I must begin with a mandatory disclosure – I am an unapologetical financial novice. I struggle to the point of exasperation in understanding the gobbledygook of financial whizkids. But I care two hoots about their much-fangled jargon, which I suspect is to keep the greenhorns perpetually out of bounds from their elitist club. I also believe that the geniuses of finance and economy are trapped in their own web of complexities and byzantine labyrinths, a predicament brought upon by their incessant desire to make simple things ever more intricate. What else would explain the global debt crisis, which so ominously threatens to wreak havoc not only on the world’s banking system, stock markets, currency markets and international trade, but also on entire nations and their helpless populace ?
I write this piece on such an inherently difficult subject as “World Debt”, though being a self-confessed babe-in-the-woods in the world of finance, to provide a layman’s perspective. Since the collapse of the Lehman Brothers in 2008, I have only felt my jaw dropping lower as most of the world’s greatest economies careen perilously close to imminent disaster. I must try and make sense of this perfect storm as much as I possibly can.
Is it all that bad ?
Apart from the need of money to run the government machinery, a nation for its own progress must first infuse capital into its economic engines, and for that it must borrow. That is good debt – money put to use instead of lying idle. If the nation is productive enough, the money will come back (in the form of more taxes and increased profits from public enterprises) and the debts can be repaid. Governments can keep borrowing as long as the economy keeps growing, so a widely used statistic to measure a country’s financial health is the debt-to-GDP ratio.
Is there a limit to which a Government can accumulate debt, before it reaches a tipping point ? Apparently not, at least not in theory, and in reality we have seen that a certain country called Iceland froze in a monetary manner as it ratcheted up its debt to a whopping 1,200% of its GDP !
But just as there is a ceiling to which an individual or a corporate can obtain credit, a sovereign state should logically have a limit beyond which it treads into a surefire quagmire. I am afraid there are no hard-and-fast rules for such upper limits, but economists point out that a debt level of 80% to 100% of GDP would be living life on an edge.
Okay, so now we have a benchmark. Bravo. Let’s look at this yardstick to assess the financial state of some of the world’s rich nations which have been in the news lately for all the wrong reasons.
In 2010, Japan had a combined household, corporate and government debt level of 456% of GDP, the highest in the developed world. Portugal came second with 363%, followed by UK at 322%, Greece at 273% and US at 268%. If the debt-to-GDP ratio was a thermometer with a maximum scale of 100%, the mercury would have burst out of the glass tube long time ago and the patients would have been buried incognito after finding no claimants for their bodies. But this has not happened. Why ? Beats me. Maybe there are lies, damned lies and statistics. All I know is the combined debt of the developed nations rose from 160% of GDP 30 years ago to 310% in 2010 - three times its acceptable level ! That’s bad debt !
If we look at just the public debt, that is the money that the Government owes its own citizens, then the numbers are less scary. Japan has a public debt of 196% of GDP (still very precarious), Portugal has 82%, UK has 74%, Greece has 127% and US has 61%.
Whatever numbers you take, depending on your personal choice or convenience, the point is there is a worldwide propensity to gobble up more and more debt as long as there is somebody lending. I have no doubt in my mind that if we exhaust ourselves of lenders on this earth, we will find aliens in outer space to part with their riches.
What went wrong ?
Or, to put the question in a more fashionable way : “Who moved my cheese ?” Life was hunky-dory for as long as we can remember, with a few hiccups here and there, and all these mountains of debt, just like Rome, weren’t built in a day. If we were all living with life on credit so peacefully, what has caused this sudden brouhaha about owing money to someone at some point in time ?
Actually, the answer to this is relatively simple, especially with the hindsight of the US-led mortgage sub-prime crisis of 2008. Allow me to explain.
The Western world had for several decades been experiencing steady growth with low levels of unemployment and inflation. With buoyant economies and increasing asset prices, the debtors could easily keep making their interest payments, and creditors were sure of their return of capital. So everyone was happy – it paid to borrow, it paid to lend. Thus began a “debt supercycle”, where optimism led to euphoria, and individuals to corporates to countries kept up the borrowing binge, using debt as the instant solution to chase faster ‘growth’. What a wonderful world.
If only the wonderful world had lasted. The problem with debt is the need to repay it. Take the US mortgage sub-prime crisis as an example, which is still fresh in our minds. As long as asset prices were rising, the creditors kept their faith. The spoilsport came in the form of falling prices, aptly called ‘deflation’, which created a downward spiral wherein assets were sold off to repay debts as creditors suddenly turned jittery, triggering further price falls and further sales. What accelerated the contagion were the supposedly ‘no-risk’, but ultimately hugely risky, new fancy-toys conjured up by the wizards of Money Street – Collateralized Debt Obligations. (To know more about this abstruse term, just google it, or search in Wikipedia). The ensuing liquidity crisis in the banking system throughout the world was so severe that the authorities feared the cash machines would stop working !
