High debt squeezes headroom for growth, economists warn

At a recent seminar hosted by MBMG International, Australian economics professor Steve Keen told the audience, mostly investors, that there was a close correlation between growth of private debt and aggregate demand. When private debt growth slowed, aggregate demand collapsed, and unemployment rose accordingly.

“Credit acceleration drives the economy and asset markets. The [current] unprecedented level of private debt leads to no headroom for growth,” he said. “The economy has to grow without growing debt.”

Keen focused on extreme levels of private debt seen in the global economy right now as another accident waiting to happen – probably in the next two to five years. It could be just another recession in a long-term cycle of going nowhere for the next couple of decades, Japanese-style, but Keen was also worried that social pressures, especially in Europe, could lead to the kind of austerity conditions that brought Adolf Hitler to power in the 1930s and led to World War II.

According to ING research, in 2012, total global debt reached US$223 trillion (Bt7.16 quadrillion) or 313 per cent of world gross domestic product. Aside from $55.7 trillion of public debt, the rest belonged to the private sector – financial-sector debt was $75.3 trillion and household or corporate debt $92.3 trillion.

Supporting Keen’s point is a 2011 report by the World Economic Forum and McKinsey. It showed that while global credit stock doubled from $57 trillion to $109 trillion from 2000 to 2010, it would need to double again to $210 trillion by 2020 to provide the necessary credit-driven growth for world GDP to retain its current growth rate.

At the seminar, best-selling author Richard Duncan noted that since 1945, the world had been dominated by “creditism”.

“We see all economic and capital market activity ultimately driven by credit. This is a manipulation. It’s not capitalism,” Duncan said.

Total credit in the United States increased more than 50-fold from $1 trillion in 1964 to $57 trillion in 2013, which helped spurred economic growth in the country during the period. Duncan said that under capitalism, the economic growth dynamic was driven by investment and savings. But under “creditism”, it is driven by credit creation and consumption. 

While this had created unprecedented prosperity around the world, it now is on the verge of collapse because the private sector cannot bear any more debt. And if credit ceases to expand, economic depressions are guaranteed, he said.

 

Debt a dirty word?

ING has said “debt” could be a dirty word, but in most cases, it shouldn’t be. It noted that the rise in US indebtedness coincided with improvements in technology and the globalisation of trade, human labour and finance.

At the Bangkok event, Duncan also foresaw a continued increase in public debt in weak economies. With public debt at about 100 per cent of GDP or more than $14 trillion, the US needs to inject more liquidity into the market. Economic growth will ensure the government’s ability to finance the existing debt and interest burden.

“Now, we’re on the government’s life support. It’s sad,” he said.

He noted that countries that boost debt to stimulate their economies should learn how to spend the extra liquidity wisely. Japan served as a good lesson. When its economy sank into depression in the 1990s, the public debt rose quickly from 60 per cent of GDP to 215 per cent now. Unfortunately, much of the debt was for the construction of roads and bridges. If it had invested in technology, Japan could have played a dominant role in the world now, he said. 

Likewise, the US is advised to invest in genetic and nano-technology areas, which “will pay for the cost many times over”.

Duncan noted that globalisation had helped soften the inflation that could have happened in several countries resorting to expansionary monetary policy. 

Paul Gambles, chief investment officer of MBMG, said another reason for low inflation could be that a small amount of the extra liquidity is circulating in the real economy. In the US, $2 trillion is trapped in excess deposits in the commercial banks and going nowhere except, via margin lending, into the equity markets.

Wall Street last week showed a seventh straight week of gains, which helped boost the sentiment in global markets.

“Nobody wants asset-price inflation,” he said. “Asset inflation can hurt.” He painted three potential scenarios as a result of the United States’ loose monetary policy.

First, quantitative easing will work in creating exit-velocity growth and real inflation that will outstrip and devalue debt.

Second, the global economy will “turn Japanese” and we will suffer lost decades while the debt slowly and painfully endures – except that this is not an outcome, just a long transition to an outcome.

Third, there are major events such as a default, actual or effective, or the kind of event that ended the Great Depression, that is, a world war. He noted that each outcome would create huge risks and opportunities, and it is up to investors to construct risk-adjusted portfolios using asset matrices that can withstand the most unfavourable outcomes.