Fear of Debt Curbs Economic Recovery

by Inya Ivkovic, MA

World governments are struggling under serious mountains of debt, which, along with the still weak and disappointing U.S. home sales, is putting a serious damper on the optimism among economists and investors alike that orders of durable goods and other economic data have brought recently. Recently, yields on government bonds have risen sharply. This has brought single-minded global focus to the fact that Western governments have amassed far too much debt in their
efforts to stimulate economies, which is more than likely to push the costs of borrowing into the stratosphere and choke any attempt at recovery.

Dimming the outlook were also the disappointing sales figures of newly built U.S. single-family dwellings. Sales of new homes were lower than expected in April and correcting downward compared to March figures. Additionally, as of March 31, 2009, one out of eight households in the U.S. was late making its mortgage installments or was in the process of foreclosure. Such disappointing performance of the sector widely considered responsible for triggering the global economic slowdown only further underscores the depth and breadth of the “Great Recession,” as many have come to call it.

Of course, the recovery in the housing market depends on the recovery of the unemployment situation. The unemployment situation is not expected to bottom out until at least the second half of next year, so the housing market is not likely to bottom out until the fourth quarter of next year at the very best.

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But what has made economists and investors hope that the recession might be abating? For starters, April data for new orders for durable manufactured goods posted the biggest gain in the past 16 months, although March data had somewhat offset the hype. Also, according to government figures, fewer Americans have applied for jobless benefits in April. And again we heard statements that, just because things are not worse — although they could be — this is good news, and the economy might have finally hit the bottom.

The “Ice Age” in the “Eurozone” — the 16 countries sharing the euro as their common currency — also showed signs of thawing. The region’s business climate index rose for the second month in a row in May. Although, to be fair, the starting point when measuring that “climate” was very low, indicating that the manufacturing sector might be recovering, albeit in a subdued manner. In concrete terms, Europe’s Business Climate Indicator increased to 3.17 point in May, from an upwardly revised reading of 3.26 in April.

On the other side of the world, Japanese retailers saw more customers in their stores, which contributed to rising retail sales in April, which was also the first month that retail sales had increased since September of last year. However, Japanese economists fear that this is solely due to the effects of government stimulus, which is likely to be short-lived, because employers are still cutting jobs and wages.

Further curbing the enthusiasm was the Organization of Petroleum Exporting Countries (OPEC), which, at its recent meeting in Vienna, has said that production targets are not going to change because the industrial production is still weak, world trade is still contracting, and unemployment is still high in most economies. In other words, the OPEC is very much aware that the ongoing global economic downturn, precipitated by the credit and financial crises, has had an adverse, deep and broad impact on global demand for oil. But, unless oil prices rise, there is nothing to create momentum behind energy stocks, which was one of the main reasons why North American
indices rose in spite of concerns about debt levels and the housing market.

Illustrating just how much economists and investors are concerned about monstrous debt levels, U.S. government bonds have endured heavy selling pressures lately, as record amounts of money have flooded financial systems, resulting in the record $1.75-trillion budget deficit. The downdraft was so pronounced that the normal relationship whereby U.S. Treasuries track equities inverted more than normal. The move was this exaggerated because of mortgage-related selling, supersized money supply and concerns what all this would do to inflation down the road.