There was good reason for wanting to avoid economic apocalypse back in 2008, as there is now. Central bankers around the world knew the history of the Great Depression. Along with governments, they weren’t going to allow a deflationary crash on their watch. So led by the mighty US Federal Reserve, they slashed interest rates, bought stocks and bonds, bailed out bad debts and averted catastrophe.
But now they are in a fix. After every attempt to raise interest rates and return to normal, there has been a stampede. The 2013 ‘Taper Tantrum,’ the 2015-2016 cyclical bear market, and then the 2019 crash. The cycle of recession and renewal has been broken. Stock, bond and credit markets learned to rely on state financed life-support. On Twitter you could see experienced traders laughing, because they know the Fed will never be able to stop propping the markets up.
But it’s not working anymore. Around 2010, the economists Carmen Reinhart and Kenneth Rogoff wrote a paper on debt dynamics. They examined economic data on government debt, inflation and growth across 44 countries and two centuries. They found that when the ratio of total national debt to gross domestic product (GDP) exceeded around 90 per cent, it led to lower growth.
They were criticised as apologists for austerity. But their point remains obvious. If you already have high levels of debt, people are less likely to lend you more. If you are paying huge amounts of interest, you can’t invest in the future and you are far more vulnerable to external shocks. Like Coronavirus.
The US national debt is a good example, especially as the world is dependent on the US economy. In 2008, the US national debt was just over $10 Trillion. By the end of 2019, it had grown to around $23.2 trillion. That meant US national debt doubled in ten years and is now 108 per cent of US GDP, which was around $21 trillion in 2019.
Interest rates have averaged around two per cent over the last decade. So the USA has been paying around $300 billion a year to service that debt. Given that the USA borrows more than it earns, like most governments in the west, it has been borrowing to pay the interest. The US economy isn’t going to grow faster any time soon, so this will keep repeating and debt interest will keep compounding. It’s a debt trap.
It also happened in the UK. Remember David Cameron’s 2010 election campaign posters? The big picture of Gordon Brown with the line: “I doubled the national debt, let me do it again.” He didn’t, but the Conservatives nearly did. In 2010 the total national debt was around £1.2 trillion. Now it’s around £1.9. This year we will likely reach the 90 per cent debt to GDP ratio.
Its not just the UK and the USA. France’s debt to GDP ratio is 99 per cent, Italy’s is 133 per cent and in Germany it’s still around 60 per cent. Japan’s ratio is an eye-watering 237 per cent, and that may be where we are heading. We are about to find out. The high debt, low growth economies of the west now face another historic deflationary event. And there is no choice but to respond when the alternative is a human catastrophe.
In the UK, the recent budget saw the inevitable interest rate cuts and the biggest infrastructure investment since the 1950s. Much of this should have happened after 2008. If it had, we would have been better placed to whether the storm. The further announcements of more government support was inevitable. But the ‘Keynsian’ theory of paying back the money when the economy grows won’t work this time.
Central bankers know our debt mountains can never be paid off. The markets can’t function without easy credit. Like a drug addict who needs ever larger doses. Now our high streets will need the same. And this time, with the entire global economy going into deep freeze, central banks will have to ‘go nuclear.’ They will have to print at least an entire year’s GDP. In the USA ,that’s over $23 trillion.
When the storm passes, we’ll be in a new world and we will have to try new ways to ignite and sustain growth. In Hong Kong, the government pledged to give around £1,000 to every adult over 18 to cushion the blow of Coronavirus. The Australian Government is considering the same policy, and it will likely happen here.
Universal Basic Income may come next. Fashionable liberal economists have pushed it for years, US central bankers have talked about ‘helicopter money,’ and the proposal was in Labour’s 2019 election manifesto. Some believe it is the inevitable response to Coronavirus, and when many have no job or income, who can disagree?
It might get people spending, and could be our best chance to reflate the economy. But there are other incentives to spend. With negative real interest rates, banks might start charging customers to hold cash. In April, one EU bank is already set to charge clients minus 0.5 per cent on some of their Euro cash holdings.
But despite UBI spreading money more widely, zero interest rates will still allow the asset-rich to borrow at low cost. The asset-poor will be left behind by reflating asset bubbles. Governments will have to be seen to spread the burden. So rumours of a Mansion Tax from the government may have been a well-judged toe in the water. New York’s Mansion Tax has already increased after being imposed last year.
What it comes down to is that many western countries, like the USA, are about to double their national debt in record time of two or three years. The money-tree will be stripped bare. Rises in debt may become exponential. Picture a chart of a country’s national debt as an upward sloping line from left to right. The line will get steeper and steeper in ever-shorter time scales.
This matters because there are consequences. In response to the Coronavirus, Germany may scrap its ‘debt-brake’ law that limits deficit spending. It was passed following the 2008 crash. Many believe it came from a psyche still scarred by the hyperinflation of the Weimar Republic in the 1920s. Then, the government printed paper money to pay its debts after the first world war, and 20 years of chaos followed. While that was a very different economic world, the principle can still apply. Remember what happened in Zimbabwe?
Right now the imperative is to protect people’s lives and jobs, the Government is doing the right thing and hopefully more intervention is coming. The inevitable recession will be mitigated and some growth will return. But we will have the highest levels of peace-time debt ever seen, and debt repayments will be colossal. So despite interest rates staying at rock bottom, we will be in the mother of all debt traps.
It will mean a new era of economic and fiscal policies. It will mean a more divided society, more Government control of economies and the financial markets. There will be ‘helicopter money,’ confiscatory taxes and new powers for the state. We’ve been on this road for a while and its ramping up quickly now. It won’t lead to dystopia. But even in these difficult times it’s worth a passing thought for the consequences.