Global debt and the Catch-22

Global debt and the Catch-22

by Bill Jamieson
article from Friday 6, February, 2015

IS THE great debt crisis slowly but steadily receding into the past? A survey from McKinsey Global Institute compels a total re-think of this comforting illusion. 

Since 2008 the rhetoric of Western governments and central banks has been of “austerity”, de-leveraging and earnest promises on debt and deficit reduction. Surely, after seven years of this, that frightening plunge into huge levels of debt would been reversed? But what do the figures show? 

The McKinsey study covering 47 major economies finds that global debt, far from having shrunk since 2007, has grown by $57 trillion (£37.4 trillion). It now stands at $199 trillion, equivalent to 286 per cent of global GDP. The single biggest contributor is government debt, up by $25 trillion over these seven years.

Such figures are so big as to be beyond remedy. On this perspective, Greece is not, as many have asserted, a unique, one-off case requiring singular remedy but an example, albeit in extremis, of a profound financial problem facing most of the advanced Western economies: how can countries protect economic growth while at the same time pursuing policies of debt and deficit reduction?  

Of those 47 major economies, only five - Israel, Egypt, Romania, Saudi Arabia and Argentina - have succeeded in reducing their debts. A further five have seen massive rises in indebtedness. The  debts of China have risen by 83 percentage points, Portugal's by 100 percentage points, Greece's by 103 percentage points, Singapore's by 129 percentage points and Ireland's by 172 percentage points.

On the UK McKinsey finds that debt has increased by 30 percentage points, to 252 per cent of GDP (this figure excluding financial sector or City debts). Government debt has jumped by 50 percentage points of GDP, while corporate and household debts have declined by 12 and 8 percentage points of GDP respectively.

In overall terms, only 12 big developed or developing countries have bigger debts than Britain's.

McKinsey is not alone in worrying that the sort of credit bubbles which popped up in 2007 are now emerging elsewhere. Making similar observations recently have been economists at the Bank for International Settlements, which acts as a think-tank for central banks. 

The dilemmas for governments are as acute as ever.  Here, too, the case of Greece has exposed not a country specific problem but a Catch-22 trap shared across many Western economies. 

Countries that embark on aggressive deficit and debt reduction may initially win the plaudits of central banks. But the more aggressive the de-leveraging, the greater the likelihood of a slowdown in economic growth. Government revenues stall or fall, while lower economic activity hits GDP and forces up the debt-to-GDP ratio: countries end up going backwards on their debt-reduction measures. 

This is at the heart of the crisis in Greece and why its new finance minister 

Yanis Varoufakis has proposed a swapping of existing government debt into growth-linked bonds where the interest rate is kept low until economic growth revives. 

But who would determine the level of growth that would trigger a rise in bond interest payments? How would that growth be measured, and by whom? 

It would also be politically high risk to go down this route, as other debt-laden countries in the Euro zone – Portugal, Italy, Spain and Ireland - would insist they were granted similar arrangements. 

The idea has already met with immediate objections from Germany. Such a proposal would not address the need for Greece to undertake structural reforms, tackling corruption and pushing ahead with state asset sell-offs. Debt moderation would let the country off the hook – and Germany is opposed to anything that smacks of central bank financing of imprudent governments.

Arguably more controversial than more sovereign debt restructurings is McKinsey’s suggestion of writing off bonds held by central banks. Japan’s debt to DP ratio, for example, could tumble from 234 per cent to 94 per cent. But even if high-lending central banks agreed, once down this route there is no end of debt that governments would push to have ”forgiven”

Meanwhile, what of the policy implications here? Not only do the Labour and Conservative parties seem to have resigned themselves to higher levels of debt for an indefinite period (the SNP enjoying the luxury of not needing to worry about debt and deficit at all) but the campaign for the May election is proceeding with spending promises as prominent as ever – more money for the NHS (of course), road improvements in marginal constituencies, more money for housing, sweeteners here,  ‘helpful extras’  there – all financed by continuing resort to deficit and debt. 

Slowly, invisibly, two profound changes have stolen across our economic and political landscape. First, big debt going to be with us for far longer than was ever envisaged when the coalition took office in 2010. And ultra-low interest rates, far from being a short-term emergency reaction to the prospect of deep recession, now appear to be a continuing requirement for economic growth to be sustained. Low interest rates are no longer a product of financial crisis but of a more permanent change in finance. Nothing has changed – and everything. The one grim consolation from the McKinsey survey is that we are not alone. 


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