Debt Crises in Context
Analysis By - Keith Rankin
Much in the economic world seems paradoxical. Certainly people and governments around the world are under pressure to, simultaneously, both spend more and save more. Yet we don't feel under pressure to lend more, even though "lending" and "saving" mean essentially the same thing!
In a global financial balance sheet, the amount of lending is exactly equal to the amount of borrowing, in the same way that the number of brides is exactly equal to the number of bridegrooms. In a given period (such as a year), surpluses (savings plus debt repayments) are exactly equal to deficits (withdrawals of past savings, plus borrowings).
A credit/debt contract is an exchange of goods and services over time, much like normal trade which represents an exchange between parties in a single time period. The creditor party transfers goods and services to the debtor party at the time of the contract, and the debtor party agrees to transfer a slightly larger amount of goods and services to the creditor party in the future.
The two big global financial stories of the mid-2000s' decade were: (I) the huge Asian surpluses exactly offset by the huge western deficits; and (ii) the huge collective surplus of the relatively rich (mostly westerners) offset by the equally huge collective deficit of the relatively poor (especially relatively poor westerners).
stories really meant were:
· Asian countries transferred huge amounts of goods and services to western countries in the 2000s' decade, in return for an obligation by western countries to transfer an even larger amount of goods and services to Asian countries in future decades.
· Relatively rich westerners transferred huge amounts of goods and services to relatively poor westerners in the 2000s' decade, in return for an obligation by relatively poor westerners to transfer even larger amount of goods and services to relatively rich westerners in future decades.
In each case it is the creditors who, in principle, determine when the contracted obligations will be settled, and the duration of the settlement period.
Clearly neither of these global economic contracts will actually be completed. The first halves of each contract were undertaken in the 2000s' decade. The second halves will not take place for two reasons. The first reason is that neither the Asian countries nor the western rich show any sign that they want to receive goods and services from their debtors over the coming decades; they continue to be more committed to production than consumption. The second reason is that that neither the west nor the poor have (or are likely to have) the capacity to transfer goods and services to their Asian and rich western creditors on anything like the scale that would be required if they were to meet their contracted debt obligations. Many debts incurred in the 2000s' credit boom have indeed been formally written off in personal and business bankruptcies.
One of the arts of the finance industry is the continued postponement of debt obligations, to the relief of both creditors who do not seek repayment, and debtors who cannot repay.
Historians looking back on the 2000s' decade from, say 2050, will see the surplus flows of goods and services of the 2000's as being unrequited. The interesting questions for observers today are simply how and when such debt obligations will unravel. The principal unravelling events of the past have been depressions, inflations, and wars.
The two big stories of the mid-2000s have now been superseded by the big story of 2009-11, the "sovereign debt crisis". As before, it helps to see this from a global perspective.
In this latest debt crisis, the
private sector (households and businesses combined) has run
up huge surpluses (by increased saving and debt repayment)
while the public sector (governments) has contracted equally
large deficits. The strange thing is that many politicians
(and political hopefuls) * from Angela Merkel and David
Cameron to Sarah Palin and Don Brash * want increased
private sector surpluses (for example, more household
saving) and, simultaneously, reduced government deficits
(called "fiscal consolidation"). This outcome can no more be
achieved than can having more married men than married women
Maybe these politicians are saying that private businesses with high debts and/or low sales should be taking on more debt in response to households saving more and governments spending less. If so, they should say so. It's not clear to most of us though, that the solution to the sovereign debt "crisis" is a massive expansion of business debt.
If the private sector already in surplus tries to lend ever more to the public sector, and the public sector refuses to borrow more from the private sector, then spending and incomes decline across the world, preventing the private sector from achieving its intended surplus. Just as it's possible for the number of offers of marriage to exceed the number of acceptances, in the end the number of men who marry in a given year will always be the same as the number of women who marry in that year. In a marriage depression, as in an economic depression, the numbers tend to fall on both sides of the equation.
While New Zealand's sovereign debt overreach is small compared to that of many countries, the issues faced in New Zealand are representative of the world as a whole. If the New Zealand government is to borrow less, then this can only be achieved by NZ households, NZ businesses or foreigners either saving less, repaying less or borrowing more.
In the last 30 months of private sector "deleveraging", there has been a surplus flow of goods, services and resources from private to public uses. The contract has been one of private sectors around the world voluntarily taking a smaller share of today's economic cake (GDP) for themselves, and thereby ceding to governments of the world a greater share. Private households and businesses take less now in return for more later. It's simply a trade over time between the public and private sectors.
This contract, however, is one which governments have been reluctant to agree to, because it means that, once the present phase of the world economy is over, governments will be required to repay or otherwise service this debt by taking smaller shares of future GDP. Governments with more now would have less later, especially if they try to consolidate their debt before the private sector is ready to reduce its surpluses.
The quandary for the governments of the world is whether they want to take on an obligation to run surpluses in a future period determined by the private sector. The alternative for governments to taking on this obligation, today, is that the private surplus of goods and services being produced now will be unused, wasted, thereby driving the global economy further into depression, unemployment and poverty. (In the nineteenth century, an economic depression was known as a "general glut", a period in which many goods and services offered for sale would find no buyers, despite widespread public and private need.)
The policy alternatives
are that governments keep borrowing the private sector
surpluses that exist in the wake of the 2008 global
financial crisis, or they refuse to borrow those surpluses
driving the global economy into a 1930s'-style depression.
If governments successfully exhort us to save (ie lend)
more, thereby increasing the already large private sector
surpluses, then the governments of the world will have to
borrow more, because the private sector, taken as a whole,
can only lend to governments.
Keith Rankin teaches Economics in Unitec's Department of Accounting and Finance.