And now the Atlanta Fed, which has lately been both far more pessimistic and far more accurate about US growth than other mainstream economists, is creeping towards the Blue Chip consensus. It recently bumped its Q2 growth forecast growth to 2%, more than enough to offset the negative Q1 reading. If this forecast holds, then first-half growth will be at least marginally positive, with serious momentum heading into the Fall.
That’s quite a change, but not an improvement. In fact it illustrates the corner into which the developed world has painted itself. By borrowing another $57 trillion since 2008 and pushing interest rates down to zero and below, the (formerly) rich countries are now living in an “all news is bad news” world.
Consider: If growth stays low then all that new borrowing was worse than wasted, increasing leverage and financial fragility while leaving central banks and governments with few options going forward. If the past seven years’ debt orgy didn’t ignite a boom, will another binge be worth the effort? Will borrowers be energized by -2% rates if 0% left them cold?
On the other hand, as now seems at least plausible, if the past few years’ monetary and fiscal experimentation does end up generating a bit of growth, what then? With the prices of financial assets at records and hard assets like trophy real estate and fine art far beyond previous records, rising growth will, as the Fed keeps promising, trigger rising rates, and not necessarily in an orderly fashion. The recent bond market excitement, in this scenario, is just a taste of bigger, nastier things to come. See Bond Market Turmoil: Yields Hit Fresh Highs in June.
What will spiking bond rates (which is to say a collapsing bond market) do to the rest of the financial system? That’s not easy to answer. Government borrowing costs would obviously rise as trillions of dollars of short-term debt is rolled over at higher rates, sending deficits back to Great Recession levels. Corporations would find selling bonds to buy back stock a suddenly bad deal and would probably stop — pulling a major prop from beneath stock prices. On the other hand, all the money pouring out of bonds would have to go somewhere, and could well flow into equities, sending valuations into the stratosphere and finally pulling retail investors in at the very top.
The conclusion? Beyond a certain point leverage stops helping and starts hurting. And the fact that no amount of growth leads to a happy outcome for the US, Europe and Japan implies that we’re there.