FSA chairman Lord Turner has warned of the deflationary dangers of global economies having to deleverage their public and private debt at the same time.
In a speech yesterday in Frankfurt, Turner warned “we are far from out of this crisis”, setting out the huge deleveraging challenge to be faced. “It is far deeper and more difficult to escape than many of us initially thought,” he added.
Turner told delegates that meeting this challenge would require a combination of debt servicing, debt-writedown and forms of controlled debt monetisation.
Turner said that in previous debt fuelled crises leverage has tended to shift from private to public sector. However, he warned that with both private and public sectors forced to deleverage simultaneously, there was the risk of “self-reinforcing downward deflationary spirals’.
He said: “We face indeed the danger that the very policies which we know are essential for greater long-term stability – higher capital and liquidity requirements in the banking system and sounder fiscal policies underpinned by disciplines on public debt issuance – may in the short run produce deflationary effects which depress our economies and thereby undermine our ability to delever.”
Out of the options to achieve deleveraging- real growth, debt servicing, debt restructuring or inflation- Turner said everyone is in favour of real growth. But he warned this would be difficult to achieve given the current economic conditions. “We need to be realistic about how real growth can possibly come to the rescue,” he said.
To deal with the eurozone crisis, he said the central bank must be free to use all possible levers, including quantitative easing. But he warned this is impossible where there is subsidiary sovereign debt- debt issued by a political authority which does not issue its own currency- as it would lead to national debt indiscipline.
As a result, he suggested radical reform of the eurozone was required. He said: “The eurozone architecture needs to combine tight political and market discipline of subsidiary sovereign debt with the creation of Eurobonds, and with an acceptance that if necessary the ECB can conduct quantitative easing operations at the eurozone aggregate level.”