Government Debt Soars Into Stratosphere
We had a global financial crisis in 2008 that was widely acknowledged to be the result of an unmitigated credit bubble egged on by loose central bank policy after the peak of the tech mania in 2000. Of course, central banks themselves did not acknowledge their responsibility. According to Ben Bernanke, it wasn't the suppression of administered interest rates that set off the credit bubble that collapsed so spectacularly in 2008. Instead it was a 'lack of regulation'. Right. We wonder if Mr. Bernanke would be interested in acquiring a certain bridge in Brooklyn?
So what did our vaunted policy makers decide to do to battle the effects of the expired credit bubble? Simple, they did what they always do: they replaced it with an even bigger one. How much bigger has recently been revealed by the quarterly BIS review.
As Bloomberg informs us: “Debt Exceeds $100 Trillion as Governments Binge”.
A few excerpts:
“The amount of debt globally has soared more than 40 percent to $100 trillion since the first signs of the financial crisis as governments borrowed to pull their economies out of recession and companies took advantage of record low interest rates.
The $30 trillion increase from $70 trillion between mid-2007 and mid-2013 compares with a $3.86 trillion decline in the value of equities to $53.8 trillion, according to the Bank for International Settlements and data compiled by Bloomberg. The jump in debt as measured by the Basel, Switzerland-based BIS in its quarterly review is almost twice the U.S. economy.
Borrowing has soared as central banks suppress benchmark interest rates to spur growth after the U.S. subprime mortgage market collapsed and Lehman Brothers Holdings Inc.’s bankruptcy sent the world into its worst financial crisis since the Great Depression. Yields on all types of bonds, from governments to corporates and mortgages, average about 2 percent, down from more than 4.8 percent in 2007, according to the Bank of America Merrill Lynch Global Broad Market Index.”
“Given the significant expansion in government spending in recent years, governments (including central, state and local governments) have been the largest debt issuers,” said Branimir Gruic, an analyst, and Andreas Schrimpf, an economist at the BIS. The organization is owned by central banks and hosts the Basel Committee on Banking Supervision, which sets global capital standards.
In the six-year period to mid-2007 global debt outstanding doubled from $35 trillion, according to data compiled by BIS.
Marketable U.S. government debt outstanding has soared to a record $12 trillion, from $4.5 trillion in 2007, according to U.S. Treasury data compiled by Bloomberg. Corporate bond sales globally surged during the period, with issuance totaling more than $21 trillion, Bloomberg data show.”
(emphasis added)
Just to get this straight: in the six years to 2007, global debt doubled from $35 trillion to $70 trillion. This debt expansion seemed to stop in its tracks when the bubble imploded in 2008. In the six years since then, another $30 trillion in debt has been added.
In other words, in a span of just 12 years, global outstanding debt went from $35 trillion to $100 trillion. Keep in mind though that this refers only to debt that exists in the form of securities. Given that the most recent debt expansion consists mainly of government debt expansion, we know for a fact that much of this debt is unproductive. The funds have simply been consumed.
Here is a chart from the BIS report illustrating the situation:
The global credit bubble. There are now about $100 trillion in debt securities outstanding worldwide – click to enlarge.
Admittedly, while this debtberg was built, money has lost a lot of its purchasing power, so it is not as large as it appears on a nominal basis. There may well be additional and possibly quite discontinuous losses in the exchange value of money at some point going forward, given the huge expansion in the money supply witnessed all over the world.
Where to From Here?
There is zero evidence that this debt growth has had any positive effect on economic growth – rather the opposite. The global debt binge can be said to have gone into overdrive from 1971 onward, when Nixon decided to 'temporarily' default on the US gold obligation according to the Bretton Woods agreement. Ever since, real economic growth in the developed nations has been much lower than in the post war decades preceding the default, when debt growth was far more subdued (because it was at least a little bit constrained by the gold exchange standard). Moreover, given that outstanding debt has roughly tripled over the past twelve years, we can conclude that such large debt growth is in fact extremely detrimental to the real economy's performance. Obviously, economic growth in developed nations has been completely underwhelming over this time span.
We should add here, the size of the debt as such is not the decisive point in this context. If the debt represented genuine savings and had been invested productively, its size should not worry us. However, we know that the impetus for this debt expansion has come from the artificial suppression of interest rates by central banks and we therefore know for a fact that much of this debt has not been employed productively. On the contrary, it has likely led to vast growth in capital malinvestment. Of course there is no question that there was e.g. enormous malinvestment in housing in numerous nations (and continues and/or has resumed in many more). We would argue though that there exist a number of less obvious instances of malinvestment that simply await their eventual unmasking.
