Transcript Deflation - Royal Bank of Scotland Group websites

Green shoots or weeds?
Robert Gardner, Head of Macroeconomics
What to expect in the next 30 mins: an RBS double-act

Robert:

A simple framework for thinking about the future

An evaluation of the options
 Our view....

Peter:


A closer look at the Nordic region
Q&A
Slide 2
A simple analytical framework.....
High Policy Traction
Higher Capacity,
Higher Trend Growth
Lower Capacity,
Lower Trend Growth
Low Policy Traction
Slide 3
Four potential scenarios......
High Policy Traction
Goldilocks
Returns
Return of Macro
Instability
Higher Capacity,
Higher Trend Growth
Lower Capacity,
Lower Trend Growth
Slow Grind
Higher
Deflation
Low Policy Traction
Slide 4
The worst outcome.......
High Policy Traction
Higher Capacity,
Higher Trend Growth
Lower Capacity,
Lower Trend Growth
"Deflation"
• Very deep downturn then stagnation
• Deflation
• No scope for policy normalisation
• De-leveraging: frustrated
Low Policy Traction
Slide 5
Disaster Avoided?
Slide 6
Not exactly.....
Peak to Trough Decline in GDP (Percentage Points)
Ire
Jap
Ger
It
Fin
UK
Den
Fr
Nor
Swe
0
-1
-2
-3
-4
-5
-6
United States
Eurozone Average
-7
-8
-9
-10
Slide 7
Source: Datastream
Deflation fears appear to be receding......
3.00
Inflation Expectations (10Y TIPS - 10 Y Tresuries)
2.50
2.00
1.50
1.00
Deflation Scares
0.50
0.00
2003
Source: Datastream
2004
2005
2006
2007
2008
2009
Slide 8
Unprecedented policy action stopped the rot
Change in Interest Rates (2007-2009, bps)
0
-50
-100
-150
-200
-250
-300
-350
-400
S/Term Rates
-450
L/Term Rates (10Y Yields)
-500
Source: Datastream
UK
US
Ger
Fra
India
China
Japan
Slide 9
Key asset markets may have found a bottom....
250
230
House Prices
(Index, 2000=100)
UK
210
190
US
170
150
130
110
Source: Datastream
Stabilisation?
90
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Slide 10
Real activity also appears to be stabilising
65
Global Purchasing Managers Indicators
(Index, >50 = expansion)
60
UK
55
World
EZ
50
US
45
Contraction
40
35
2006
Source: Datastream
2007
2008
2009
Slide 11
Goldilocks Returns?
Slide 12
Straight from despair to elation?
High Policy Traction
"Goldilocks Returns"
•
•
•
•
•
Quick recovery, robust growth
Plenty of slack
Low inflation
Steady Policy Normalisation
De-leveraging: quick and smooth
Lower Capacity,
Lower Trend Growth
"Deflation"
• Very deep downturn then stagnation
• Deflation
• No scope for policy normalisation
• De-leveraging: frustrated
Low Policy Traction
Slide 13
Investors seem more convinced of the durability of the upturn
115
Equity Market Performance (Index 2007 = 100)
105
95
85
Swe
75
US
Nor
EZ
65
Key indices up by 40% to 65%
55
45
Source: Datastream
Jul 09
May 09
Mar 09
Jan 09
Nov 08
Sep 08
Jul 08
May 08
Mar 08
Jan 08
Nov 07
Sep 07
Jul 07
May 07
Mar 07
Jan 07
35
Slide 14
Who said economists weren’t an optimistic bunch?
US Economic Data and Outlook (y/y %, Period Average)
4.00
2004-2006
2011-2013
3.00
2.00
1.00
0.00
Source: Datastream
Growth
CPI
Slide 15
Unfinished Business
Slide 16
Our best guess.....
High Policy Traction
"Goldilocks Returns"
Lower Capacity,
Lower Trend Growth
•
•
•
•
•
Quick recovery, robust growth,
Plenty of slack
Low inflation
Steady Policy Normalisation
De-leveraging: quick and smooth
Higher Capacity,
Higher Trend Growth
"Slow Grind Higher"
•
•
•
•
Deep downturn, slow recovery
Low inflation
Gradual policy normalisation
De-leveraging: slow and painful
"Deflation"
• Very deep downturn (-10%) then stagnation
• Deflation
• No scope for policy normalisation
• De-leveraging: frustrated
Low Policy Traction
Slide 17
Inventory liquidation brutal, but final demand still lacking
1.6
US Inventory to Sales Ratio - Still Bloated....
1.5
1.4
1.3
1.2
1992 1994 1996 1998 2000 2002 2004 2006 2008
Source: Datastream
Slide 18
Repairing household balance sheets will take some time
10%
US Household Balance Sheets
(% change between Q2 2007 peak and Q1 2009)
5%
+234bn
0%
-5%
-10%
-15%
-20%
Source: Datastream
-9,643bn
Financial
-4,206bn
Housing
-13,640bn
Total
-13,874bn
Debt
Net Worth
Slide 19
Mechanisms for balance sheet adjustment

