven’t budged an inch. 10 year Treasury yields are at

rock bottom, still lower than they were in the immediate aftermath of the collapse of Lehman Brothers in

2008. The Federal budget deficit has dramatically improved but the fiscal position is nothing like as

healthy as it typically has been through previous economic cycles (charts 1-3).

1. Still waiting for the Fed

Source: Thomson Reuters Datastream, National Bureau of Economic Research

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71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

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The world economy’s titanic problem

Remarkably enough, it’s six years since the last recession…

…suggesting the next one may not be too far away…

…yet there is a total absence of traditional policy ammunition


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2. Yields are close to rock bottom 3. The Federal deficit has improved but, by past standards, isstill large

Source: Thomson Reuters Datastream Source: US Treasury, National Bureau of Economic Research

Other regions offer a similar narrative. True, the European Central Bank tried to raise interest rates in

2011, but its attempts ended in ignominious failure: having reversed its rate increases, the ECB is today

committed to quantitative easing that, on current plans, is likely to extend all the way through to

September 2016. The Bank of Japan is in a similar position. The Bank of England is no longer

increasing its balance sheet via quantitative easing but, despite having had the urge, it has so far been

unable to find an opportunity to raise interest rates. Fiscal positions, meanwhile, are mostly poor – at

least when compared with those pre-crisis.

4. The ECB raised rates and ended up with egg on its face 5. Quantitative easing no longer looks unconventional

Source: Thomson Reuters Datastream Source: Thomson Reuters Datastream, Bloomberg

Three reasons why policy hasn’t “normalised”

One reason for this lack of action – this failure to rebuild stocks of ammunition – is simply that the pace

of economic recovery has not been particularly strong. Chart 6 shows the average annual US growth

rates during equivalent six-year periods following economic troughs over the last forty years. The latest

recovery is particularly weak. Then again, so was the previous recovery. Back then, however, the

Federal Reserve was able to raise interest rates 31 months after the trough in economic activity. This

time, 70 months have elapsed (at the time of writing) and still the Fed hasn’t acted.

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Lehman Brotherscollapse

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6. The recovery since the last trough has been very weak in the US

Source: Thomson Reuters Datastream, HSBC, National Bureau of Economic Research

A second reason for a lack of action reflects – at least in part – the very weak starting point. The US

economic collapse during the global financial crisis was far worse than experienced during all previous

post-war downswings. From peak to trough, US GDP fell 4.2% (see table 7).

In the past, however, deep recessions were typically followed by strong recoveries. This time around, a

deep recession has been followed by an insipid recovery: more L-shaped than V-shaped. Chart 8 shows

the average annual growth rate for the US economy from equivalent peaks in economic activity since the1970s: this time around, performance has been hugely disappointing.

7. The overall decline in US GDP through the financial crisis was huge compared with earlier recessions

Cycle Peak date Trough date Annualised average% change

Total % change

1953-1954 July 1953 May 1954 -2.5 -1.91957-1958 August 1957 May 1958 -4.0 -3.01960-1961 April 1960 February 1961 -0.4 -0.31969-1970 December 1969 November 1970 -0.2 -0.21973-1975 November 1973 February 1975 -2.5 -3.11980 January 1980 August 1980 -4.4 -2.21981-1982 July 1981 November 1982 -2.1 -2.5

1990-1991 July 1990 February 1991 -2.7 -1.32001 March 2001 November 2001 0.7 0.52007-2009 December 2007 May 2009 -2.9 -4.2


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8. The growth rate of the US since the last peak in economic activity has been pitiful

Source: Thomson Reuters Datastream, HSBC , National Bureau of Economic Research

This, in turn, might imply that the US economy still has a significant shortfall in demand: activity has yet

to return to the path that might have been predicted before the onset of the financial crisis. Put another

way, perhaps the US still has a sizeable output gap. Some have argued that this persistent weakness

reflects a premature decision to tighten fiscal policy when what was needed was continuous fiscal stimulus.

