The Bear’s Lair: The years of fiscal profligacy

The IMF last week released figures showing that word debt had reached $152 trillion, a record 225% of world GDP. Even though governments’ borrowing costs are ultra-low, budget deficits in the U.S. Britain and Japan are running at extraordinarily high levels, yet all the chatter is about ways to increase them rather than rein them in. Actuarially, the prospects are for even worse deficits as more baby boomers retire and European birth rates shrink the population. Truly this is unsustainable, to be succeeded by a global crash or several decades of grinding austerity. By 2050, the current period will be known as the years of fiscal profligacy, and will be universally condemned.

The sectoral breakdown of the debt increase is highly disturbing. In rich countries, both in 1002-2008 and 2009-2015, total debt increased by about 35% of GDP. However, whereas in 2002-08 the 35% increase was divided equally between households and non-financial corporations, in 2009-15, the vast majority was governments. What’s more, in rich countries gross debt increased over the period from 200% of GDP to 270%.

In emerging markets, the picture was less dire. Total debt increased from around 100% to 120% over the 2002-08 period, with government debt declining over the first half of the period and increasing in the second half, while household and financial debt increasing modestly over both halves of the period. Given the excessively low interest rates pursued by the world’s major economies over this period, this must be rated a solid performance by emerging market governments and their economies as a whole. As in most areas of economic management, emerging markets since 2009 have not been perfectly run, but their fiscal management beats the hell out of that in the rich “advanced” economies.

Low-income countries have an even better picture, though their management has deteriorated since 2008. Total debt has declined from 130% of GDP to around 80% of GDP, although that decline came entirely in 2002-08, when government debt in low income countries declined by an astounding 60% of GDP, presumably partly because of the African and other debt write-off schemes of the period. Still, the backsliding since 2009 has been modest, and overall these countries have been admirably fiscally managed, especially given their problems of poverty.

The problem of global fiscal profligacy is thus entirely concentrated in rich countries. Not coincidentally, those countries are also the places where the insane monetary policies of the last decade have been concentrated (though some emerging markets, in particular, have also relaxed monetary discipline more than they should have.)

As a result, debt ratios in rich countries have soared. Notoriously, Japan’s ratio of government debt to GDP is over 250%. Since it is running deficits even at a “primary” level before interest payments, of around 5% of GDP every year until 2021 (the end date of the IMF projections) this debt to GDP ratio is going to get worse at a pretty rapid clip. Japan’s population is declining and its productivity growth is currently negative, so there is just nowhere for GDP growth to come from, to offset this trend.

Most other rich countries are on the same path as Japan, just less far down the road. Any country that is running a “primary” budget deficit, which includes the U.S., Britain, Australia, France, Canada, the Eurozone as a whole and the G7 and G20 as a whole, has no hope of getting its budget in order without really serious fiscal austerity that no country has shown itself willing to undertake.

What’s more, it’s no good bleating about “cyclically adjusted” – the global economy is now close enough to full employment that all the above areas except the euro area are still in primary deficit even before interest payments. (The euro zone’s primary deficit picture is better than its actual deficit picture because the “cyclical adjustment” assumes that countries like Spain and Greece will bring down their unemployment levels from 20% and 23% respectively to more normal levels.)

If the current fiscal trajectory of the world’s rich countries is unsustainable, it will not in the long run be sustained. In some cases, a period of massive austerity may save the system from a government debt default; in others, especially Japan, a government debt default appears unavoidable.

Either way, the nonsensical Keynesian view now prevalent that economies can be stimulated by massive wasteful government spending on “infrastructure” will be exploded. There is no question that the infrastructure in many Western countries, especially the United States, is showing signs of decay. There are two reasons for this: One is population increase; excessively liberal immigration policies have produced population gluts in massive cities like London and New York, straining the resources of the social security system and overcrowding road and rail transport. You only have to experience the blissfully uncongested rush hour in Cleveland, a city that has halved in population since its road infrastructure was built in the 1960s (yes, there’s the odd pothole, but there’s so little traffic you can dodge around them), to realize the strain that excess population growth has put on many big cities, even as rural areas have been depopulated.

The other reason for the decay of infrastructure, as I have written before, is its vast expense. Two factors, lawyers and environmentalists, appear to have combined to make the real cost of public works as much as ten times its level of 100 or even 50 years ago. Consequently, even excessive levels of spending on infrastructure, in terms of national output, do not actually get you much infrastructure. The solution is not to waste yet more money on infrastructure; Japan tried that and it does not work. The solution is to cut back drastically on environmental regulation and permitting and safety requirements, so that infrastructure can be built in the same quick, efficient, cost-effective way it was 100 years ago.

President Barack Obama is busy planning a library/mausoleum that will be even more grandiose and pointless than those of the last half dozen Presidents. He has one problem: he will probably be still with us in 2050, when the public will be looking back on the current generation of politicians and cursing the legacy they have left. Social security systems worldwide will be bankrupt. Governments will be compelled to balance their budgets, because the international markets for government debt will demand gigantic risk premiums after the massive defaults of the 2030s and 2040s.

Pension funds throughout the world will be insolvent, as will insurance companies, because the government debt defaults will have wiped out the great majority of their funds (and the collapse in stock prices led by the defaults will have finished off the rest.) Most private savings will be held in gold bullion and unleveraged real estate (which will be cheap because the mortgage market will have disappeared). Currency values will have collapsed along with the government bond markets. Infrastructure will be truly decrepit and crime will be rampant, as governments will have cut back on essential services because they have no money. Unemployment will be high, and many of today’s rich will be impoverished, but new-rich Mafiosi will flourish, as always when society has become disordered. Moderate sized nuclear wars will have devastated much of the planet, as foolish and inept authoritarian governments attempt to quell the wrath of their populations by foreign aggression.

The reputation of most of today’s politicians will by then be at rock bottom, as they are condemned for the Keynesian profligacy that will have ruined human civilization (at least for several decades.) Luckily for most of them, they will have passed on, and will thus not witness their obloquy. Just a few of the youngest will be left. Mario Renzi of Italy, a sprightly 75, will contemplate the ruins of Rome, as his 8th Century ancestors did before him. David Cameron of Britain, a healthy 84, will have a reputation that is at least decent – his feeble attempt at “austerity” will be recognized for the public-relations-driven scam that it was, but he will be universally thanked for the referendum that allowed Britain to escape from the crumbling Sovietized ruin that is the European Union.

On the other hand, Barack Obama, an ailing 89, will rightly be blamed for having been the leader directing the worst of all policies in the West, both fiscal and monetary. As for Shinzo Abe of Japan, he will have the lowest reputation of all, both for the absurdities of Abenomics and for the return of Japan to its 1945 living standards, but at 96 he is fairly unlikely to be still with us, given the collapse of the Japanese healthcare system.

Civilization will rebuild from this disaster, of course (there are other potential disasters that it is less likely to survive.) The rebuilders will have difficult problems of depleted resources, lack of market confidence in debt obligations and a partially radioactive planet. They will however have one enormous advantage: any economist or politician spouting Keynesianism will be stoned to death by infuriated mobs.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)