Asset price growth – difficult for policy to gain traction

Inflation – erode the real burden of debt, return of macro instability

Widespread default to eliminate debt overhang – financial devastation

Debt rescheduling - debt for equity swaps, partial mortgage debt
forgiveness

Income growth/debt repayment – slow and painful
Slide 20
Surplus economies also have to make adjustments
12
Current Account Balances (% of GDP)
10
China
8
6
Germany
4
Japan
2
0
-2
Source: Datastream
2008
2007
2006
2005
2004
2003
2002
2001
2000
-4
Slide 21
Economic growth – where does it come from?
3.0
UK Economic Growth
0.7
2.0
1.0
Labour force growth
Productivity growth
2.1
0.0
Long term GDP growth = 2.8%
Slide 22
There are lots of headwinds:

Labour force growth:
• Demographic trends will be a drag
• Pressures to limit immigration won’t help either

Productivity growth
• Lack of investment impacts capital stock
• Cost of capital across the economy will be higher
• Fixing public sector balance sheets: crowding out
• Moving resources across sectors is likely to be costly
Slide 23
Blast from the past?
High Policy Traction
"Return of Macro Instability"
•
•
•
•
Quick return to growth,
No slack, volatile inflation, interest rates
Return to “boom-bust” cycle
De-leveraging: disorderly
"Goldilocks Returns"
•
•
•
•
•
Quick recovery, robust growth,
Plenty of slack
Low inflation
Steady Policy Normalisation
De-leveraging: quick and smooth
Higher Capacity,
Higher Trend Growth
Lower Capacity,
Lower Trend Growth
"Slow Grind Higher"
•
•
•
•
Deep downturn, slow recovery
Low inflation
Gradual policy normalisation
De-leveraging: slow and painful
"Deflation"
• Very deep downturn (-10%) then stagnation
• Deflation
• No scope for policy normalisation
• De-leveraging: frustrated
Low Policy Traction
Slide 24
The return of macro instability?
250
Economic Volatility
(10 Year Rolling Coefficiant of Variation of Real GDP Growth)
200
Return of Macro-Instability?
150
The "Great Moderation"
UK
100
50
US
Source: Datastream
Slide 25
2008
2006
2004
2001
1999
1997
1995
1992
1990
1988
1986
1983
1981
1979
1977
1974
1972
1970
1968
1965
0
Key messages/implications

The worst is over, but we’re not out of the woods yet
– Balance sheets have to be repaired – no quick fix
– Sluggish growth for a protracted period
– Policy stimulus likely to remain in place for some time

The post crisis world will be different
– Trend rates of growth will probably be lower
– Taxes will be higher/public spending will be lower
– Trade imbalances need to unwind too
– Deficit countries – lower consumption, saving higher, higher net exports
– Surplus countries – higher consumption, lower saving, lower net exports

A tougher environment, but a more sustainable one
Slide 26
Questions
Slide 27
Cost of Capital is going to be higher....
Corporate Bond Spreads
(£, 1-5Yr vs UK Gilt, Bps)
1400
BBB
1200
1000
800
600
400
1998-2008 average
spreads
200
AA
Source: Datastream
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
0
Slide 28
Fiscal policy also provided a vital lift...
Change in Budget Balance (% of GDP, percentage points, 2007-2009)
US
UK
Japan
China
Fra
India
Ger
0.0
2.0
4.0
6.0
8.0
10.0
12.0
Source: Datastream
Slide 29
Return to “normality”?
90
VIX Implied Volatility Index
80
70
60
50
40
Volatile Conditions
30
20
Normal Conditions
10
0
Source: Datastream
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Slide 30
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