However, other measures of slack in the economy don’t fully support for this view. Charts 9 and 10 show

the unemployment rate and the manufacturing capacity utilisation rate for the US economy going back tothe mid-1970s. In each case, the first increase in Fed funds in each tightening cycle is marked with a

vertical line. On both measures, the amount of “slack” in the US economy is no greater than in earlier

economic cycles: indeed, it could be argued that the Federal Reserve is “behind the curve”.

9. Back to normal on the unemployment rate…. 10. …and on capacity utilisation?

Source: Thomson Reuters Datastream, National Bureau of Economic Research Source: Thomson Reuters Datastream, National Bureau of Economic Research

That view, in turn, might reflect the impact on supply performance of the financial crisis either in terms of

a drying-up of credit to start-up companies and otherwise rapidly-expanding smaller enterprises or,

instead, as a result of the creation of exceptionally easy financial conditions for large inefficient

companies, thereby limiting the impact of Schumpetarian creative destruction. Either way, a lowerlong-term growth rate – and associated weak productivity growth – would imply a structurally lower level

of real interest rates, exactly what we’ve witnessed in the post-crisis world.

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A third reason for a lack of action – and doubtless a big influence on central bankers tasked with meeting

inflation targets – is the persistence of low inflation, measured in terms of both prices and wages.

Charts 11-13 show both headline and core consumer price inflation alongside wage growth in the US

since the mid-1970s, again with vertical lines representing the beginning of each cycle of monetary

tightening. There have been no occasions during which the Fed has raised interest rates when headline

inflation has been as low as it is today. There has been only one occasion when interest rates were raised

when both core inflation and wage growth were as low as they are today – and that was at the beginning

of the last tightening cycle. And no one today – including members of the FOMC – expects interest rates

to rise as quickly or as far as was the case back then (chart 14). So long as inflation stays low – and, in

particular, so long as inflation remains below target – the case for aggressive monetary action within the

context of current central bank mandates appears to be weak. That message has only been reinforced by

the persistent habit in the post-financial crisis word for forecasters to over-estimate inflationary outcomes:

there is a lot less inflation out there than is commonly supposed (chart 15).

11. US headline inflation is non-existent


12. Inflation is persistently low… 13. …and so is wage growth


Source: Thomson Reuters Datastream, National Bureau of Economic ResearchNote: Uses average hourly earnings (USD per hour) for all private sector workers since2006 and average hourly earnings for production & nonsupervisory workers in the privatesector prior to this.

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16. Headline inflation, at least, is mostly well below target

% Year Headline inflation Core inflation

US 0.0 1.8Japan* 1.6 0.7UK 0.0 1.0Eurozone -0.1 0.6

*National CPI excluding VAT effect. Japanese core CPI is "US style core" (ex food and energy)Source: National sources Note: Inflation rates for March 2015

Try to avoid it

Higher levels of bank capital, greater liquidity buffers, more aggressive stress tests, macro-prudential

policies: each of these is designed to prevent a repeat of the global financial crisis. In meeting that

relatively narrow aim, they might well work. However, there’s more than one crisis, more than one

recession. In the postwar period, recessions have been caused by exogenous shocks (1970s oil price

hikes), inflationary battles (the Volcker monetary tightening in the early 1980s), credit slumps (the early

1990s “credit crunch”) and the bursting of equity bubbles (2000). While it is tempting to believe that all

recessions have roughly the same causes, in reality they don’t – one reason why they are so difficult to

predict. A warning comes from the IMF in its latest Global Financial Stability Review: in Europe, “the

challenges facing life insurers should…be tackled promptly. Regulators need to reassess the viability of

guarantee-based products and work to bring minimum return guarantees….in line with secular trends in

policy rates. Prompt…actions are needed to mitigate damaging spillovers from potential difficulties of

individual insurers.” There is no shortage of systemic risks.

