Hamish McRae: When in enormous debt, do as the Greeks must do: tighten your belt

Economic Life: One troubling aspect of the past boom was the dependence on financial services to drive growth
Click to follow
The Independent Online

Look on the bright side: at least the British taxpayer does not have to come to the rescue of Greece. But before you rejoice overly in the news that the support for the country will come from other eurozone members, which essentially means the two strongest, Germany and France, note that the sort of fiscal adjustment that Greece will have to make is very similar to that facing the UK. Besides, who is going to help us when we hit the wall?

To be clear: it is much better that the eurozone should support Greece in its efforts to instil fiscal discipline and avoid a default. There is a real danger of a progressive collapse of confidence in sovereign debt, taking in the weaker eurozone members in the first instance but extending much more widely. No country, right up to and including the US, can consider itself immune from the fear that it might not be able to meet its debts.

The possibility of a fear of default spreading to Spain, Portugal and Italy has been widely trailed. Here in the UK we are vulnerable to a loss of confidence should the next government fail to get the deficit under control.

But of course the greatest threat to global economic stability would be a loss of confidence in the US and the dollar. In the short-term the dollar has strengthened as a result of fears about other currencies. The reality is that US indebtedness is a threat to us all.

The central issue that will dog the recovery will be the extent to which the world recovers from its excessive burden of debt and the way it does so. The horrid word to describe this process is "deleveraging". Giving some kind of guarantee to a country to help it cope with a debt crisis, which is what seems to be happening in the case of Greece, buys time. But it only buys time; it does not fix the problem, for the debt still has to be serviced and eventually repaid.

This is an immediate problem for the eurozone, for though it is quite easy to cover Greece's debts, there has to be some kind of political settlement as to what is to be done. In the context of Europe this will not be easy, for obvious reasons. Greek resentment at being bailed out will increase as the terms emerge. People tend to blame the bankers when they cannot pay back their debts, and in effect the rest of the eurozone is becoming banker to Greece.

But I think it is more helpful to see Greece in a global context, as the canary in the mine warning of toxic fumes about to sweep over all of us. Just about every country has to deleverage. How will that be done?

A couple of weeks ago McKinsey, the management consultancy, produced a really fine report called Debt and deleveraging: The global credit bubble and its economic consequences, which sought first to quantify the problem and then to look at the ways in which it might play out.

If we look at total debt in different countries as a proportion of GDP; that is, government debt, commercial debt and personal debt all added together, then we vie with Japan to top the pile.

What is remarkable is how quickly we have allowed things to whizz out of control. Back in the middle 1990s UK indebtedness was within the same broad band as most other developed countries, a little high but not outstandingly so. From then onwards we have plunged deeper and deeper into debt.

It would be easy to blame the present government for this situation because it has happened on its watch and it must bear some responsibility. After all, it sought to take the credit for the long expansion that this borrowing financed. But we should not neglect the fact that the country as a whole has over-borrowed, not just the Government.

Besides, with one significant exception, the lines all go up. In the case of Spain, probably the next in line for a eurozone rescue, the pace of increase is similar to the UK. France and the US, very different countries in terms of their self-perception, have very similar overall borrowing levels. Note too that indebtedness rose in most cases in good years and bad. It rose in the early 1990s recession, during the 1990s boom, through the dot-com bust and then through the most recent boom and bust too.

The interesting exception is Canada, for until this crisis struck a year or so ago, it has actually reduced its borrowing levels, so they were lower in 2008 than they were in 1992.

So how do you get debts down? McKinsey has identified four main ways of deleveraging, and they are shown, together with some examples, on the right-hand side.

The first and actually most common is "belt-tightening". This is when countries expand debts more slowly than the growth of the economy. Canada during the 1990s would be an example of that. Four other examples are noted on the right.

The next most common thing to do is to inflate your way out trouble, by allowing inflation to reduce the real value of the debts. That is in effect stealing from savers. Note that two of the weak eurozone countries, Spain and Italy, followed this course of action. But now that they are members of the eurozone, they cannot do that trick again. Adopting the euro enabled then to get their interest rates down, high interest rates being one consequence of investor distrust generated by that high inflation in the 1970s. But while they remain in the eurozone they cannot devalue their currencies as they did before.

Then there is default. You just don't pay back the debts. We think of that as a Latin American practice, but that is what happened in the US during the early 1930s, when many of its banks went bust. It is a policy that carries huge costs – in the case of the US, leading to the Great Depression – but it can and does happen.

Finally there is what most people would consider the best way of coping with a debt burden, which is to grow your way out of it. Rearmament enabled the US to do that, but the more encouraging examples are Nigeria and Egypt, both of which have dug their way out thanks to rapid growth – in the case of Nigeria helped by the oil boom.

What does this mean for the rest of us? In practice the only practicable options will be a combination of the first and the last, with more emphasis on the belt-tightening because it is hard to see quite where the rapid growth might come from. Indeed one of the troubling aspects of the past boom, certainly as far as the UK has been concerned, has been the dependence on financial services to drive growth. Even those of us who are reasonably optimistic about the medium-term future of the industry would have to acknowledge that it will not be the engine of growth over the next decade that it has been over the past one. So the forthcoming "belt-tightening" in Greece will be the model for us all.

h.mcrae@independent.co.uk

Comments