Professional Investment Services

Debt and Government Spending Means You Should Be Wary of this Stock Market

Economic data around the world continues to disappoint. It certainly doesn’t paint a picture of a recovering economy. Yet that’s the impression the stock market gives you. You need to remain cautious and very sceptical of what the stock market is saying.


As you may have heard, the International Monetary Fund (IMF) warned last week of the growing risks of a pronounced global slowdown. From Bloomberg:


‘A key issue is whether the global economy is just hitting another bout of turbulence in what was always expected to be a slow and bumpy recovery or whether the current slowdown has a more lasting component,” the IMF said in its World Economic Outlook report. “The answer depends on whether European and U.S. policy makers deal proactively with their major short-term economic challenges.’


The IMF, and most other global bodies like it, are usually completely ignorant of what’s going on. You don’t get to a top position in these bureaucracies by thinking outside the box and fretting about economic downturns. You get there by sticking with the herd and not making any mistakes or ‘chicken little’ forecasts.

So the fact that the IMF has warned on this suggests that the economic issues we face are acute.

I do take issue with the IMF’s notion that ‘the answer depends on whether European and US policymakers deal proactively with their major short-term economic challenges.’

No Short Term Fix for too Much Debt


So often, analysis by the experts suggests all that is required to ‘fix’ the world’s economic problems is for policymakers to be ‘proactive’ or to deal with the problem.

Such rhetoric is flimsy, throwaway rubbish. And to suggest these are ‘short-term economic challenges’ is ridiculous. They are the result of a credit/debt system that has grown out of control.

As you no doubt know, the world’s economic problems are the result of too much debt. By this I mean the level of global debt overshadows the world’s stock of productive assets.

In one way or another, these productive assets provide the income to service the debt and create sustainable economic growth. If income growth is strong, things like a country’s debt-to-GDP ratio remains under control.

But in most of the world’s large economies debt-to-GDP ratios are getting worse. This means debt growth is higher than economic growth. In other words, the injection of additional debt does not produce much in the way of additional income. The debt is becoming increasingly unproductive.

This is not surprising, considering a very large portion of the world’s debt growth comes from government spending. Government spending (financed by borrowing) is the least productive form of spending. That’s because much of it is ‘consumed’ via welfare payments to maintain social cohesion.

Very little government spending these days goes into genuine productivity enhancing infrastructure projects (Australia’s National Broadband Network is the exception, but the potential productivity benefits are a long way off).

So injections of government spending provide a very short term (consumption led) boost to GDP, but once the stimulus wears off, the ‘recovery’ falters and calls for more spending grow louder. Meanwhile, the stock of government debt continues to grow and the economy must continue to service that debt with its smaller percentage of productive assets.

Knowledge is Power in this Economy


Can you see where this is going? With each new round of government spending or debt monetisation the ratio or proportion of healthy and productive assets diminishes.

This type of fiscal and monetary policy stimulus has been the cornerstone of the Western World’s economic policy for years now. In their desperation to avoid economic slowdowns or recessions, policymakers have created an incredibly fragile economic structure.

What I mean by that is that global debt levels are now so high, and the economic structure is so fragile (because it relies on continuing, unproductive government spending to keep its head above water), that a seemingly minor economic slowdown could morph into something far more drastic.

It’s like what hedge fund manager Ray Dalio mentioned in an interview recently. He said words to the effect that he was more worried about a depression than a recession. I think that concern is due to the fragility of the global economic structure.

And the IMF flippantly suggests policymakers just need to be proactive to deal with ‘major short-term economic challenges’?

They are seriously kidding themselves. When you have the world’s economic policeman spouting such nonsense, you know there’s not much hope for realistic policy prescriptions.

That’s because realistic policy prescriptions are not politically feasible. So instead we get coordinated stimulus…more government spending, more central bank debt monetisation and more liquidity injections.

This provides a short term boost to markets, as you’ve seen in recent months. But the reality is that the underlying structure of the financial system and the real economy, which provides fundamental support to markets and asset prices, becomes weaker with each round of stimulus.

Knowledge is the most powerful asset you can have in dealing with these treacherous markets. If you simply listen to the daily output of the mainstream financial media, you’d think things are fine.

Greg Canavan
Editor, Sound Money. Sound Investments