The danger for policymakers is not so much that they haven’t worked hard to prevent the next crisis but,

rather, they cannot easily know in advance what the next crisis might look like. Admittedly, they can at

least hope to make sure that the financial system itself will be more resilient in coming crises than it was

in the last crisis, but that doesn’t alter the fact that all previous crises – whatever their cause – have been

accompanied by sustained easing of monetary and fiscal policy.

Table 16, for example, shows the extent to which US policy rates have fallen – from peak to trough –

across all downswings since the 1970s. On average, rates have fallen 6.2 percentage points. At a

minimum, they have fallen 5.0 percentage points. Other than the huge early-1980s decline as Paul

Volcker’s monetary medicine began to work, the amplitude of interest rate cycles has been remarkablysimilar, even if the level of interest rates across cycles has varied: across all cycles, interest rates have

fallen between 5 and 6.25 percentage points. Today, they can’t really fall at all unless we end up in a

world of increasingly negative nominal interest rates, a situation that might ultimately prove highly

damaging to the stability of the financial system if people increasingly chose to withdraw funds from

banks to store in the form of cash.


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17. US rates normally fall a long way during downswings – now they can’t (%)

End of easingcycle

Policy rate at end of easing cycle Rate at start of easing cycle Decline in target rate since start ofeasing cycle

July 1977 4.75 11.00 -6.25September 1980 11.00 16.50 -5.50February 1984 8.00 19.00 -11.00November 1986 5.88 11.44 -5.56January 1994 3.00 8.00 -5.00June 2004 1.25 6.50 -5.25December 2008 0.25 5.25 -5.00

Average - - -6.22

Source: Thomson Reuters Datastream, HSBC, National Bureau of Economic Research

Use quantitative easingIf interest rates really cannot fall and traditional fiscal policy is constrained by either unusually large

deficits or uncomfortably high debt, one option would simply be to continue with quantitative easing.

This, after all, has been the Japanese experience: QE was first introduced by the Bank of Japan in 2001,

even if it wasn’t quite embraced with the enthusiasm seen in both Japan and other countries in the

aftermath of the global financial crisis. Yet there is little evidence to suggest that this first QE experiment

achieved very much: if anything, it simply reinforced the perception that raising interest rates from zero

was more difficult than had originally been expected.

Today, there are potentially bigger difficulties. They relate, in part, to the extent to which equity markets

have advanced well beyond what might be justified by underlying economic fundamentals. Chart 18, for

example, shows the Shiller historic PE ratio going back all the way to the 19th century. On this measure,

current US valuations are incredibly stretched: indeed, only in the late-1990s during the tech bubble and

ahead of the 1929 crash were valuations even more stretched. Janet Yellen, Chair of the Federal Reserve,

is understandably a little worried: on 6 May she highlighted that “equity market valuations at this point

generally are quite high. There are potential dangers there.”

Admittedly, there are good reasons for equity valuations being higher than normal: interest rates are

incredibly low and the profit share in GDP is currently incredibly high. However, if interest rates are low

because the long-term growth outlook is discouraging and there is a paucity of investment opportunities,

the only fundamental way in which currently high PEs can really be justified is via a continued increase

in the profit share within GDP. Otherwise, stretched PEs are only likely to be sustained through

continuous addiction to quantitative easing and other related policies.


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18. Has QE shoved equity valuations up… 19. …or are investors anticipating even more in the way ofprofit increases?

Source: Shiller Online data Source: Thomson Reuters Datastream, HSBC

This creates a tricky dilemma for central banks. Quantitative easing was adopted originally not only to

push up the value of financial assets but also to encourage higher levels of spending: households would

feel wealthier thanks to rising real estate and equity prices while listed companies would more easily be

able to raise funds for investment thanks to buoyant stock markets. To the extent that QE prevented a

1930s-style meltdown, that ambition might have been met. Policymakers, however, hoped not only to

avoid a depression but also to encourage a return to reasonable economic growth. That has proved more

difficult. Even the better economic performers – notably the US – have struggled to return to the growth

rates of old.

