Hamish McRae: Reports of the demise of easy money may be a generation or two premature

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The Independent Online

"A dog," according to Professor Hans-Werner Sinn, "does not hoard sausage. The German governments did not do so either. When there was money in the till, they spent it. And when there was not enough money, they went into debt."

"A dog," according to Professor Hans-Werner Sinn, "does not hoard sausage. The German governments did not do so either. When there was money in the till, they spent it. And when there was not enough money, they went into debt."

Professor Sinn is the chairman of the influential Ifo Institute for Economic Research in Munich and this was the introduction to his paper last month attacking German fiscal irresponsibility. The ratio of debt to GDP at the beginning of the 1970s was 20 per cent. By 1980 it had doubled to nearly 40 per cent and by 1998 had risen to 61 per cent. It will approach 68 per cent of GDP next year. At the moment, servicing this debt costs €65bn (£43bn) and Professor Sinn argues that were interest rates to normalise, the cost would be more than €100bn. Germany, he argues, is heading for a crisis and that crisis must be averted. German politicians used to say that "wealthy future generations" would help shoulder the bill. Professor Sinn points out that it is present day German taxpayers who are that wealthy future generation and they have to pay the bill. The German state must learn to live within its means.

It is worth starting with this Ifo paper, not because the German public debt situation is particularly difficult, but for two other reasons. First, Germany's plight is actually fairly typical of the situation of almost all large developed countries. Italy and Japan have fundamentally worse fiscal indebtedness than Germany and on some measures France and the US are both in trouble, too. And secondly, this is not just a fiscal issue: the world as a whole is plunging deeper into debt - as UK homebuyers very well know.

So the big question is not just whether or how Germany can cope with its debts were interest rates to return to normal levels, though that is absolutely crucial, for it could well be debt that scuppers the euro. It is also how borrowers everywhere - national, local, personal, corporate, whatever - will cope with normal interest rates as and when they come.

Start with the national situation. The first graph shows the sharp deterioration of the budget balance of Germany, along with those of other large developed nations. It also shows some projected modest improvements for this year and next. The interesting thing here, surely, is the similarity of the swing into deficit, not the quite small variations between the different nations.

The real difference is the growth performance and the implications that has for debt levels. Thus the US is projected to grow about 4.5 per cent this year. You don't need to be a whizz at maths to realise that if you grow by 4.5 per cent and have a budget deficit of 4.5 per cent your overall debt ratio stays the same. Germany is projected to grow only 1.5 per cent, so a deficit of about 4 per cent increases its debt ratio.

So growth matters hugely. So, too, does demography. The next set of bar charts show the proportion of the population aged over 60 in 2000 and in 2030. Why 2030? Well that is when a lot of the debt being issued now is coming up for repayment. As you can see, we all get older, but ageing is a much more serious problem for Germany, Italy and Japan than it is for the US, UK and France. Yet Germany, Italy and Japan already have greater indebtedness.

The final set of bars show public pensions as a percentage of GDP. Now pensions are not the only additional burden on the taxpayer from an older population. Health care will be a further cost and there will presumably have to be other forms of residential care too. Here the US and UK stand out as the only countries where the public pension payouts do not rise significantly. But that is because we both have poor public pension provision and that may be hard to sustain politically.

It is really quite hard to imagine what things might be like in Italy in 2030 with 20 per cent of GDP going in public pensions. It would mean that almost half of all the revenues of the state would have to be set aside to pay the pensions of former employees. Germany's position is almost as bad. (I would like, by the way, to know the future pension liabilities our present Chancellor has built up with his grand public hiring spree of the past three years.)

The big conclusion that you are drawn to is that unless there is urgent action, the governments of Italy and Germany will have to declare a moratorium on their debts. That is almost unthinkable. I suspect the implicit calculation that politicians make - aside from the knowledge that they will no longer be in office - is that inflation will somehow whittle away the real value of the debt. Bondholders will pay. Indeed, there is almost a built-in need for inflation in these public accounts. It is the only way the books can be made to balance.

That leads to the questions about other forms of indebtedness, including that of most readers of this newspaper. British homebuyers have about £1,000bnof outstanding debt. Should we worry? Well, against that debt is the value of UK housing stock, say £3,000bn, maybe a bit more. Homebuyers borrow against the security of an asset, whereas governments borrow against the security of a future flow of tax income. Were the housing debts spread evenly the debt levels look acceptable, but of course they are not. Just as some homeowners here in Britain would be vulnerable to a sharp rise in interest rates, so too would most national governments.

This leads to the question that I suspect is in the back of the minds of many UK homebuyers and should be at the front of the minds of the Bank of England's Monetary Policy Committee members as they consider today whether to increase interest rates by another click. It is this: are we moving into a world where debts are so large that the global economy could not stand a sharp increase in interest rates and there will have to be cheap money for a long time?

This is not a new question. In the 1920s and 1930s, UK national debt had exploded in size as a result of the cost of financing the First World War. So there was a tremendous effort to drive down interest rates. War Loan, originally issued at 5 per cent, was converted into 3.5 per cent stock. Easy money financed the building boom of the London suburbs and enabled the UK to make a swifter escape from the depression than any other large developed country.

I don't know the answer but it is easy to see that there will be a lot of political pressure everywhere to hold down interest rates for a generation or more. Yet at the same time there will be great pressure on people to save more to ease the retirement burden on governments. So how do you get people to save, if you deny them a decent return on their money? How, so to speak, do you get dogs to hoard sausage?

My guess - and it is no more - is that interest rates will indeed remain low and we will move towards various systems of compulsory savings. We won't be bribed to save more because there will not be enough money to bribe us. We will be forced to do it. And how we get some sort of positive return on money will be a tough problem indeed.

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