Hindustan Times
It’s all about debt
What ails the world economy? Please take a look at the Economist’s debt clock to understand what’s the problem. The world governments’ debt is $ 40 trillion and, as the clock ticks away before your eyes, is increasing rapidly.
The clock allows you to see what global government debt was in the recent past. A mere 10 years ago it was $ 18 trillion. And next year its going to be $ 46 trillion.
And that’s only government debt. Think of household debt, which is staggeringly high in most developed countries – even ones that are doing well in the present uncertainty, like Australia.
One visualizes a blue-green earth floating in a red ink universe.
That’s what this is all about, the heart of hearts. Debt. Economies like the US, much of Europe and Japan piled up huge amounts of debt during the 2000s. One consequence was a bubble in household mortgages which, when pricked, blew down the real estate and financial sectors. Then, to get their economies out of the resulting recession, governments piled on more debt hoping that, eventually, growth would follow and they would be able to balance the books later on.
So far that has seemed to be happening.
Working out so much debt from your economy is never easy. An interesting study by McKinsey on the lessons of past red ink massacres showed that it takes six to seven years for a country to carry out the necessary deleveraging. If a government reduces its debt to GDP ratio by about a quarter, things tend to start looking upwards.
There are broadly three ways a government can work debt out of its system.
One is austerity. Increase taxes, lower expenses. Basically keep the books in order and ban deficits.
Two is debt forgiveness. In other words, just write off loans that people, even governments, own. “Take a haircut” is a phrase being heard often these days regarding banks and other creditors.
Three is inflation (or its close cousin, currency devaluation). Inflation reduces the worth of money. So if you’re paying two per cent interest, but your currency is losing value at four per cent, the value of your debt will fall rapidly. The Weimar republic famously suffered from hyperinflation but the latter did wipe out Germany’s war debts.
You can see then what ails various governments as they grapple with debt.
The financial lobbies in most countries have proven too strong for option two to get much traction. Remember Chancellor Angela Merkel grumbling that creditors should take some losses for the worthless Greek bonds they hold, that it can’t all be on the shoulders of German taxpayers.
Option three is happening, but not through inflation. The US dollar is quietly falling. But this is not an option for the bits of the eurozone countries. The Greeces and Portugals of the eurozone can’t devalue their way out of their recession because they are tied to a monetary policy ultimately determined by iron horses like Germany.
So that leaves you austerity, belt-tightening, and all that.
Which is what most of these governments are trying to do. But this is politically the most difficult policy to enact. No one likes to see their government handouts and public services cut. The McKinsey study, which looked at 45 previous cases of deleveraging in recent history, said 32 of these cases went for cost-cutting.
In the US, this combined with an unusual degree of political polarization, curious debt ceiling legislation and somewhat wimpish leadership by the White House to generate the debt default crisis.
In Europe, it is triggering riots in the poorer countries. In the wealthier countries is helping feed anti-immigration sentiment. And there is euro-scepticism everywhere.
Japan has been such a long-standing mess that there isn’t any policy they haven’t tried, except perhaps inflation – which is tough with an ageing population and shrinking demand. Grey demography, as Daniel Gros explained in a recent analysis, is such a dampener on growth that government policy can do almost nothing.
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