The Financial Jigsaw – Issue No. 18

My unpublished (100,000 word) book “The Financial Jigsaw”, is being serialised here weekly in 100 Issues by Peter J Underwood, author

We left last week with the question: how much is too much government debt also known as sovereign debt?  See here for:  Issue 17  This week, to end this Chapter 3, we will focus on government debt and how it affects us all, making sometimes for an unstable economy at the same time. 

CHAPTER 3

CREDIT and DEBT

“What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?”
Adam Smith – Economist

“There is no means of avoiding the final collapse of a boom brought about by credit expansion.  The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

 Ludwig Von Mises 

The measure of acceptable government debt levels

As of 2018 it seems that there is no consensus about debt levels and their effect on general economic health.  The nearest anyone has got to pinning down a reasonably acceptable number is fully analysed by leading economists: Carmen M. Reinhart & Kenneth S. Rogoff in their book “This Time is Different” published in 2009.

This excellent research has sparked, in 2013, a vitriolic battle between these economic titans and a leading Nobel Prize winning economist, Prof. Paul Krugman who supports the general idea that government debt doesn’t matter and thus any computed level is irrelevant.

Since the USA is the most indebted country in the world, measured by the amount owed now exceeding USD 20Tn (2018), it tends to be the focus of the published data and economic statistics upon which so much of the financial and political world rely.  The fact that the debt level is worsening at the rate of some USD 1Tn per year makes finding a solution all the more urgent.

The world’s future is dependent, to a large extent, upon the outcome of these debates which will set monetary and fiscal policies for many years into the future.  It will be the coming generations, and especially Gen X (beginning birth dates from the early 1960s to the early 1980s) and Millennials (1980s – 2000s), who will be seriously affected by the actions taken in the coming months and years.

It is these people who will be in most need of understanding the completed picture of our jigsaw puzzle. Debt, in all its forms, is at the core of the global problem and to fully appreciate the many implications of financial policies being proposed today, which will adversely affect our individual lives, requires a great deal of dedication in an attempt to understand the issues described here.

By economic convention the degree of risk attached to levels of sovereign debt is measured by reference to national GDP.  Unfortunately, as is common in all economic theory, confusion arises because much depends upon what is determined to be ‘the national debt’ although GDP measurement is generally more robust.

A nation’s debt can include a range of government obligations which are mainly assessed by reference to the commitment measured over time.  For example: pension funds have massive reserves today but are not required to pay out pensions immediately, they become future obligations over many years.  It is much the same with our individual money management thinking.  It can be frightening to think that one has a £150,000 loan to repay against the home but spread over 25 years at the rate of say, 4% per annum, our monthly payment is reasonable, we don’t often think about the total outstanding debt.

This a normal, human thinking process and is no different for our political and financial masters who are happy to dismiss major financial burdens if they are more than five years away; it is their short-term thinking and created in part by our five/four year election cycle that causes these effects.

The Americans are fond of using the well-worn mantra: ‘kicking the can down the road’ which you may have heard on occasion.  I have avoided including charts and graphs as far as possible because my objective is to paint a word picture of my jigsaw puzzle which I believe helps to form a deeper understanding of the subject.  Diverting briefly however; Edgar Dale claims (supported by psychological research) that we remember:

• 10% of what we read
• 20% of what we hear
• 30% of what we see
• 50% of what we see and hear
• 70% of what we discuss with others
• 80% of what we personally experience
• 95% of what we teach others

So I may be on a losing wicket here, but at least I have tried.

Public and private debt

There is a significant difference between public debt and private debt.  Since 2007 (the start of the Great Recession) private debt as a percentage of US GDP has reduced by 40%; this is known to economists as ‘deleveraging’.  The difference has been totally made up by a 40% increase in public debt which can only have come from bond issuance and QE to compensate for the massive US government annual spending deficits.

The overall US economy has not fundamentally deleveraged by simply reversing the increase in debt during the 2008 Great Recession, which was expected to be only short-term, but has maintained levels at or near the start of the Great Recession indicating that no progress on overall debt reduction has been made.

This is the essence of the current, raging debate about debt levels and where they should be to maintain a sustainable economy and avoid further economic crises.  There is little to be optimistic about after ten years of great personal sacrifice and the imposition of economic austerity.

Too much debt reached a pinnacle in 2007 and the resultant crash created the extreme economic conditions we see today; yet our financial masters continue to pile debt upon debt as a supposed solution.  The global economy is relying more than ever on the “full faith and credit” of the U.S. government; we have now taken on much more debt in all economies throughout the world but we have no idea what limits should be applied before another crisis occurs; the economists and policy makers are ‘flying blind’ – it is all a grand experiment and a dangerous one at that.

I am reminded of the famous quote from Albert Einstein: “Insanity is doing the same thing over and over again and expecting different results”.  The sad conclusion is that those who chose to rise above us and have the power to change our lives for the better are displaying such a total lack of common sense that ‘human stupidity’ can be the only plausible cause.  Einstein again sums up this proposition:  “”Two things are infinite: the universe and human stupidity; and I’m not sure about the universe.”

The final result of Reinhart & Rogoff’s calculations was their proposition that, when government debt grows beyond 90% of GDP, the stability of national economic structure becomes unstable.  Their book provides a history of financial crises in their various guises; their basic message is simple: we have been here before.

Using clear, sharp analysis and comprehensive data, they document that financial fallouts occur in clusters and strike with surprisingly consistent frequency, duration, and ferocity.  They examine the patterns of currency crashes, high inflation, hyperinflation, government defaults on international and domestic debts; they include the cycles in housing, share prices, capital flows, unemployment and government revenues surrounding these crises.

Whilst countries do weather their financial storms, Reinhart and Rogoff prove that short memories make it all too easy for crises to reoccur.  Their results also give strong support to the use of Complexity Theory in its application to the stability of global economies. They offer an essential step toward improving our global financial system, both to reduce the risk of future crises and to better handle catastrophes when they happen.

There is much more to understand about government debt and how it is created and is the subject of Chapter 5 about government.  Before we go deeper into the beginnings of public debt we need to understand more about how public and private debt is managed.  This corner stone of the global financial jigsaw puzzle is the subject of the next Chapter about central banks and their pivotal role within the overall system of global finance.

To be continued next Saturday

Author: Austrian Peter

Peter J. Underwood is a retired international accountant and qualified humanistic counsellor living in Bruton, UK, with his wife, Yvonne. He pursued a career as an entrepreneur and business consultant, having founded several successful businesses in the UK and South Africa His latest Substack blog describes the African concept of Ubuntu - a system of localised community support using a gift economy model. View all posts by Austrian Peter