More and more economists are warning about sovereign debt levels across the West. And it’s nice to hear they’ve finally caught on to recent market action…
The UK bond market has already crashed once.
The US treasury secretary has admitted she’s worrying about instability in the US Treasury market — supposedly home to the global financial system’s risk-free asset.
The eurozone bond market is more of a basket case, held together by a lady convicted of financial negligence for her services as the French finance minister, who now claims the inflation she caused ‘came from nowhere’.
The Greeks have a new Molotov cocktail wielding fiscal protestors in response.
Most interesting of all is Japan’s impossible debt load. Because that debacle is already unfolding in the currency markets.
I want to ask an especially awkward question — my favourite pastime. What’ll happen if governments actually try to solve the problem of too much debt by borrowing less?
You see, I think that’ll be a disaster too, because it’ll expose a very big lie at the heart of the financial system.
The problem with national debt is not so much that we have to pay it back. We don’t. Not these days. We can just borrow the money again from someone else. Or, often, from the same person. They call it ‘rolling over your debt’. You just borrow to repay your obligations.
The trouble with debt is not about the interest either. You can always borrow more to cover that too. And few governments prioritise other payments over interest.
The real issue is one of momentum. Of constantly needing to borrow more and more to create the illusion of economic growth.
You see, the presumption is that our economies will steadily grow, and this will, over time, make our debt load affordable. A trillion-dollar debt doesn’t matter if your economy will be measured in the quadrillions in the future. Even if it’s a long way away, today’s trillion needn’t matter.
This is the argument that keeps bond investors from having the sort of meltdown we saw in the UK.
But what if the last five decades of GDP growth in the West was built on borrowing more? The ability to add an incremental amount of debt, which looked like GDP, but was really just borrowing, fooled us into thinking that our economic growth was somehow inherent.
That presumption is now baked into the economic models, which say that our debt is sustainable because our economy can grow its way out.
Borrowing more and more might’ve looked like we were growing the economy, creating wealth in the form of home equity, or adding infrastructure for the future. And we were, in a sense.
But it has stopped working, which we’ll get back to in a moment. First, to grasp the point I’m making, try reversing these assumptions.
If we stop borrowing more and more to try and get our debt under control, we will also lose the GDP growth that ever-increasing debt created. The same GDP growth we relied upon to presume the debt was affordable at all, given enough time.
Of course, borrowing to create the illusion of GDP growth hasn’t worked very well. Debt-to-GDP ratios are now at problematic levels in a long list of countries. Which, by definition, means debt grew a lot faster than GDP. A rather good indicator that borrowing more to goose your GDP isn’t a very good economic model for long…
Historical analysis shows that nations that get into as much debt as Japan, the US, eurozone nations, and many more don’t get out of it in a very nice way. Analyst Lyn Alden put it best:
‘Over the past two centuries, 51 out of 52 countries that reached sovereign debt levels of 130% of GDP ended up “defaulting” [within 0 to 15 years], either through devaluation, inflation, restructuring, or outright nominal default.’
But the point I’m trying to make today is not that the debt is too high, but that the policy response to this situation of attempting to cut borrowing will make the economic growth upon which the debt rested evaporate too. And I suspect the lost growth will be a bigger problem than the interest bill or the debt itself because it calls into question the entire debt load, not short-term issues like interest or repayments.
Let me put it another way. The more we try to solve the problem of too much debt by bringing down borrowing, the more we’ll undermine GDP. And it was only GDP growth that made the debt plausible in the first place.
Throw in a bit of demographic decline and struggling productivity growth, and you begin to realise that not only is the debt unaffordable, but our economy will not make it to quadrillions in time to handle the debt we have now.
The challenge ahead of us is much bigger than it seems. Because the palatable solutions are much less plausible than we expect, and the unpalatable solutions are much more likely.
Until next time,
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Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend
