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By Roger Bootle
We can all breathe a sigh of relief that the world is not going to come to an end as a result of a default by the US government. Well, for now, anyway. But this does not mean that debt problems have gone away. Indeed, across the Pacific a serious debt problem is still building in Japan.
Whereas the US debt crisis has been triggered by a disagreement between Democrats and Republicans over the role of the state in the economy and society, and specifically over “Obamacare”, Japan’s debt problem is a slow burner.
As a share of GDP, government debt has been growing since the early 1990s. This is the result of the long-running weakness of economic growth, repeated fiscal stimulus packages and a long period in which the overall price level has stagnated or fallen. Japan has managed to muddle through, but it now looks as though it is close to a tipping point.
The scale of the problem is staggering. Japan’s net government debt is about 140pc of GDP. This is way ahead of the US, which is on 87pc, and not that far below Greece. What’s more, it is easy to see the ratio increasing further. The IMF expects net debt to rise to 148pc of GDP over the next five years. In fact, if the economy performs badly, inflation remains low or borrowing costs rise, debt could easily follow an explosive path, with the ratio quickly rising towards 300pc of GDP.
So what to do? If Japan followed anything like this path, then some form of default would eventually become inevitable. Accordingly, why not cut the whole process short and get the thing over and done with by defaulting now?
Quite apart from all the usual objections to default, Japan suffers from another major obstacle, namely that its debt is overwhelmingly held by Japanese financial institutions, including banks. A default would land the financial sector with massive losses and could cause a catastrophic financial crisis.
The orthodox way to tackle debt is to impose austerity via cuts to government spending or increases in taxes. In fact, Japan will increase its consumption tax in April and quite considerable deficit reduction is promised for the next few years.
But this runs into two problems that are familiar from a European perspective. First, such austerity is not popular and the politicians in Japan may yet baulk at the scale of the tightening to be imposed.
Second, austerity tends to reduce GDP – even though George Osborne may believe that it hasn’t done so in the UK. If it does reduce GDP, then the debt to GDP ratio would probably rise.
Faster economic growth would help but is in practice difficult to achieve. The government is pursuing some supposedly radical structural reforms but it is unlikely that, even if these are pushed through, they will have much of an impact soon enough. And in trying to grow its way out of the debt problem, unlike America, Japan faces a huge demographic hurdle. It simply isn’t making enough Japanese. The size of the workforce is already falling and will continue to do so for decades.
The way out for Japan is to try to engineer a higher rate of inflation, perhaps much higher than the current 2pc target. For any given rate of increase of real GDP this would give a higher rate of growth of nominal GDP, that is to say, expressed in money terms. With debt fixed in money terms this would, other things being equal, bring down the debt to GDP ratio.
Admittedly, other things may not be equal. The danger is that markets would force up the rate of interest on Japanese debt and thereby increase the amounts that the government had to pay out in debt interest. That could easily offset the effect of higher inflation.
In fact, it could lead to the debt ratio ending up higher. Yet in the Japanese case, this is unlikely.
The Bank of Japan would continue to hold short-term interest rates at close to zero for several years. That would ensure that the rates on short-term debt remained subdued. Moreover, it would continue to buy huge quantities of Japanese government debt. It might also consider obliging financial institutions to hold extra amounts of government debt.
How would Japan achieve higher inflation? Quantitative easing (QE), or printing money, as it is colloquially known, will eventually give you higher inflation – provided that you do it on sufficient scale. This is what the Japanese central bank now seems prepared to do.
A fall of the yen would be a crucial part of the mechanism by which inflation moved higher.
This is what has happened recently. Japanese inflation has risen to 0.9pc, but almost wholly as a result of the fall of the yen from the high 70s to the dollar to about 100. There has been hardly any domestically generated inflation. But if the yen continued to weaken, that would surely follow.
Throughout the past 30 years, Japan has been a testing ground both for problems and their possible solutions that have appeared later in the West. It experienced a bubble economy in the late 1980s and then experienced the pain of a long drawn-out balance sheet recession, brought on by the collapse of asset prices and the drying up of credit.
It also went through a slow dragging deflation of consumer prices before anyone in the West thought that this was an issue. And for some time now it has faced the problems caused by an ageing and falling population.
Could it also show the way on the inflation solution to the debt problem which continues to bedevil so many countries in the West? For the UK, a deliberate embrace of higher inflation remains only a risk rather than a probability. For we are in a very different position from Japan. Our debt ratio is nowhere near as high and our potential to grow our way out of the problem is much greater, not least due to our more favourable demographic prospects. The same is true for the US.
But there are several members of the eurozone for whom this is not true. Greece and Italy spring to mind. Unless their debt is “forgiven”, some form of default appears inevitable.
While they remain in the euro, of course, they cannot default through inflation because they do not control their own monetary policy.
But if they were to leave the euro, the Japanese experience might be highly influential.
Roger Bootle is managing director of Capital Economics email@example.com
October 28, 2013
Sovereign Valley Farm, Chile
You know the old rule of thumb about laws–
The more high-sounding the legislation, the more destructive its consequences.
Case in point, HR 3293– the recently introduced Debt Limit Reform Act. Sounds great, right? After all, reforming the debt seems like a terrific idea.
Except that’s not what the bill really does. They’re not reforming anything. HR 3293′s real purpose is to authorize the government to simply stop counting a massive portion of the US national debt.
You see, one of the biggest chunks of the debt is money owed to ‘intragovernmental agencies’.
For example, Medicare and Social Security hold their massive trust funds in US Treasuries. This is the money that’s owed to retirees.
In fact, nearly $5 trillion of the $17 trillion debt (almost 30%) is owed to intragovernmental agencies like Social Security and Medicare.
So now they basically want to stop counting this debt. Poof. Overnight, they’ll make $5 trillion disappear from the debt.
On paper, this looks great. But in reality, they’re setting the stage to default on Social Security beneficiaries without causing a single ripple in the financial system.
Remember, when governments get this deep in debt, someone is going to get screwed.
They may default on their obligations to their creditors, causing a crisis across the entire financial system. Or perhaps to the central bank, causing a currency crisis.
But most likely, and first, they will default on their obligations to their citizens. Whatever promises they made, including Social Security, will be abandoned.
And if you read between the lines, this new bill says it all.
Not to be outdone by the United States Congress, though, the International Monetary Fund recently proposed a continental-wide ‘one off’ wealth tax in Europe.
Buried in an extensive report about Europe’s troubled economies, the IMF stated:
“The appeal is that such a tax, if it is implemented before avoidance is possible and there is a belief that it will never be repeated, does not distort behavior (and may be seen by some as fair).”
In other words, first they want to implement capital controls to ensure that everyone’s money is trapped. Then they want to make a grab for people’s bank accounts, just like they did in Cyprus.
The warning signs couldn’t be more clear. I’ve been writing about this for years. It’s now happening. This is no longer theory.
Over the last few weeks I’ve been having my staff revise a free report we put together two years ago about globalizing your gold holdings.
In the report I mentioned that capital controls are coming. And that some governments may even ban cash transactions over a certain level.
These things have happened. Cyprus has capital controls, France and Italy have limits on cash transactions. And given this new evidence, it’s clear there’s more on the way.
Every rational, thinking person out there has a decision to make.
You can choose to trust these politicians and central bankers to do the right thing.
Or you can choose to acknowledge the overwhelming evidence and reduce your exposure to these bankrupt western countries that will make every effort to lie, cheat, and steal whatever they can from you… just to keep the party going a little while longer.
It’s time for people to wake up to this reality. You only have yourself to rely on. Not the system. Not the government. And certainly not the bankers.
- Senate Dems call for automatic debt limit hikes… (news.yahoo.com)
- Don’t Give the President Control Over the Debt Limit, Eliminate It (fdlaction.firedoglake.com)
- How to Disarm Congress’s Suicide Bomb – Bloomberg (bloomberg.com)
- Should We Eliminate the Extraordinary Measures? (dmarron.com)
- Debt-ceiling disarmament should be next step for Congress (azstarnet.com)
With the latest installment of the ‘US debt ceiling’ melodrama over, for now, perhaps it’s a good time to ask, what was it all about really?
I know that officially it was supposed to be an edge of your seat, high stakes thriller about how much debt the US government can carry before some disaster strikes, and who has the authority to decide. But I think that behind the lumbering domestic stage show there was actually a different, larger battle, with different stakes, being played out. The debt ceiling debate was, to my mind, something of a proxy war. Real for those caught up in its angry rhetoric, but seen from further away, clearly just a local manifestation of something deeper, and something being directed by different people than those making speaches in the spot-light.
Actually I think the fight over the US debt ceiling is a proxy for who controls the world’s real reserve currency. And that currency is not the dollar. I suggest we would understand events more simply if we recognized that the world’s real reserve currency is debt -pure debt. We should not be confused by the fact that debt, globally, is denominated in several forms. Much like the dollar comes in bills of ten and twenty, so the debt currency comes in dollars, euros, Yen and Yuan. But they are not the currency itself they are just the different bills it comes in.
In Britain we have pound notes issued by the Bank of England but also by the Royal Bank of Scotland, Clydesdale and Ulster Bank, but they are not different currencies, they are all pounds no matter whose logo in on the notes. I think globally we are now in the early and perhaps not quite recognized days of a similar situation. It is debt which is globally traded and used to settle and value all deals everywhere. The problem is this global debt system is not yet fully formed. It is still umbillically tied to the old system of national currencies and their issuers. And like mummies everywhere the old issuers like to think they are in charge long after they no longer are.
If you are willing to accept this idea, at least for argument’s sake, then the domestic dramas in different countries over how much of this or that kind of debt backed note, with this or that logo on it, should be permitted, take on a different character. I am not saying that the domestic arguments over how many dollars or euros can be printed up, how much debt should be carried are unimportant. They are important and do have profound real life consequences for people and businesses. But I am saying that the driving logic is not domestic and nor is it controlled or even understood by most of the domestic players.
Think of the Vietnam war. In Vietnam it was North vesus South. But for the wider world North and South were just proxies for a much deeper conflict of Communism versus America. And the politicians of South Vietnam were not really in charge of very much. I think this is increasingly the situation of domestic politicans when it comes to finance, debts and currency. Only they don’t yet know this one vital fact. Thus we have the dis-spiriting spectacle of watching the fag ends of our representative democracy argue about things most of them do not understand. An endless stage show where the actors strut and fret, and deliver their lines with gusto, pulling with all their puffed-up might on the familiar levers of power available to them, expecting applause. Yet all the while their drama and the levers of power they squable over are less and less connected to the actual engines of change.
The Democrats and Republicans think they are arguing over who should control the amount of debt the Fed will take on. Not realizing that neither of them, neither Republican nor Democrat controls the matter over which they are arguing. Neither do they realize – not fully at least – that theirs is no longer a theatre of power, it is mostly just a theatre. Power, fundamental power, has moved elsewhere.
What the debt-celing debate was about, I suggest, was a fight between those who think they control the Fed and the currency (because once they did) and those who do control it but would prefer we not quite realize this.
I think the real battle going on is between the financial players led by the global banks, assorted funds and Insurers, all of whom are very much addicted to fiat debt-money, and a dwindling cadre of politicians who still think central banks control the currencies and elected officials decide how much debt is enough.
This latter group seemingly cannot understand why they can’t get the Fed or the ECB to do what they both said, ever since 2008, they would do, which is to ‘exit’ or to use the prefered term ‘taper’ the ‘extraordinary’ and ‘temporary’ measures they took in 2007, then took again in 2008 and again in 2009 and again in 2010 and 2011 and 2012 and 2013. Which is, let’s be fair to our puzzled politicans and pundits, a confusingly frequent use of ‘extraordinary’ and a long time for ‘temporary’. Hence their confusion.
What our politicians – most of them but crucially not all of them – seem reluctant to underdstand is that neither the FED nor the ECB nor any other central authority, can limit the amount of debt that is issued into the global markets. The banks issue the debt not governments. But that debt, conjured into existence by extending loans does then, particularly in periods of market uncertainty, ‘need’ – or rather or ‘demand’ – backing from a national currency. This creates a pressure on central banks to ‘issue’ more sovereign debt paper to provide the backing for the ALREADY created debt.
The big banks issue the reserve currency. It is a global reserve currency and replaced the dollar some time ago, only no one noticed becaue they kept the old brand name going. It’s not even as if it is just American financial intitutions which issue dollar debt which the Fed finds itself being forced to cover – foreign banks do it to. And anyone who issues dollar denominated debt has a hand on the strings which move the Fed around. Obviously the same is true for other major currencies and their central banks.
The governments and central banks can try to influence the creation of debt though interest rates or ‘stress tests’ and setting levels of ‘regulatory capital’ that must be held. But all of these can be and are gamed by the banks. And when gaming is not sufficient then a debt crisis can be brought in to play to force the reluctant politicians to do what they ‘must’. And that last ploy is the debt ceiling.
Once private debt has been created the central banks are under-pressure to create public debt with which to back it. They know this is how it works they are on record as saying so. But they are caught in a dilemma. The politicians and the public think the government and central banks are in charge and can tell the markets how much debt is enough. The central banks know they do not really have this power because in reality it is the markets not the central banks who are in charge and decide how much debt is good for THEM.
What can the central banks do? Nominally they work for the government. The people even think they work for them (ho ho!) Whereas the logic which controls lies in the markets and the levers are in the banks. If the Central banks were to come clean and tell the government and the public who is really in charge, who they really work for, what would happen? So they don’t come clean, at least not in public, leaving the poltiicans to argue fatuously amoung themselves for our entertainment.
There are only a limited number of end games I think. The issuance of debt will go on despite the increasing drama of the decisions. The question for the banks will be how best to manage it with the minimum of fuss and least chance of the real situation becoming too clear too early.
Debt issuance will go on because the present economic system, fueled as it is by debt, requires growth above the rate of interest they are all charging each other. The Pension companies require more growth than that because they have long term obligations to pay out at a higher rate. In boom times growth takes care of itself. In bad time that growth ‘must’ be provided by ‘stimulus’ AKA public debt. The minimum growth they want for the headlines is 3%. Which seems reasonable till you do the maths and find 3% growth means a doubling every 17 years. Given the frequency of ‘busts’ built into the debt based system and how much they cost the public each time – (and they are built in – I explained one aspect of this in the last part of the Securitization series. (For completeness here are parts 1 and 2.) This series is my take on the same logic than Minsky had of course already come to before and more fully) – it is clear how much ‘growth’ is going to be based on public debt. So the debt will grow.
But while it does, other parts of the economic system and their political friends will complain about the size of the debt. So there will continue to be a pressure to stop the debt ‘getting out of control’. How to sqaure this idiot’s circle? The answer is already here only in its infant form. Public Debt created to back private debts will be ‘required’ to grow. Public debt for other things will therefore be under pressure to be cut. So far what has been cut has been the easy and the small beer.
The sums ‘saved’ have been tiny in comparison with the sums created in order to ‘help’ the financial system, even though the misery created in cutting them has been huge. But who cares about miserable poor people when you’re a rich happy one? Nevertheless the sums saved through ‘austerity’ are not going to be sufficient over even the medium term of the next decade. The ‘savings’ need to be orders of magnitude greater. For that the only option is to target the long term, ‘unfunded commitments of health, state pension and long term welfare. These are what the bankers will target when people have been softened up and the next bust hits.
The option I think they will go for is complete privatization of health, welfare and state pension.
All these long term ‘unfunded obligations’ as they are called appear in public debt accounts as future liabilities, future debts. But as soon as the same obligations are shifted to the private sector they become future profits rather than future debts. No matter that people might not be able to pay for them – accountants are not paid to worry about such details. To you and me it might seem daft to think that by moving things from one column to another , from public to private that this will suddenly make things better. And of course it won’t. The private sector will argue it will be ‘better’ because they are so much more ‘efficient’. Believe that if you like. But the main thing is the acounting exercise will make the number in the public debt column go down.
The important thing for any discussion of public debt levels, is that removing these ‘obligations’ from the public account suddenly cuts the future public debt. Freeing up all that now uncommitted future debt to be available for pumping into the private financial sector . Which it would suddenly make ‘good economic sense’ to help, given the now very buoyant future demand for private health, pensions and welfare provision.
Public debt is always seen by the financial world as a drain, an obligation. The same obligations re-cast as serivces are seen as a source of future profit. Thus I think we will see in the next few years an all out attack on every aspect of public service provision. Libertarians amoung you might cheer at this point. I think you will not cheer when you see what is going to replace what you currently dislike.
I believe the era of the Nation-State is coming to an end not because of attack from outside enemies but because Nation-States are being dismantled from the inside – by the State itself. But the State has no itention of losing power. It is simply changing jobs and employer. The big welfare state is being dismantled but in its place is going to come an even bigger and certainly more repressive Corporate State.
But the End of the Nation-State and the emergence of a global system of Technocratic, Managed rather than democratic Corporate-States is a larger discussion I am still writing.
- Central bankers trust gold more than money (therealasset.co.uk)
- Treasuries Losing Cachet With Weakest Foreign Demand Since 2001 (bloomberg.com)
- How Long Until the U.S. Dollar Loses Its Reserve Currency Status? (dailygainsletter.com)
- De-Crowning The Dollar (safehaven.com)
- How Long Until The U.S. Dollar Loses Its Reserve Currency Status? (etfdailynews.com)
- Why The U.S. Dollar Is In Trouble (etfdailynews.com)
The political class in Washington has failed to reach a deal. They are effectively playing a game of chicken with the markets to see who blinks first. As usual, there are plenty of lies and spin swirling around this situation.
The US Treasury has stated it will run out of cash on October 17.
This in of itself is a strange claim as technically we hit the debt limit back in May and have been resorting to “extraordinary” measures since then. I don’t recall anyone in at the Treasury talking about the importance of the “debt ceiling” then, do you?
Secondly, the Government has effectively been running a Ponzi scheme with our debt for the greater part of 20 years. Over $5.7 trillion of our debt is owned by the Federal Government, ($2.1 trillion is owned by the Fed, $2.6 trillion is owned by Social Security, and over $1 trillion is owned by various Federal Retirement entities).
Indeed, the single largest owner of US debt is not in fact China, but our own Government. We’ve been running this kind of scheme for over 20 years.
Now this is not to say that a debt ceiling breach or a possible default on some payments are NOT huge issues. What I am saying is that the US Government can shuffle money around just as it has for the last 20 years to insure that we meet our debt obligations….
- Ponzi Scheme National Debt? (billlawrencedittos.com)
- Lew’s Testimony on Debt Mirrors SEC’s Definition of Ponzi Scheme (cnsnews.com)
- The Biggest Ponzi Scheme In The History Of The World (thehovistrader.wordpress.com)
CommentsView/Create comment on this paragraphBERKELEY – The dollar is the world’s go-to currency. But for how much longer? Will the dollar’s status as the only true global currency be irreparably damaged by the battle in the US Congress over raising the federal government’s debt ceiling? Is the dollar’s “exorbitant privilege” as the world’s main reserve currency truly at risk?
CommentsView/Create comment on this paragraphTo be sure, the purveyors of dollar doom and gloom have cried wolf before. When the subprime-mortgage crisis hit, it was widely predicted that the dollar would suffer. In fact, the greenback strengthened as investors seeking a safe haven rushed into US Treasury bonds. A year later, when Lehman Brothers failed, the dollar benefited from the safe-haven effect yet again.
CommentsView/Create comment on this paragraphData from the International Monetary Fund confirm that these shocks caused little (if any) decline in the dominance of the dollar in central banks’ holdings of foreign-currency reserves. Likewise, data gathered by the Bank for International Settlements show that the dollar dominates global foreign-exchange transactions as much as it did in 2007.
This chart from Citi’s Matt King pretty much sums it up (and contrary to what Magic Money Tree growers will tell you, debt is not wealth).