Wednesday, February 4, 2015

The debt mountain becomes ever more unstable

In recent weeks we've seen how the new Greek government's determination to dig its way out from underneath a mountain of debt, by fair means and/or foul, has sent shockwaves through the European financial system.  It looks set fair to do the same to the economy of the entire world.  This is despite the fact that Greece's Gross Domestic Product (GDP) is less than one-half of one per cent of the Gross World Product.

In one sense, Greece's debt problems are a microcosm of those facing the entire globe.  According to the Financial Times:

The world is awash with more debt than before the global financial crisis erupted in 2007, with China’s debt relative to its economic size now exceeding US levels, according to a report.

Global debt has increased by $57tn since 2007 to almost $200tn — far outpacing economic growth, calculates McKinsey & Co, the consultancy. As a share of gross domestic product, debt has risen from 270 per cent to 286 per cent.

. . .

The report is likely to fuel debates among economists about what is an appropriate level of debt in an economy. McKinsey argues much of the expansion in developing countries has reflected the healthy development of financial markets, but in advanced economies high debt could constrain growth and create fresh financial vulnerabilities.

High debt levels could make it harder for central banks to “normalise” monetary policy without disrupting the real economy — the US Federal Reserve plans to raise interest rates this year for the first time since 2006. “High debt levels are an outward sign of structural problems,” says Charles Dumas, chairman of Lombard Street Research.

. . .

McKinsey’s conclusions echo warnings by the Bank for International Settlements in Basel, which acts as a think-tank for central bankers. BIS research had found that “when private sector credit-to-GDP ratios are significantly above their long-term trend, banking strains are likely to follow within three years”, Jaime Caruana, BIS general manager, said in a speech late last year.

There's more at the link.  Highly recommended reading.

To put those numbers in perspective, the Gross World Product (i.e. the sum of the Gross National Products of every nation on Earth) was estimated to be 'approximately US$87.25 trillion in terms of purchasing power parity, and around US$74.31 trillion in nominal terms'.  Averaging those two figures for the sake of simplicity gives us $80.78 trillion - but if the Financial Times' figure for world indebtedness is correct, that means there's almost $2.50 in debt for every dollar of world income.

Never before in the history of the world have numbers like these been bandied about.  Nobody can envision what $200 trillion looks like - it's a meaningless number;  yet that's the total amount of debt in the world economy right now.  It's literally unthinkable.  The interest on that debt is already crippling many economies, and it'll do the same to the USA in the not too distant future, as the Wall Street Journal pointed out yesterday.

Sooner or later, something's got to give.  The solution can only be found in a limited number of ways.

  1. Pay back the debt.  With so much owed in comparison to the size of the world economy, that's effectively a non-starter.
  2. Deliberately encourage inflation, so that 'expensive' old debt can be repaid with 'cheap' inflated dollars or other currencies.  This works, but at ruinous cost to national economies, and has disastrous effects on those relying on fixed incomes or pensions, which seldom (if ever) keep pace with inflation.
  3. Simply keep on rolling over the debt in the hope that the problem will be ignored until the current crop of politicians are all safely retired (on their carefully inflation-proofed official pensions) and can leave someone else to clean up their mess.

At the moment, it looks as if governments all over the world have chosen option (3).  That bodes very ill indeed for our economic future, because the interest payments on that debt will keep on getting bigger and bigger until they consume the lion's share of national budgets - and our taxes.  Meanwhile, governments will try all sorts of tricks to get their hands on more money, even if it means taxing funds that were previously exempt (witness President Obama's proposals to tax college savings funds (since abandoned) and the accumulated capital of US firms in other tax jurisdictions).

I, for one, will do everything in my power to reduce my tax liabilities by legal means, so that I can keep as much as possible of my money for my own needs.  If that means relocating or restructuring my finances, so be it.  Many people are already doing that to a greater or lesser extent by working on a cash or barter basis.  The taxman never gets to hear about such income.  I predict that's going to become a normal way of life for many people before too long.



RM said...

Over 40 years ago, I heard a man say that the then current level of debt, and its ever increasing amount, was not forever sustainable. His answer, for the US, was to repudiate the debt. With all the national and international issues such a move would have brought about, it simply wasn't going to happen. Now, it is even less likely to occur. One thing is certain, I believe. If this is not dealt with soon and in a definitive way, we will be forced to deal with it later when we have even fewer options. The old farmers were right. Eventually, your chickens do come home to roost.

Bob said...

Whenever I read about this huge mountain of debt, i ask myself:

Who do we owe all this to?

Who had that much money to lend in the first place?

How was all that money first created, and who created it?

That 200 trillion of global debt... I'd believe none of it was ever real money in the first place... just numbers and zeroes on paper.

Nobody ever seems to address these questions.

Why don't we find out who engineered this calamity and send them up the river? That, or just shoot the bastards.

c w swanson said...

This kind of thing depresses me, because it's so true. There simply no way that this can be paid back, and most of it, I'd wager, is owed to various entities that manage retirement money for Americans.

The only possible solution is to aggressively change the laws to encourage business, and thereby tax revenue, while at the same time halving the size of the government. Redefinition of entitlements consistent with our ability to pay is also a must.

Since there is no political will for that, we will likely have to ride this bus into the concrete abutment.

Bob, we should make the list of names now, and publicly promise revenge against them and their progeny when the disaster happens. That might just discourage current politicians from even more fiscal insanity.

Rolf said...

The low-pain solution: have the Fed "buy" the debt, or at least a huge part of it, then write it off. Essentially you monetize a large chunk of it. Then you pay market rates on the remaining (much smaller) debt. Far from perfect, but the best idea that has any possible chance of happening I've heard yet.