It may be that QE has merely driven a wedge between financial hope and economic reality. Worse, if the

next recession simply provokes more QE, are investors already beginning to believe that, once again, they

are to be continuous beneficiaries of what was once affectionately known as the “Greenspan put”? This

was the belief – held most strongly during the late-1990s tech bubble – that the Fed would stand ready

to offer support in the event of economic weakness, inevitably encouraging even more in the way of

risk-loving behaviour.

Knowing that central banks are potentially hooked on QE for the long term is, at best, likely to lead to the

mis-pricing of financial assets. That, in turn, might lead to a deterioration in the quality of investment

and, hence, lower productivity growth over the medium term. At worst, it may lead to a repeat of the

asset price bubbles that have proved to be so disruptive to economic activity. In the absence of

conventional policy ammunition, an addiction to QE could ultimately mean that the second great

depression was only postponed, not avoided altogether.

Move away from inflation targeting

Inflation targeting in theory offers precision, transparency and predictability. While that all sounds rather

marvellous, there is an obvious problem: if central banks only worry about inflation – and not, for

example, about asset price bubbles – the danger is that the rest of us start to take risks which ultimately

lead to the kinds of imbalances that preceded the onset of the global financial crisis. Put another way,

if nothing is expected to go wrong, it surely will go wrong.

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It’s not just the financial crisis that demonstrates this problem. In the late-1980s, Japanese inflation was

mostly well-behaved: between 1985 and 1990, the average rate was a mere 1.1%. Judged on inflation

outcomes alone, it appeared that Japanese policymakers were doing a very good job. Indeed, given that

inflation was, on average, below the 2% rate which has become the inflation target du jour , it could be

argued that Japanese monetary policy was, if anything, too tight.

20. Japanese inflation was “too low” in the late 1980s even though monetary conditions were “too loose”

Source: Thomson Reuters Datastream

In hindsight, however, it’s clear that monetary conditions in Japan in the late-1980s were far too loose.Inflation may have been quiescent, but equity and land prices were soaring, corporate debt was exploding

and monetary growth was through the roof. The absence of inflation merely camouflaged the underlying

imbalances emerging within the Japanese economy. Eventually, of course, the bubble burst, asset prices

collapsed, deleveraging began in earnest, monetary growth shrivelled and Japan succumbed to deflation

and, thereafter, to two lost decades.

Taking the Japanese experience – and, indeed, the experience of the US in the years before the onset of

the global financial crisis – it could be argued that central banks should stick to their inflation targets less

rigidly. There are times when an inflation rate higher than 2% might be perfectly acceptable. Equally,

there are times when an inflation rate significantly lower than 2% – perhaps even a period of deflation –

might be acceptable, notably during periods of excessive hot money inflows which boost both asset prices

and the value of the exchange rate (as happened in Japan in the late-1980s and may now be happening in

Sweden). What matters is not the inflation rate alone, but rather the inflation rate in the context of

broader measures of financial and economic instability. In Japan’s case, monetary policy in the 1980s

should have been tighter than it was, even if the inflation rate would have been even lower as a result.

Tighter monetary policy would have reduced the risk of asset price bubbles and credit booms. Ironically,

it might even have reduced the risk of deflation in the 1990s: a smaller asset price bubble would

presumably have led to a smaller asset price bust.

In the late-1980s, virtually all indicators suggested Japan should raise interest rates: money supply, credit

growth, asset prices, unemployment, a rapidly-narrowing balance of payments surplus and rapid

economic growth all suggested interest rates should be higher. Only the inflation rate suggested there was

no need to act. The situation today, however, is rather more ambiguous. The problem is not so much a

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disconnect between the inflation rate and all other indicators: it is, instead, a disconnect between growth

and inflation on the one hand and asset prices on the other. There is, if you like, both a real and a virtual

economy, and they are heading in different directions. Tighter monetary policy to deal with potential

asset price bubbles might simply intensify deflationary pressures or throw economies into recession

(as the ECB and Riksbank discovered having raised interest rates in 2011). Continuously loose monetary

policy designed to support growth and prevent inflation from falling too far might simply intensify asset

price bubbles, paving the way for eventual economic collapse.

