Why This Recovery Isn’t Going the Way It Should

The banks simply have not resumed lending as before:

In a normal economic cycle, a flood of capital market liquidity would fuel a recovery. However, there is nothing normal about this cycle as major channels of finance in the real economy remain blocked. Increased corporate issuance and rallying equities may raise the amplitude of the inventory cycle, stabilise consumer wealth and slow job losses.

But without policy measures to restore normal credit creation the pressure of leverage on company and consumer balance sheets will keep spending below depressed income evels. As international markets price in the beginning of Fed, ECB and Bank of England exit strategies next year and China moves to restrict loan growth, this hardly bodes well for global growth.

The capital markets recovery of 2009 has reduced the need for emergency levels of public support in the financial system but it has not reduced the need to improve the economic effectiveness of liquidity.

Without a reasonable flow of credit, an economic recovery will be forestalled for a long time.

Part of the problem lies in the definition of “reasonable.”  The credit flood of the last several years was anything but.  For those who became accustomed to that level of economic activity–albeit artificial–what exists now is unacceptable.

But how soon we forget: for years a few bawled about the enormous amount of “toxic” debt.  That toxicity was the product of two factors: the debt wasn’t properly collateralised and supported by income to start with (subprime mortgages) and then was overresold.

The result is an enormous amount of bad debt for the system to work through.

So why should we expect a problem of such a magnitude to work itself through overnight?

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