MORGAN STANLEY: The risk of a Great Depression-style global debt-deflation cycle is 1 in 3

Downturn may be 'the big one'
Chris Zappone
July 29, 2008 - 12:26PM

[link to business.smh.com.au]

The risk of a Great Depression-style global debt-deflation cycle is one in three, according to an investment bank economist.

Beyond an anticipated cyclical slowdown in the next six months, Morgan Stanley economist Gerard Minack has raised the possibility of a substantial structural risk caused by lower asset pricing, high household debt levels, and a cash shortage.

"I think that for many Anglo economies the risk of a pronounced deleveraging-deflation cycle is higher now than it has been since the Great Depression," Mr Minack said in a note to clients.

"What makes this cycle different - and elevates the risk of a major unravelling - is the extremes that those trends have now reached."

In the United States, where the implosion of subprime debt values has affected other debt and asset markets, a number of economic gauges have risen to levels not seen since the time of the Great Depression, Mr Minack said.

Total US debt compared to the gross domestic product has surpassed levels seen in the mid-1930s. US household gearing is at an all-time high, as were US house prices before their fall in the wake of the subprime crisis.

Because of the tight links between the world's financial markets, a prolonged slump in the US could weigh down the global economy.

"The time is coming when we will all have to take a view on whether this cycle downturn is 'the big one'," Mr Minack wrote.

"That is, whether the virtuous forces that sustained the Anglo world's inter-linked boom in debt, leverage, and asset prices are turning vicious, leading to sustained debt reduction, asset price weakness, and, as a by-product, sharply lower rates and inflation."

Falls in home prices, employment levels and consumer spending give some suggestion about the magnitude of a possible slowdown in the months ahead, Mr Minack wrote.

He's not alone in his views that the slowdown we're seeing may not be of a cyclical, garden variety.

The International Monetary Fund released a report overnight warning that global markets remain fragile and face systemic stress one year after the subprime market crisis first emerged in the US.

The financial organisation noted there is no bottom in sight for the falls of the US housing market.

Looking ahead, the IMF expects global growth to stall, declining from 5% in 2007 to 4.1% in 2008 and 3.9% in 2009 amid an environment of "negative interaction between banking system adjustment and the real economy."

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