Use fiscal policy instead of monetary policy

Traditional macroeconomic analysis – particularly that based on a Hicksian IS/LM framework – argues in

favour of fiscal activism, particularly in a world where interest rates are close to or at zero. If, in theevent of another recession, interest rates really cannot fall and QE threatens to drive an uncomfortable

wedge between the real and the virtual economy, fiscal policy would appear to be an obvious alternative.

Yet, as with monetary policy, it’s difficult to argue there is a great deal of flexibility on fiscal policy –

unless, that is, governments are willing and able to tolerate deficits and debt levels far higher than seen in

the peacetime past. Yes, debt levels have been significantly higher in wartime, but wartime is very

different: market economies become siege economies, inflation pressures are hidden through rationing

and – notably for those who end up in military service – individuals are willing to make greater sacrifices

than normal for the good of the nation.

Charts 21 and 22 show the history of government debt in both the UK and the US going all the way backto the 1700s. UK government debt has often been significantly higher than it is today, but in the early

days of Empire – thanks to the booty associated with conquest – it was a little easier to cope with the

servicing costs (in any case, the increases in debt in the 18th Century were mostly a reflection of an

absence of tax revenue: income tax was eventually introduced at a paltry rate by William Pitt the Younger

in 1798). In the US, however, debt levels are already very high relative to all periods other than the

Second World War and, according to the Congressional Budget Office, set to head a lot higher.

21. The history of UK public debt – it’s been higher, but they were different times

Source: Bank of England. Number since the global financial crisis include the debts of publically-owned financial institutions

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Income taxintroduced

The Battle ofWaterloo

World War 1 World War 2The Congress of Vienna


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22. The history of US government debt – unprecedented peacetime levels

Source: Congressional Budget Office

Those increases are, in effect, a consequence of claims already made on future economic production,

most obviously in areas associated with population ageing: pensions and healthcare. It is the same story

through much of the developed world. Government debt levels are set to rise rapidly as a share of GDP

even in the absence of another recession. Throw a recession into the mix and it’s a lot more difficult to

see how much cyclical fiscal flexibility there could be unless governments – and voters – are ultimately

willing to follow Japan’s path: slow growth thanks to an ageing population accompanied by eye-

wateringly high levels of government debt.

These future claims suggest the room for fiscal flexibility is a lot smaller than was the case in the 1930s

when Franklin Delano Roosevelt launched his New Deal. Back then, Roosevelt inherited a fiscal position

from Herbert Hoover that was relatively healthy: an insignificant deficit accompanied by government

debt that amounted to only 38% of GDP. Moreover, there were no significant future spending

commitments of the kind we see today. Fiscal stimulus – a novel idea at the time – may have been

controversial, but the chances of it working to boost economic activity were quite high given the healthy

starting position and an absence of future spending commitments. Today, it is much more difficult to

make the same argument. The best that can be said – and this certainly chimes with the Greek experience

– is that pursuing aggressive fiscal austerity in the midst of a deep recession is likely to end in tears. That,however, is not an argument in favour of aggressive fiscal activism.

Use fiscal and monetary policy in conjunction with each other

When debt levels are low, interest rates are high and budget deficits are small, dealing with recessions is

relatively easy, even if preventing them in the first place is problematic. When debt levels are high,

interest rates are at zero and budget deficits are large, dealing with recessions is a lot more troublesome.

There is little room for policy adjustment and, given high levels of debt, policy multipliers are likely to be

either very small or totally non-existent. This suggests that high levels of debt need to be tackled directly.

One way to do this is to push asset prices higher in the hope that, by doing so, debts will be more

willingly held, balance sheets will look healthier and the pressure to deleverage will be reduced.