The dream run in which debt was being lapped up as if there was no tomorrow, ended in a cold-sweat real nightmare only when the lender, suddenly fearing the loss of his capital, demanded his dues back in full. The chasm of mistrust grew deep and fast, forcing the unprecedented largesse of the bank bail-outs. And the story is not over yet.
What’s the solution ?
The problem of world debt, just as the issue of corruption, is easy to describe, but the solution is far from simple. The whole concept of a nation at the brink of a ‘debt default’ is inconceivable to many, though it is not different in nature from an individual or a company going bankrupt.
The unpretentious solution to debt is not to allow it to spiral out of control in the first place – prevention is better than cure. Your grandmother and grandfather were right when they said “Learn to live within your means.” Whichever diet program you follow, there is only one formula for losing weight : calories out should be more than calories in. To live a healthy financial life, earnings should be greater than expenses. Period.
But we are talking about curing the excesses already committed over several decades by governments, who are now facing payback time. Rising government debt is a Ponzi scheme that requires an ever-growing population to assume the burden—unless some deus ex machina (god out of the machine), such as a technological breakthrough, can boost growth.
The choices for avoiding a debt default are as stark as they are bitter. Governments would have to launch severe austerity programs, decide how quickly to cut their deficits and simultaneously bolster growth, actions which are seemingly at cross purposes to each other. This would necessarily punish their populations, so used to a certain level of lifestyle, albeit by borrowing from the future. Clearly, a society built on consumption will have to pay more attention to saving. An attitudinal change would have to be essential to change the notion that using borrowed money to buy assets is the smart road to riches. All these are unpalatable options, and therefore governments are trying all sorts of tricks to prolong the solution – from raising debt ceilings, to restructuring loans, to bail outs and so forth.
Each government will have to take the bull by the horns find its own way to reduce its burden. There can obviously be no straight-jacketed solutions, as each country has its own peculiar set of issues. But just as sick companies can turn around, and individuals can come of their bankruptcies, nations can also find their way out of their debt traps. It’s a question of strong political will and collective resolve of its responsible citizens.
I write this piece on such an inherently difficult subject as “World Debt”, though being a self-confessed babe-in-the-woods in the world of finance, to provide a layman’s perspective. Since the collapse of the Lehman Brothers in 2008, I have only felt my jaw dropping lower as most of the world’s greatest economies careen perilously close to imminent disaster. I must try and make sense of this perfect storm as much as I possibly can.
Is it all that bad ?
Apart from the need of money to run the government machinery, a nation for its own progress must first infuse capital into its economic engines, and for that it must borrow. That is good debt – money put to use instead of lying idle. If the nation is productive enough, the money will come back (in the form of more taxes and increased profits from public enterprises) and the debts can be repaid. Governments can keep borrowing as long as the economy keeps growing, so a widely used statistic to measure a country’s financial health is the debt-to-GDP ratio.
Is there a limit to which a Government can accumulate debt, before it reaches a tipping point ? Apparently not, at least not in theory, and in reality we have seen that a certain country called Iceland froze in a monetary manner as it ratcheted up its debt to a whopping 1,200% of its GDP !
But just as there is a ceiling to which an individual or a corporate can obtain credit, a sovereign state should logically have a limit beyond which it treads into a surefire quagmire. I am afraid there are no hard-and-fast rules for such upper limits, but economists point out that a debt level of 80% to 100% of GDP would be living life on an edge.
Okay, so now we have a benchmark. Bravo. Let’s look at this yardstick to assess the financial state of some of the world’s rich nations which have been in the news lately for all the wrong reasons.
In 2010, Japan had a combined household, corporate and government debt level of 456% of GDP, the highest in the developed world. Portugal came second with 363%, followed by UK at 322%, Greece at 273% and US at 268%. If the debt-to-GDP ratio was a thermometer with a maximum scale of 100%, the mercury would have burst out of the glass tube long time ago and the patients would have been buried incognito after finding no claimants for their bodies. But this has not happened. Why ? Beats me. Maybe there are lies, damned lies and statistics. All I know is the combined debt of the developed nations rose from 160% of GDP 30 years ago to 310% in 2010 - three times its acceptable level ! That’s bad debt !
