Take losses hard and fast

As any good trader will tell you, take your losses hard and early.  Another is take losses and let your profits run.  Another is the first loss is the best loss.  

A recent report by McKensey Global Institute makes this point (with far greater research) strongly when it comes to turning around collapsing economies after a banking crisis. It considers debt and deleveraging, the pace of same, and the road to recovery depending on its pace and its depth.  

This is the first bit of contemporary research that points the finger directly at what is wrong with the EU response to their problems.  It states the bleeding obvious.  Here, I referred to the single most important symptom.  Once the diagnosis has been made, then the medicine can be taken.  And in this case the medicine is writing off all the bad debt that is unlikely to be repaid.  Do it quickly, and painfully, and then move on.  The report concludes:

“…history shows that, under the right conditions, private-sector deleveraging leads to renewed economic growth and then public-sector debt reduction.”

And again this is not rocket science.  This is what has occurred in most successful economic turnarounds in the past fifty years.  I know because I was there [along with many others of course].  And this is why it is so difficult watching the machinations in Europe.  Not only have the wrong symptoms been identified, but the wrong medicine is being applied in the form of austerity measures.   

What occurred last August was a liquidity crisis.  That has now been appeased by the ECB.  But the underlying illness is massive losses sitting on the balance sheets of all the banks.  The deleveraging the McKinsey report refers to, is not just people / companies paying off loans.  It is includes massive write-off of bad debts. 

McKinsey concludes that “deleveraging proceeds in two stages. In the first, households, the financial sector, and nonfinancial corporations reduce debt, while economic growth remains very weak or negative. During this time, government debt typically rises as a result of higher social costs and depressed tax receipts. In the second phase, economic growth rebounds and then the longer process of gradually reducing government debt begins.”

Their examples illustrate that an “economy is ready to resume sustained growth after private-sector deleveraging when certain conditions are in place: the financial sector is stabilized and lending volumes are rising; structural reforms are in place to boost productivity and enable GDP growth; credible medium-term public deficit reduction plans have been adopted and restore confidence; exports are growing; private investment resumes; and the housing market is stabilized and residential construction is reviving.”

As mentioned here, austerity programs don’t work.  Governments increase debt during the difficult times – when markets have failed – and decrease debt during the good times.  

There are some other conclusions to draw as well from the report.  USA has been pretty swift in taking losses, and indeed continues to do so right at the retail level.  Indeed, its economy looks to be far more advanced than I anticipated and suggests an earlier recovery than many realise.

Frankly, the UK looks very troubling; however this was covered comprehensively by The Telegraph.  And especially as its debt level has just passed GBP 1 trillion for the first time.

And another standout is Australia.  It has the lowest government debt by far (21%), but it has a jaw-dropping 105% household debt to GDP.  Substantially greater than Spain (82%), Italy (45%) and Greece (62%) and ranks second only to Ireland at 124%.  And as Macrobusiness analyses in some depth, since the GFC, household debt has increased A$222 billion.   Makes that aussie dollar look a little wobbly frankly. 

Back to the EU.  Let the banks stop fiddling their balance sheets and go bust.