Quantitative easing has done precisely that but, as already noted, the increase in asset values has, to date,

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not translated fully into decent economic growth and higher inflation – which, in turn, suggests it might

not be immediately effective in another downswing.

An alternative approach is simply to accept that debts are too high and that their value needs to be

reduced. There are many explicit ways of doing this – ranging from default, public spending cuts and

punitive wealth taxes – but there is also one much-used implicit way: the creation of inflation.

Despite huge amounts of monetary stimulus – zero interest rates and quantitative easing – so far there has

been little evidence that central banks have managed to push inflation higher on a sustained basis. True,

UK inflation was higher than expected in the years following the financial crisis but the rate subsequently

collapsed. Japanese inflation – excluding the consumption tax - edged a little higher in the months

following the adoption of QE in 2013 but, more recently, has been heading lower again. If the aim is to

reduce the real debt burden via higher inflation, it’s clear that the policy has, so far, failed.

There is, however, a way of almost guaranteeing higher inflation. It’s called helicopter money. It works only if

the fiscal and monetary authorities work together not only to expand the supply of money but also to guarantee

the extra money is spent rather than saved. The finance ministry announces a large increase in government

borrowing funded by bond sales not to the public but, instead, to the central bank. The newly-issued money is

then used to provide a “monetized” tax cut or increase in public spending. In other words both the supply of

money and its velocity rise, virtually guaranteeing an acceleration in the growth rate of nominal GDP. The

likelihood in the short term would be a rise in both prices and quantities.

If, however, the benefits of this policy are so blindingly obvious, why has no government or central bank

so far fully gone down this “irresponsible” path? The answer is simple. Monetized deficit financing can

all too quickly lead to a loss of faith in the integrity of a country’s monetary and financial institutions.

The risk is a mixture of currency collapse on the foreign exchanges and, eventually, a revulsion towards

money that would create a world of hyperinflation. Preserving the integrity of our monetary and financial

institutions is an important public good: risking another 1920s Weimar or modern-day Zimbabwe doesn’t

make a whole lot of sense (chart 23).

23. No one wants a Zimbabwe

Source: The Zimbabwe National Statistics Agency

0%

50000000%

100000000%

150000000%

200000000%

250000000%

0%

50000000%

100000000%

150000000%

200000000%

250000000%

99 00 01 02 03 04 05 06 07 08

Zimbabwe inflation rate


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Facing reality: creating conditions in which ammunition can be rebuiltIdeally, policymakers need more in the form of conventional policy ammunition. As yet, they don’t have

it. Those who have tried to rebuild their ammunition have failed: rate increases have been followed by

rate reductions, deficit reduction plans have largely gone unmet and, where governments have been

forced to deliver aggressive austerity, the output losses have been unacceptably large. Policymakers need

some new lifeboats to deal with the next recession but their attempts to build these lifeboats are in danger

of causing the next recession.

The challenge, then, is to find a way of building lifeboats without threatening another economic

downswing. To do so will require acts of political bravery. There has to be a reason for higher interest

rates and, if it isn’t a decent economic recovery, it needs to be something else. Persistently low interest

rates in a simple sense represent an excess of savings over investment. Raising investment has, to date,

proved problematic, at least in the developed world. Companies may be profitable but have preferred to

hoard cash than take risks with capital spending. Meanwhile, attempts by governments to bring deficits

under control have tended to have a bigger negative impact on capital than on current spending.

A better option might be to reduce savings. Falling interest rates are not just the result of central bank

policy. Indeed, central banks are often merely “rubber stamping” forces beyond their control. One of

those forces is an ex-ante excess of savings.

Ben Bernanke – the former Chairman of the Federal Reserve – famously once talked about the “global

savings glut”, a story loosely linked to the idea that some countries had excessively high savings, leaving

them with large balance of payments current account surpluses and, hence, huge capital outflows. Some

elements of that glut have now disappeared: the Chinese current account surplus has tumbled, the

Japanese now have a current account deficit and – on the other side of the equation – the US has a much

smaller current account deficit. Despite these developments, however, interest rates have remained very

low by past standards (chart 24).

