Evening Must-Read: Martin Wolf: Trapped in a Cycle of Credit Booms

Martin Wolf: We are trapped in a cycle of credit booms: “The eurozone seems to be waiting for the Godot of global demand…

…to float it off into debt sustainability…. China is struggling with the debt it built up…. Without an unsustainable credit boom somewhere, the world economy seems incapable of generating growth in demand sufficient to absorb potential supply…. Financial sectors have deleveraged in the US and UK… so, too, have households…. Meanwhile, public debt has risen sharply…. Since 2007 the ratio of total debt, excluding the financial sector, has jumped by 72 percentage points in China, to 220 per cent of GDP…. Credit cycles matter because they frequently prove so damaging…. [Maybe] the pre-crisis trend was unsustainable… the damage to confidence… the debt overhang…. Mass bankruptcy, as in the 1930s, is devastating. But working out of debt is likely to generate a vicious circle from high debt to low growth and back to even higher debt…. Managing the post-crisis predicament requires a combination of prompt recognition of losses, recapitalisation of the banking sector and strongly supportive fiscal and monetary policies… use both blades of the scissors: direct debt reduction and recapitalisation on the one hand and strong economic growth on the other…. Yet the biggest lesson of these crises is not to let debt run ahead of the long-term capacity of an economy to support it in the first place. The hope is that macroprudential policy will achieve this outcome. Well, one can always hope…