Debt - the elephant in the room that the world can't deal with

Das Capital: Since 2007, the total debt  of the big economies has increased, not decreased

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The reality the world won’t countenance is that debt levels are simply too great to be dealt with by conventional means. Since 2007, the total public and private debt of the big economies has increased, not decreased – by $57trn (£36.5trn), or 17 per cent of GDP. As at mid-2014, global debt was $199trn, or 286 per cent of the world’s GDP. In comparison, global debt was $142trn (269 per cent of GDP) in 2007 and $87trn (246 per cent) in 2000.

If unfunded entitlement obligations – such as pensions, healthcare and old-age care – are included, the level of indebtedness increases dramatically. A crude measure of sovereign net worth is the present value of tax revenues and government assets and investments, less debt and the present value of liabilities, such as pensions, healthcare, etc. As a percentage of GDP, this measure shows the US at minus 800 per cent, Germany minus 500 per cent, France minus 600 per cent and the UK minus 1,000 per cent. Italy is at minus 250 per cent, Spain minus 1,100 per cent, Ireland minus 1,400 per cent and Greece minus 1,600 per cent.

Even in emerging countries, where levels of borrowing were less extreme at the start of the financial crisis, debts have increased. In Asia and Latin America, bank credit has risen at double-digit rates in recent years. And in China, debt levels  have quadrupled.

Reduction of these liabilities is extremely difficult, perhaps impossible, in a world of no or low growth and low inflation. Despite the view of some analysts that this is a “beautiful deleveraging”, the reality is that the process has barely begun. It will have a big economic impact and take many years.

Traditional tools for dealing with high debts – austerity, growth, inflation, or default/ restructuring – are unavailable or unpalatable. Policymakers will rely on existing fiscal and especially monetary policies to avoid economic collapse.

A sequence of events may be repeated. A weak economy forces policymakers to implement a programme of expansionary fiscal measures and quantitative easing (QE). If the economy responds then increased economic activity and some of the side-effects of QE will encourage a withdrawal of stimulus. This will result in higher interest rates and a slowing economy, which will trigger expansionary initiatives, leading to another round of the same cycle. If the economy does not respond to expansionary policies, there will be pressure for additional stimulus.

Extension in the forms of QE can be expected, encompassing purchases of a wider range of assets, as in Japan. As desperation increases, more extreme policy measures can also be expected, reflecting what Edmund Burke called ”the utopianism of the professors”.

Central banks could pay “profits” from QE to governments, this profit being the difference between the yield on government bonds and the nominal cost of reserves created to buy them.

The fictional profit may be used to finance tax cuts. The US Government has considered cancelling US Treasury bonds held by the Federal Reserve to reduce debt. This ignores the loss to the Fed from the write-down of its holdings.

In a variation of the helicopter drops of money favoured by the former Fed chairman Ben Bernanke, one scheme advocates a “treasure hunt” where cash is buried and the population are urged to seek it out and spend it. Other proposals include finite time limits on currency, which would lose all value if not spent by the specified date.

It is possible the global economy will become trapped in QE for ever.

Since the bursting of its debt- inflated bubble in 1989-90, Japan has been mired in two decades of minimal growth and disinflation or deflation, despite repeated attempts to reflate the economy. Chronic budget deficits have resulted in government debt increasing to 240 per cent of GDP. Tax revenues are less than  50 per cent of budget outlays ,with 24 per cent of budget spending needed to service debt. Interest rates have been at or near zero for more than a decade. The central bank has used repeated bouts of QE to try to boost economic activity.

In early 2013, Japan, under the new Prime Minister Shinzo Abe, launched new initiatives combining fiscal expansion with a further, very large QE programme, exceeding anything attempted elsewhere. 

To date, the scheme has weakened the yen and boosted stock and property prices, without much effect on the real economy. Japan may provide a case study in the problems now confronting the world.

Satyajit Das is a former banker and author of ‘Extreme Money’ and ‘Traders, Guns & Money’