If we look at just the public debt, that is the money that the Government owes its own citizens, then the numbers are less scary. Japan has a public debt of 196% of GDP (still very precarious), Portugal has 82%, UK has 74%, Greece has 127% and US has 61%.
Whatever numbers you take, depending on your personal choice or convenience, the point is there is a worldwide propensity to gobble up more and more debt as long as there is somebody lending. I have no doubt in my mind that if we exhaust ourselves of lenders on this earth, we will find aliens in outer space to part with their riches.
What went wrong ?
Or, to put the question in a more fashionable way : “Who moved my cheese ?” Life was hunky-dory for as long as we can remember, with a few hiccups here and there, and all these mountains of debt, just like Rome, weren’t built in a day. If we were all living with life on credit so peacefully, what has caused this sudden brouhaha about owing money to someone at some point in time ?
Actually, the answer to this is relatively simple, especially with the hindsight of the US-led mortgage sub-prime crisis of 2008. Allow me to explain.
The Western world had for several decades been experiencing steady growth with low levels of unemployment and inflation. With buoyant economies and increasing asset prices, the debtors could easily keep making their interest payments, and creditors were sure of their return of capital. So everyone was happy – it paid to borrow, it paid to lend. Thus began a “debt supercycle”, where optimism led to euphoria, and individuals to corporates to countries kept up the borrowing binge, using debt as the instant solution to chase faster ‘growth’. What a wonderful world.
If only the wonderful world had lasted. The problem with debt is the need to repay it. Take the US mortgage sub-prime crisis as an example, which is still fresh in our minds. As long as asset prices were rising, the creditors kept their faith. The spoilsport came in the form of falling prices, aptly called ‘deflation’, which created a downward spiral wherein assets were sold off to repay debts as creditors suddenly turned jittery, triggering further price falls and further sales. What accelerated the contagion were the supposedly ‘no-risk’, but ultimately hugely risky, new fancy-toys conjured up by the wizards of Money Street – Collateralized Debt Obligations. (To know more about this abstruse term, just google it, or search in Wikipedia). The ensuing liquidity crisis in the banking system throughout the world was so severe that the authorities feared the cash machines would stop working !
The dream run in which debt was being lapped up as if there was no tomorrow, ended in a cold-sweat real nightmare only when the lender, suddenly fearing the loss of his capital, demanded his dues back in full. The chasm of mistrust grew deep and fast, forcing the unprecedented largesse of the bank bail-outs. And the story is not over yet.
What’s the solution ?
The problem of world debt, just as the issue of corruption, is easy to describe, but the solution is far from simple. The whole concept of a nation at the brink of a ‘debt default’ is inconceivable to many, though it is not different in nature from an individual or a company going bankrupt.
The unpretentious solution to debt is not to allow it to spiral out of control in the first place – prevention is better than cure. Your grandmother and grandfather were right when they said “Learn to live within your means.” Whichever diet program you follow, there is only one formula for losing weight : calories out should be more than calories in. To live a healthy financial life, earnings should be greater than expenses. Period.
But we are talking about curing the excesses already committed over several decades by governments, who are now facing payback time. Rising government debt is a Ponzi scheme that requires an ever-growing population to assume the burden—unless some deus ex machina (god out of the machine), such as a technological breakthrough, can boost growth.
The choices for avoiding a debt default are as stark as they are bitter. Governments would have to launch severe austerity programs, decide how quickly to cut their deficits and simultaneously bolster growth, actions which are seemingly at cross purposes to each other. This would necessarily punish their populations, so used to a certain level of lifestyle, albeit by borrowing from the future. Clearly, a society built on consumption will have to pay more attention to saving. An attitudinal change would have to be essential to change the notion that using borrowed money to buy assets is the smart road to riches. All these are unpalatable options, and therefore governments are trying all sorts of tricks to prolong the solution – from raising debt ceilings, to restructuring loans, to bail outs and so forth.
Each government will have to take the bull by the horns find its own way to reduce its burden. There can obviously be no straight-jacketed solutions, as each country has its own peculiar set of issues. But just as sick companies can turn around, and individuals can come of their bankruptcies, nations can also find their way out of their debt traps. It’s a question of strong political will and collective resolve of its responsible citizens.
Till then, these nations can continue to live in their world of delusion.
Endpiece : Rather go to bed without dinner than to rise in debt. - Benjamin Franklin
Endpiece : Rather go to bed without dinner than to rise in debt. - Benjamin Franklin
References
1. The global debt clock – The Economist (website)
2. Repent at leisure – The Economist, June 24th, 2010
3. Equitymaster’s 5-minute wrapup – September 5, 2011
