When you hear an orthodox economist, particularly one who was early to warn of the dangers of real estate bubbles around the world, speaking of a debt jubilee as the best of bad option, you know a crunch is coming. Here is the key quote from William White, former chief economist of the Bank of International Settlements, in an exclusive interview with Ambrose Evans-Pritchard of the Telegraph:
The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.
White gives a dire set of underlying causes, and one of them is what economists would call a lack of policy space, which in layspeak means “no remedies available to treat the disease.” Yet even though White is almost certainly correct as to the endgame, which is that many people who hold financial assets will find that they are worth a lot less than they believe, one of the reasons is that even people like White, as he exhibits in this interview, subscribe to economic beliefs that are part of the problem. In other words, there are treatments that would work, even now, but mainstream economist reject them and thus look as if they will have to relearn the lessons of the Great Depression.
Mind you, White is largely correct, most of all in his pointing out that debts need to be written down, and if they aren’t in a formal manner, they will be forcibly written down, via default. But where he errs is in deeming debt always and ever bad, and in further not acknowledging (or recognizing) that for a fiat currency issuer like the United States, using debt to finance government spending is a political requirement, not an economic one. The federal government could simply deficit spend, but our funding procedures are a holdover from the gold standard era. Thus some of the lack of policy space he complains about is due to self-imposed constraints, like the perverse and self-destructive fear of running deficits in economies that are tipping into deflation and have plenty of underutilized resources.
Let’s parse the interview.
What White Gets Right
Losses are baked in; the question is when and how loss recognition takes place. From the article:
The next task awaiting the global authorities is how to manage debt write-offs – and therefore a massive reordering of winners and losers in society – without setting off a political storm.
Yves here. This passage reveals the real problem: the upheaval, specifically the recognition of losses by lenders and investors, which is mistakenly perceived as a transfer to borrowers, as opposed to a coming to terms of creditor bad decisions and/or bad luck, is what the political classes have been desperately trying to avoid. It not only will end the delusion among the wealthy that the ZIRP-inflated value of their financial assets was real. It will also create a crisis among retirees who have been forced by policy to rely less on government-run retirement programs and into private retirement programs, where studies have shown that the viability of those accounts is determined almost entirely by investment results in the decade prior to retirement. In other words, unless we see serious intervention, expect the neoliberal “Die sooner” prescription to be in operation in a bigger way than ever.
Europe is likely to be where the storm hits first. Again from the article:
Mr White said Europe’s creditors are likely to face some of the biggest haircuts. European banks have already admitted to $1 trillion of non-performing loans: they are heavily exposed to emerging markets and are almost certainly rolling over further bad debts that have never been disclosed.
The European banking system may have to be recapitalized on a scale yet unimagined, and new “bail-in” rules mean that any deposit holder above the guarantee of €100,000 will have to help pay for it.
A Chinese devaluation would be destabilizing. Not news, but important to keep in the mix:
A Chinese devaluation clearly has the potential to metastasize. “Every major country is engaged in currency wars even though they insist that QE has nothing to do with competitive depreciation. They have all been playing the game except for China – so far – and it is a zero-sum game. China could really up the ante.”
What White Gets Wrong
White depicts debt as always bad. This is a crock and here is why:
Government accounting, unlike business accounting, fails to distinguish between spending (income statement) and investment (balance sheet). The next bombing run to Iraq, which does zip to enhance the productive capacity of the US, is treated exactly the same as investing in infrastructure or R&D like basic research (and yes we fund a ton).
A fiat currency issuer can never go bankrupt. It can only create too much inflation
Government borrowing does not burden future generations. This is one of the most confused ideas of the debt discussion. As James Montier of GMO pointed out:
At some point in the future, everyone alive today will be dead. At that point in time the bonds that make up the government’s debt will be held entirely by our children and grandchildren. That debt will, of course, be an asset for those who own the bonds (just as it is today). There may well be distributional issues if all of those bonds are owned by, say, the grandchildren of Bill Gates, but these will be intragenerational issues, not intergenerational ones.
Thought of another way, let’s imagine that for some strange reason a future generation decides to repay the national debt. Who will they repay it to? Themselves, of course; once again showing that government debt simply can’t be an intergenerational issue.
What does hurt future generations is lousy management of society and the economy, and for that blame should be assigned to the leadership classes that created and implemented bad policies. Operating in an “apres moi, le deluge” manner, such as the rampant short-termism in the business and political elites, is producing bad outcomes for the young, in the form of high unemployment, unstable job tenures, and head in the sand attitude towards management of the environment, both resource scarcity and climate change. But it’s also a category error to frame this as a generational issue, even if the young are taking it in the chin. So too are middle aged people. I have, for instance, a colleague who is a top professional in his field, who has just turned 60, who is terrified of losing his job because he will have no way to support himself, and even at his income, has not been able to save enough (having to live in high cost NYC) to retire at all well. He regularly says he does not want to live long beyond 70. I suspect there are many who in his age cohort who are managing to block out what their future looks like once they no longer have a steady income.
This decay has much more to do with the financializaton of the economy and how that has created a new self-referential super elite (Davos Man is its most visible symbol) and distorted their perspective even more than it would otherwise be.
Now with that caveat, there are plenty of parties who ought to be careful about borrowing. For instance, household debt levels are negatively correlated with GDP growth. State governments like New Jersey and countries that don’t control their currency (like member states of the Eurozone or countries that run currency pegs) do have to be mindful of their borrowing levels. But even that idea puts the shoe on the wrong foot. It’s lenders who are supposed to not make stupid loans since they are the ones at risk. Borrowers are too often overly optimistic or even crooked. The “blame the deadbeat” meme of the post crisis era shifts blame away from reckless or incompetent lenders and crooked securitizers who were confident they could dump their crappy credits on unsophisticated investors.
But White’s aversion to borrowing of any sort is tantamount to ruling our more fiscal spending, when that is precisely what the economy will need more of, particularly as credit losses are realized, voluntarily or not. We’ve said since the crisis that the medicine that was needed was debt restructuring coupled with aggressive deficit spending to counter the economic downdraft. This formula is not magic but the same bad orthodox thinking that helped produce the crisis rules it out as a policy option.