Recent comments by the head of the Organization for Economic Co-operation and Development (OECD)'s review committee put the debt problem (about which we've spoken before in these pages) into stark perspective. The Telegraph reports:
"Debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a potent cause for mischief," he said.
"It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something," he told The Telegraph on the eve of the World Economic Forum in Davos.
. . .
The next task awaiting the global authorities is how to manage debt write-offs - and therefore a massive reordering of winners and losers in society - without setting off a political storm.
Mr White said Europe's creditors are likely to face some of the biggest haircuts. European banks have already admitted to $1 trillion of non-performing loans: they are heavily exposed to emerging markets and are almost certainly rolling over further bad debts that have never been disclosed.
The European banking system may have to be recapitalized on a scale yet unimagined, and new "bail-in" rules mean that any deposit holder above the guarantee of €100,000 will have to help pay for it.
The warnings have special resonance since Mr White was one of the very few voices in the central banking fraternity who stated loudly and clearly between 2005 and 2008 that Western finance was riding for a fall, and that the global economy was susceptible to a violent crisis.
. . .
Combined public and private debt has surged to all-time highs to 185pc of GDP in emerging markets and to 265pc of GDP in the OECD club, both up by 35 percentage points since the top of the last credit cycle in 2007.
. . .
Mr White said QE and easy money policies by the US Federal Reserve and its peers have had the effect of bringing spending forward from the future in what is known as "inter-temporal smoothing". It becomes a toxic addiction over time and ultimately loses traction. In the end, the future catches up with you. "By definition, this means you cannot spend the money tomorrow," he said.
. . .
Mr White said the Fed is now in a horrible quandary as it tries to extract itself from QE and right the ship again. "It is a debt trap. Things are so bad that there is no right answer. If they raise rates it'll be nasty. If they don't raise rates, it just makes matters worse," he said.
There's more at the link. Bold, underlined text is my emphasis.
I'd like to highlight two elements of Mr. White's comments. Both have direct and immediate implications for the USA as well as Europe.
- "... this will be uncomfortable for a lot of people who think they own assets that are worth something." It sure will! There are millions of people out there who believe that the value of their assets - particularly their homes - will in due course pay for a comfortable retirement when they 'downsize'; i.e. sell their no-longer-needed big, expensive homes, buy something smaller and cheaper, and bank the difference. However, their ability to sell their homes depends on the ability of potential buyers to get mortgage financing. Most people can't afford to pay cash for such big-ticket purchases. If there is no credit available . . . if no-one except the most well-heeled of consumers can get a loan . . . then no-one will be able to afford to buy the houses and other assets that these people must sell if they want to have any sort of worthwhile lifestyle in retirement. They'll end up asset-rich, but cash-poor . . . and you can't eat your McMansion, or use it to buy food. What's more, if you don't have enough income in retirement to continue to pay the mortgage each month, the bank will repossess your home anyway. That's 'uncomfortable' all right!
- "... new 'bail-in' rules mean that any deposit holder above the guarantee of €100,000 will have to help pay for it." This will also apply in the USA. Federal Reserve Vice Chairman Stanley Fischer said in 2014 that "the United States is preparing a proposal to require systemically important banks to issue bail-inable long-term debt that will enable insolvent banks to recapitalize themselves in resolution without calling on government funding". I'm sure you can work out the implications of that for yourselves. In case you can't, please refer to the following links, which explain it more fully:
Will Be Parted During the Next Banking Crisis
New Rules: Cyprus-style Bail-ins to Take Deposits and Pensions
Financial Meltdown and the Confiscation of Bank Savings
Fed Vice Chairman Warns:
Your Bank May Seize Your Money to Recapitalize Itself