24. The global savings glut looks smaller today

Source: HSBC, National sources

-800

-700

-600

-500

-400

-300

-200

-100

0100

200

300

400

500

-800

-700

-600

-500

-400

-300

-200

-100

0100

200

300

400

500

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

US China Germany Japan

USDbn USDbnCurrent account


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One possible explanation for the persistence of structurally-low interest rates is that the Eurozone has

replaced China and Japan as the “saver of first resort”: an ever-larger German current account surplus has,

more recently, been accompanied by smaller deficits and even surpluses in austerity-hit southern Europe.

Even this, however, doesn’t quite capture the underlying problem: after all, balance of payments positions

are merely accounting identities which say nothing about the level of interest rates required to make sure

the numbers add up.

A more fruitful explanation – which certainly ties in with German savings behaviour – is that nations with

ageing populations are full of people keen to postpone expenditure from the present to the future, in the hope

that they will be able to enjoy a long and rich retirement. Each person has an intuitive sense of the required

amount of financial wealth. Yet thanks to people’s collective savings behaviour, their individual wealthtargets remain out of reach: the more they save, the more interest rates fall; the more interest rates fall, the

lower the returns on their wealth; and the lower the returns on their wealth, the more they have to save.

The underlying problem is that countries with ageing populations tend to suffer from slower growth yet to

pay for all the extra retirees the countries need to have faster growth. If returns on investment are simply

not high enough, all the extra saving will simply reduce interest rates to pitifully low levels, leading for

example to remarkably low returns on annuities.

To break out of this vicious circle, the easy answer – economically, at least – is for the retirement age to rise.

This would, at a stroke, reduce the need for high savings. Faced with a longer period of work – and, hence,

of earned income – the need to save to meet a retirement nest-egg objective would be greatly reduced.Lower levels of savings would mean higher levels of consumption, higher levels of demand and, hence

higher levels of investment. Importantly, faster economic growth would also provide higher tax revenues

and higher interest rates. The ammunition needed to repel the next recession would be replenished.

Unfortunately, the chances of such radical reforms emerging are low. Political expediency – because

older people tend to be more willing to vote than the young – will doubtless trump economic necessity.

As a result, the recession-fighting ammunition will remain in short supply and the risks of a major

economic contraction will be that much greater. We will carry on sailing across the ocean in a ship with a

serious shortage of lifeboats. Many – including the owner of the Titanic – thought it was unsinkable: its

designer, however, was quick to point out that “She is made of iron, sir, I assure you she can”.

…..and the likely cause of the next recession?

Finally, it may seem that the global financial crisis was only a short while ago but we are now six years

into economic recovery, at least in the US. Recessions don’t come along like clockwork but,

nevertheless, history suggests that we are now closer to the next recession than the last one. We may not

know what will cause the next downswing but, at this stage, we can categorically state that, in the event

we hit an iceberg, there aren’t enough lifeboats to go round.

As for possible causes of the next recession, the best that can be offered is a list of possible suspects.

Given that recessions are triggered for all sorts of reasons and mostly arrive unannounced, it would be

foolish to claim that the list of suspects is anything but speculative and incomplete. Still, to end on aless-than-cheerful note, here are those suspects:


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Disclosure appendix

Analyst Certification

The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the

opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their

personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific

recommendation(s) or views contained in this research report: Stephen King

Important DisclosuresThis document has been prepared and is being distributed by the Research Department of HSBC and is intended solely for the

clients of HSBC and is not for publication to other persons, whether through the press or by other means.

