In a valedictory speech at the weekend of characteristically Latin American duration – a mind-numbing three hours – the Argentine president, Cristina Fernandez de Kirchner, claimed that her country was the only one in the world to have reduced its national debt over recent years.
I doubt she is right about being alone in this “achievement” – there must surely be others – but even if she is, I’m not sure that reduction in the national debt via the mechanism of default is anything to boast of. Only Kirchner could think this a matter of national pride.
Nonetheless, where Argentina treads, others will surely soon be following. The world is sinking under a sea of debt, private as well as public, and it is increasingly hard to see how this might end, except in some form of mass default.
Greece we already know about, but the coming much wider outbreak of debt repudiation will not be confined to sovereign nations. Last week, there was another foretaste of what’s to come in developments atAustria’s failed Hypo Alpe-Adria-Bank International. Taxpayers have had enough of paying for the country’s increasingly crisis-ridden banking sector, and have determined to bail in private creditors to the remnants of this financial road crash instead – to the tune of $8.5bn in the specific case of Hypo Alpe-Adria. Finally, creditors are being made to pay for the consequences of their own folly.
You might have thought that a financial crisis as serious as that of the past seven years would have ended the world economy’s addiction to debt once and for all. It has not. If anything, the position has grown even worse since the collapse of Lehman Brothers.
According to recent analysis by McKinsey Global Institute, global debt has increased to the tune of $57 trillion, or 17pc, since 2007, with little sign of a slowdown in sight. Much of this growth has been in emerging markets, which were comparatively unaffected by the financial crisis. Yet even in the developed West, private sector deleveraging has been limited and, in any case, more than outweighed by growing public indebtedness. The combined public sector debt of the G7 economies has grown by 40pc to around 120pc of GDP since the crisis began. There has been no overall deleveraging to speak of.
Where the West left off, Asia has taken up the pace, with a credit-induced real estate bubble that makes its pre-crisis Western counterpart look tame by comparison, much of it fuelled, as in Western economies, by growth in the shadow banking sector.
China’s total indebtedness has quadrupled since 2007 to $28 trillion, according to estimates by McKinsey. At 282pc of GDP, the debt burden is now bigger, relative to output, that the US.
Attempts to rein in this growth have so far proved problematic. The Chinese property market has slowed markedly, which in turn has knocked the stuffing out of the all-important construction sector and its feeder industries. Starved of its regular fix of debt, the Chinese economy seems as incapable of generating decent levels of growth as the mature economies of the West. The addiction to credit has gone global.
In any case, China now seems to have abandoned all attempts at tighter credit conditions. At the weekend, the People’s Bank of China (PBOC) again cut interest rates. It has also announced reduced reserve requirements in an attempt to further reinvigorate credit and prevent a hard landing. It may already be too late. The PBOC’s long-serving governor, Zhou Xiaochuan, will almost certainly soon be on his bike, in apparent punishment for the enforced policy reversal. Credit-fuelled growth, China’s high command seems to have concluded, is better than no growth at all.
Some economists claim not to be too concerned by the explosion in global credit. For them, it is merely the mirror image of rising output, asset prices and wealth. And up to a point, they are of course right. Economies engaged in across-the-board deleveraging find it extremely difficult to grow, as the depression-like conditions afflicting much of the eurozone again remind us. Decent growth requires abundant credit.
But you can also have too much of a good thing. Today’s global economy is plainly a case of it. The world has taken on more debt than it is ever likely to be able to repay, absent of implausibly high levels of output growth or contractionary fiscal consolidation. This, in turn, makes the global economy highly vulnerable to continued financial crisis and balance sheet recession. Too much capacity and too much debt make a poisonous combination.
Credit cycles tend to be much longer than ordinary business cycles, which may have something to do with the cautionary effect that financial crises have on banking practice. It can take as much as a generation for a bank entirely to forget the normal disciplines of prudential risk management, and go for broke. Unfortunately, they always do eventually, once all institutional memory of the last crisis has died off.
A paper by the Bank for International Settlement’s Claudio Borio a number of years ago traced the origins of the credit boom that preceded Lehman’s collapse to the early 1990s. Others might put it as far back as the 1980s. He was, however, talking only about the American credit cycle. Looked at from a global perspective, the real bust has yet to arrive.
Traditionally, governments have dealt with big debt overhangs through inflation and financial repression. In extremis debts are monetised via central bank money printing. It’s the legal, backdoor approach to default. Creditors get progressively squeezed by low interest rates and rising prices. Regrettably, it doesn’t work so well in a deflationary environment, and it doesn’t work at all when the credit is in a foreign currency, hence the apparently intractable debt standoff that afflicts the eurozone. Southern Europe has in effect been borrowing in a hard, northern European currency.
In the early 19th century, more than half of UK incarcerations were for unpaid debts. The debtors’ prisons were filled to bursting. Then came the realisation that excessive debt was as much a problem for the creditor as the debtor, proper bankruptcy laws were introduced, and mechanisms for burden sharing put in place. Creditors found it harder to demand their pound of flesh.
Yet when the problem is as big, and international, as it is today, such solutions become virtually impossible, and unilateral default much more likely. How might the present explosion in debt end? The only thing that can be said with certainty is “badly”.
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