Nearly 2 years ago I wrote about the risks of a double dip recession.
Here's what The Economist had to say about likely economic impact of debt reduction, in a study released in January 2010.
It (the study) finds 32 examples of sustained deleveraging (at least three consecutive years in which ratios of total debt to GDP fell by at least 10%) in the aftermath of a financial crisis. In some cases the debt burden was reduced by default. In others it was inflated away. But in about half the cases—which the report regards as the most appropriate points of comparison—the deleveraging came through a prolonged period of belt-tightening, where credit grew more slowly than output. The message from these episodes is sobering. Typically deleveraging began about two years after the beginning of the financial crisis and lasted for six to seven years. In almost every case output shrank for the first two or three years of the process.
Bang on cue, we are in all probability now entering a new, massively significant phase of debt reduction, two years on. That's why the banking crisis that became the soveriegn debt crisis may once again turn into a painful liquidity squeeze.
Whilst quantitative easing saved the world from depression - effectively replacing money supply growth that in the normal course of events would be provided by business investment - countries now have no alternative other than to reduce levels of public debt. The fact we've finally reached the point of unsustainability is evidenced by the urgency with which countries need to manage the rates at which they borrow, and to rebuild shattered investor and investment confidence.
As public debt is deleveraged, we must hope that the process of private debt reduction is nearing the bottom. If not, another recession is surely all but guaranteed. That's why everything must be done, however radical, to encourage private sector investment and hope for a rapid return to more predictable functioning of markets.
