“Neither a lender nor a borrower be”. So Polonius tells his son Laertes in Shakespeare’s Hamlet. Wise advice. But it appears to have been utterly forgotten by governments. The world has been embarked on a massive borrowing spree, borrowing to survive. Governments have argued, perhaps with some justification, that it has been important to get through the Covid-19 crisis first, and sort out the bill later.
It’s a big bill. Global debt is now $296 trillion (£215 trillion) according to the Global Debt Monitor, which monitors 61 countries, of the Institute of International Finance (IIF). That’s $36 trillion (£26 trillion) higher than prior to the Covid-19 pandemic.
Does this matter? Mrs Thatcher, the tough-minded British Prime Minister and staunch opponent of debt, would certainly have thought so. She said in 1980 “it is neither moral nor responsible for a government to spend beyond the nation’s means”. Thatcher thought it was not good policy and also unethical to run up debts. Maybe that was simply a reflection of her upbringing as the daughter of a frugal grocer. No borrowing to survive for her – just tighten your belt.
Modern Monetary Theorists (MMters), who seem to be in the saddle these days, pooh-pooh Thatcher’s parsimoniousness. For them, sovereign countries such as the US, who control their own money supply, don’t have to rely on taxes or borrowing for spending because they can print as much money as they want or need. They can’t ever default on their debts or go bankrupt. Borrow as much as you like – or create money. Or so the argument goes.
This debate is vitally important right now. The global economy needs to return to growth, but there are many signs that this growth is elusive. Could this drowning in debt be a drag on economic growth?
The risk to growth
How does one know whether growth is at risk from high debt? In answering this most international financial institutions refer to the ratio between debt and gross domestic product or GDP.
GDP is the total monetary value of all the finished goods and services produced by a country in a given time, typically a year. As a measure of how well an economy is doing, GDP has its critics (it doesn’t take account of the informal economy, nor of domestic work in the home for instance) but it’s about the most comprehensive measure we have.
According to the IIF, debt as a share of GDP – the debt/GDP ratio – fell in the second quarter of this year, from its (record) high of 362% in the first three months of 2021 to 353%. That’s still a staggering figure. The average debt/GDP ratio for emerging market economies in the late 1980s and early 1990s was around 100%; in 2010 advanced economies had a debt/GDP ratio just above 90%.
Some economists argue that high levels of debt, this borrowing to survive, have a big negative effect on GDP growth: “On average across individual countries, debt/GDP levels above 90% are associated with an average annual growth rate 1.2% lower than in periods with debt below 90% percent debt”.
There is a tremendous irony here. Governments have pumped trillions into the monetary system to support jobs and businesses. Yet all this may have done is to push up global debt to levels that drastically slow economic growth.
It also seems to imply there is a ‘safe’ debt/GDP ratio but there isn’t. There is only a ‘safe’ ratio between a country’s debt and its ability to pay off that debt. If a country has strong growth, stable expenditures, a coherent tax system, and solid expectations of future budget surpluses, it can borrow heavily. Are there any countries which can point to those today?
In 2008, the global debt/GDP ratio was 280%. Since that year’s Great Financial Crisis – which fundamentally was brought about by crazy lending and borrowing levels – global borrowing has risen by more than a third. It’s an astonishing example of amnesia.
In the US, the national debt is now rapidly approaching $29 trillion (£21 trillion), around 125% of GDP. That debt load would be much higher if off-balance sheet commitments such as Social Security (pensions) and Medicare (health provisions) were counted. These are future expenditures the government is obliged to pay by law. If the present value of these off-balance sheet items for the next 75 years were included the debt would be more like $147 trillion (£107 trillion) according to the non-partisan group Truth in Accounting. In the UK, the government debt is more than £2.2 trillion ($3 trillion).
These debts will never be repaid. That doesn’t matter, say MMTers: a government that can issue its own currency can simply create the money it needs. Provided there’s no inflation, a government deficit doesn’t matter. There is no need to worry about the government defaulting on its debt; the government can just create new money, new bonds, to pay its creditors or roll over the debt.
Life’s a gas
Voters and investors tend to be distracted by short-term issues happening in their own backyards. We have become accustomed to rock-bottom interest rates; the cost of borrowing money has rarely been cheaper. Deflation, not inflation, has long been uppermost in the minds of central bankers in the US, UK and the European Union.
But inflation is returning. Wholesale gas prices in the UK have risen by more than 400% since a year ago and in other European countries energy bills are also soaring. Natural gas prices in the US have doubled in the past six months. Such is the inter-connectedness of our economies today that the higher gas costs in the UK have forced two large fertiliser plants to shut down, which has caused supply shortages of the by-product CO2, which in turn is causing problems in food supply – CO2 is used to stun animals before slaughter and to keep some packaged foods fresh. Poultry prices will be going up, too.
Maybe it’s all a matter of confidence. So long as investors feel confident that countries can continue servicing their debts, they will continue buying the bonds attached to rolled-over debt. They will however run out of patience once it becomes apparent that higher inflation levels can only be stamped out by a rise in interest rates. Governments don’t want to raise interest rates as that would push up the cost of servicing their debt. Higher interest rates would also make credit more expensive.
But higher inflation also causes the value of currencies to decline; inflation lets debtors pay lenders back with money that is worth less than when they originally borrowed it. Inflation is a mixed blessing – good for borrowers and owners of physical assets, bad for those on fixed incomes, lenders, those who hold fiat money.
Sovereign debt defaults are not something one expects to see in such stable countries as the US or the UK. But they might happen to poorer, massively over-leveraged countries. In the private sector there are already growing risks from defaults, and risks of a global ripple effect are rising.
In China, the massive conglomerate Evergrande, which borrowed more than $300 billion (£217 billion) and which owes money to some 171 domestic banks and 121 other financial firms, is in deep trouble; it can’t pay its debts. Evergrande’s debt swamp has already knocked stock markets around the world. The authorities may choose to punish Evergrande and let it collapse; but the fall-out from that might be felt not just in China’s economy but Wall Street too. Could Evergrande trigger a series of defaults and another financial crisis, similar to 2008?
And what of gold amid all this? Generally the price of gold has an inverted relationship with the Dollar; if the Dollar loses value, then the gold price tends to rise. Higher US interest rates would strengthen the Dollar. For much of this year the US Federal Reserve has been flirting with an end to its quantitative easing policies; as inflation starts to stick around it looks like interest rates will need to rise sooner rather than later. Understandably gold has spent much of this year, like the rest of us, nervously watching the Fed, the Dollar.
At Glint, we try to achieve a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power. We strongly believe that gold is the fairest and most reliable currency on the planet, but it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.
The dominos have not yet started tumbling, but warning signs are arriving thick and fast; rocketing gas prices, Evergrande’s woes, the continuing computer chip shortage…’black swan’ events are coming at an accelerating pace. The German-American economist Rüdiger Dornbusch famously said “the crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought”. Inflation has been riding a three-legged pony but now looks like switching to a Porsche 911. The Fed wants a bit of inflation to come back. But how much? And will it be able to control it once it’s here?
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