This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer

to buy the securities or other investment products mentioned in it and/or to participate in any trading strategy. Advice in this

document is general and should not be construed as personal advice, given it has been prepared without taking account of the

objectives, financial situation or needs of any particular investor. Accordingly, investors should, before acting on the advice,

consider the appropriateness of the advice, having regard to their objectives, financial situation and needs. If necessary, seek

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not be suitable for all types of investors. Investors should consult with their HSBC representative regarding the suitability of

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The value of and the income produced by the investment products mentioned in this document may fluctuate, so that an

investor may get back less than originally invested. Certain high-volatility investments can be subject to sudden and large falls

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affected by exchange rates, interest rates, or other factors. Past performance of a particular investment product is not indicative

of future results.

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Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment

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Additional disclosures

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Global

Stephen KingGlobal Head of Economics+44 20 7991 6700 [email protected]

Karen WardSenior Global Economist


James Pomeroy+44 20 7991 6714 [email protected]

Europe & United Kingdom

Janet HenryChief European Economist+44 20 7991 6711 [email protected]

Fabio BalboniEuropean Economist+44 20 7992 0374 [email protected]

Simon WellsChief UK Economist+44 20 7991 6718 [email protected]

Elizabeth MartinsEconomist+44 20 7991 2170 [email protected]

GermanyStefan Schilbe+49 211910 3137 [email protected]

Rainer Sartoris+49 211910 2470 [email protected]

FranceMathilde Lemoine+33 1 4070 3266 [email protected]

Francois Letondu+33 1 4070 3933 [email protected]

North America

Kevin LoganChief US Economist


Ryan Wang+1 212 525 3181 [email protected]

David G Watt+1 416 868 8130 [email protected]

Asia Pacific

Qu HongbinManaging Director, Co-head Asian Economics Research andChief Economist Greater China+852 2822 2025 [email protected]

Frederic NeumannManaging Director, Co-head Asian Economics Research+852 2822 4556 [email protected]

Paul BloxhamChief Economist, Australia and New Zealand+612 9255 2635 [email protected]

Pranjul BhandariChief Economist, India+91 22 2268 1841 [email protected]

Izumi Devalier+852 2822 1647 [email protected]

Su Sian Lim+65 6658 8783 [email protected]

Sophia Ma+86 10 5999 8232 [email protected]

Ronald Man+852 2996 6743 r [email protected]

Trinh Nguyen+852 2996 6975 [email protected]

John Zhu+852 2996 6621 [email protected]

Joseph Incalcaterra+852 2822 4687 [email protected]

Julia Wang

+852 3604 3663 [email protected]

Nalin Chutchotitham+662 614 4887 [email protected]

Daniel John Smith+612 9006 5729 [email protected]

Li Jing+86 10 5999 8240 [email protected]

Prithviraj Srinivas+91 22 2268 1076 [email protected]

Global Emerging Markets

Murat UlgenGlobal Head of Emerging Markets Research+44 20 7991 6782 [email protected]

Bertrand DelgadoSenior EM Strategist+1 212 525 0745 [email protected]

Jessica WuEM Strategist+852-2822 4337 [email protected]

CEEMEA

Simon WilliamsChief Economist, CEEMEA+44 20 7718 9563 [email protected]

Alexander Morozov

Chief Economist, Russia and CIS+7 495 783 8855 [email protected]

Artem BiryukovEconomist, Russia and CIS+7 495 721 1515 [email protected]

Agata Urbanska-GinerEconomist, CEE+44 20 7992 2774 [email protected]

Melis MetinerChief Economist, Turkey+90 212 376 4618 [email protected]

David FaulknerEconomist, South Africa+27 11 676 4569 [email protected]

Razan NasserEconomist, Middle East and North Africa+971 4 423 6928 [email protected]

Latin America

Andre LoesChief Economist, Latin America+55 11 3371 8184 [email protected]

ArgentinaJavier FinkmanChief Economist, South America ex-Brazil +54 11 4344 8144 [email protected]

Ramiro D BlazquezSenior Economist+54 11 4348 2616 [email protected]

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BrazilConstantin Jancso

Senior Economist+55 11 3371 8183 [email protected]

Central AmericaLorena DominguezEconomist+52 55 5721 2172 [email protected]

Global Economics Research Team
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