Below is another chart from the BIS report, which shows the ratio of bank lending to total private sector funding in selected countries. We can infer from this chart that the total debtberg is a good size bigger than that represented by debt securities alone.
Bank lending in selected countries relative to total private sector debt funding – click to enlarge.
The BIS notes that this ratio depends on a number of factors, such as the legal tradition of the country concerned (and the protection it affords arms-length third party investors), the types of businesses doing the borrowing (whether or not they have assets that can easily be pledged as collateral) and the average size of businesses (smaller ones are more likely to borrow from banks).
Another interesting and not very surprising finding is that in 'normal' recessions (i.e. fairly mild downturns), access to credit remains more open in countries in which bank lending predominates, whereas in financial crises, the more market-based credit systems turn out to be superior. Here is an interesting excerpt:
“Banks and markets also behave differently when it comes to moderating business cycle fluctuations. In “normal” downturns, relationship banks, especially well capitalised ones, find it easier to keep lending than markets do.
Drawing on their long-term relationships with clients, banks are more inclined to offer credit during a downturn. By contrast, transaction lenders, who do not invest in information about the borrower, typically pull back during a recession.
However, a financial crisis can impair banks’ shock-absorbing capacity. When banks are under strain, they are less able to help their clients through difficult times.
In addition, during a financial crisis, banks may put off necessary balance sheet restructuring: instead, they may opt to roll over credit in an effort to postpone loss recognition (so-called zombie lending). This is something that capital market investors cannot afford to do. In a financial crisis, therefore, systems that are more market-oriented may speed up the necessary deleveraging, thereby paving the way for a sustainable recovery.”
(emphasis added)
Intuitively, this rings true, especially considering the recent experiences in the euro area. However, while euro area banks have been a bit lackadaisical in terms of deleveraging and strengthening their capital (this does not mean they have done nothing – they most certainly have), there are other signs that the liquidation of malinvested capital that has occurred in Europe was more intense than elsewhere. There has furthermore at least been a token attempt at braking government debt growth and instituting economic reform. However, as our readers know, we are of the opinion that it has been done the wrong way (by trying to squeeze the private sector while leaving the government sector largely untouched) and that the reforms have not even remotely gone far enough.
The question is though where this enormous expansion in largely unproductive debt will lead. As far as we can tell, the tendency is for this growth to continue, with only temporary slowdowns occurring from time to time. However, it is a mathematical certainty that debt growth cannot exceed real economic growth forever and ever, regardless of how low interest rates (and the associated debt service costs) are. This is not least so because real wealth generation is impeded by too low interest rates. Hence, the ability to service debt is perforce declining, even while the debtberg continues to increase. It is therefore not possible to 'outgrow' the debt accumulation. That is just not going to happen.
Also, Japan's example demonstrates the inescapable fact that even if interest rates remain at rock bottom levels, once a certain threshold is crossed, the sheer size of the debtberg becomes so daunting that debt service costs begin to inexorably rise anyway. Then one arrives in the Land of pure Ponzi finance, which is where Japan's government already finds itself today.
Conclusion:
In the long run, there are only two realistic ways in which this situation can be resolved: either there is a wave of defaults at some point (which would likely strain the ability of governments to protect depositors to the breaking point and would therefore have deflationary implications), or there is a 'flight forward', i.e., an attempt to 'solve' the debt problem via inflation – by a policy that deliberately aims at 'unanchoring' inflation expectations.
This is surely not something Western central banks would like to do, as they would risk their own destruction if the process 'gets away' from them. Sometimes though, we don't get what we want, but what we deserve. No-one knows when the strong demand for money and the continued improvement in the productivity of certain sectors of the economy that have kept the price effects of monetary inflation largely confined to financial markets and non-tradable services will give way to a declining demand for money. All we know for certain is that the supply of money has been vastly increased, but we cannot know a priori at what point it will affect the demand for money. There probably exists a threshold for this as well though, and once it is crossed, central banks may find that it is not so easy to put the genie back into the bottle. This is especially so as it seems likely that the pressure to provide easy money will continue on account of political contingencies. Besides, governments can always commandeer central banks by revoking or restricting their nominal independence.
All of this seems a distant prospect today, but all it will take is a big enough financial and economic emergency. Then a lot of things can change in a hurry.
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