[Marxism] Mountain of unpayable private debt still abig threat to capital

["Fred Feldman" <ffeldman@xxxxxxxxxxxxxxxx>]

http://www.guardian.co.uk/business/feedarticle/8288576/print

U.S. & UK on brink of debt disaster: 
John Kemp Reuters, Tuesday January 20 2009 
-- John Kemp is a Reuters columnist. The opinions expressed are his own --

By John Kemp
LONDON, Jan 19 (Reuters) - The United States and the United Kingdom stand on
the brink of the largest debt crisis in history.

While both governments experiment with quantitative easing, bad banks to
absorb non-performing loans, and state guarantees to restart bank lending,
the only real way out is some combination of widespread corporate default,
debt write-downs and inflation to reduce the burden of debt to more
manageable levels. Everything else is window-dressing.

To understand the scale of the problem, and why it leaves so few options for
policymakers, take a look at Chart 1
(https://customers.reuters.com/d/graphics/USDEBT1.pdf)
which shows the growth in the real economy (measured by nominal GDP) and the
financial sector (measured by total credit market instruments outstanding)
since 1952.

In 1952, the United States was emerging from the Second World War and the
conflict in Korea with a strong economy, and fairly low debt, split between
a relatively large government debt (amounting to 68 percent of GDP) and a
relatively small private sector one (just 60 percent of GDP).

Over the next 23 years, the volume of debt increased, but the rise was
broadly in line with growth in the rest of the economy, so the overall ratio
of total debts to GDP changed little, from 128 percent in 1952 to 155
percent in 1975.

The only real change was in the composition. Private debts increased (7.8
times) more rapidly than public ones (1.5 times). As a result, there was a
marked shift in the debt stock from public debt (just 37 percent of GDP in
1975) towards private sector obligations (117 percent). But this was not
unusual. It should be seen as a return to more normal patterns of debt
issuance after the wartime period in which the government commandeered
resources for the war effort and rationed borrowing by the private sector.

>From the 1970s onward, however, the economy has undergone two profound
structural shifts. First, the economy as a whole has become much more
indebted. Output rose eight times between 1975 and 2007. But the total
volume of debt rose a staggering 20 times, more than twice as fast. The
total debt-to-GDP ratio surged from 155 percent to 355 percent. Second,
almost all this extra debt has come from the private sector. Take a look at
Chart 2 (https://customers.reuters.com/d/graphics/USDEBT2.pdf).

Despite acres of newsprint devoted to the federal budget deficit over the
last thirty years, public debt at all levels has risen only 11.5 times since
1975. This is slightly faster than the eight-fold increase in nominal GDP
over the same period, but government debt has still only risen from 37
percent of GDP to 52 percent.

Instead, the real debt explosion has come from the private sector. Private
debt outstanding has risen an enormous 22 times, three times faster than the
economy as a whole, and fast enough to take the ratio of private debt to GDP
from 117 percent to 303 percent in a little over thirty years.

For the most part, policymakers have been comfortable with rising private
debt levels. Officials have cited a wide range of reasons why the economy
can safely operate with much higher levels of debt than before, including
improvements in macroeconomic management that have muted the business cycle
and led to lower inflation and interest rates. But there is a suspicion that
tolerance for private rather than public sector debt simply reflected an
ideological preference. 

THE DEBT MOUNTAIN
The data in Table 1 (https://customers.reuters.com/d/graphics/USDEBT3.pdf)
makes clear the rise in private sector debt had become unsustainable. In the
1960s and 1970s, total debt was rising at roughly the same rate as nominal
GDP. By 2000-2007, total debt was rising almost twice as fast as output,
with the rapid issuance all coming from the private sector, as well as state
and local governments.

This created a dangerous interdependence between GDP growth (which could
only be sustained by massive borrowing and rapid increases in the volume of
debt) and the debt stock (which could only be serviced if the economy
continued its swift and uninterrupted expansion).

The resulting debt was only sustainable so long as economic conditions
remained extremely favourable. The sheer volume of private-sector
obligations the economy was carrying implied an increasing vulnerability to
any shock that changed the terms on which financing was available, or
altered the underlying GDP cash flows.

The proximate trigger of the debt crisis was the deterioration in lending
standards and rise in default rates on subprime mortgage loans. But the
widening divergence revealed in the charts suggests a crisis had become
inevitable sooner or later. If not subprime lending, there would have been
some other trigger.

WRONGHEADED POLICIES
The charts strongly suggest the necessary condition for resolving the debt
crisis is a reduction in the outstanding volume of debt, an increase in
nominal GDP, or some combination of the two, to reduce the debt-to-GDP ratio
to a more sustainable level.

>From this perspective, it is clear many of the existing policies being
pursued in the United States and the United Kingdom will not resolve the
crisis because they do not lower the debt ratio.
In particular, having governments buy distressed assets from the banks, or
provide loan guarantees, is not an effective solution. It does not reduce
the volume of debt, or force recognition of losses. It merely re-denominates
private sector obligations to be met by households and firms as public ones
to be met by the taxpayer.

This type of debt swap would make sense if the problem was liquidity rather
than solvency. But in current circumstances, taxpayers are being asked to
shoulder some or all of the cost of defaults, rather than provide a
temporarily liquidity bridge.

In some ways, government is better placed to absorb losses than individual
banks and investors, because it can spread them across a larger base of
taxpayers. But in the current crisis, the volume of debts that potentially
need to be refinanced is so large it will stretch even the tax and
debt-raising resources of the state, and risks crowding out other spending.

Trying to cut debt by reducing consumption and investment, lowering wages,
boosting saving and paying down debt out of current income is unlikely to be
effective either. The resulting retrenchment would lead to sharp falls in
both real output and the price level, depressing nominal GDP. 
Government retrenchment simply intensified the depression during the early
1930s. Private sector retrenchment and wage cuts will do the same in the
2000s. 

BANKRUPTCY OR INFLATION
The solution must be some combination of policies to reduce the level of
debt or raise nominal GDP. The simplest way to reduce debt is through
bankruptcy, in which some or all of debts are deemed unrecoverable and are
simply extinguished, ceasing to exist.

Bankruptcy would ensure the cost of resolving the debt crisis falls where it
belongs. Investor portfolios and pension funds would take a severe but
one-time hit. Healthy businesses would survive, minus the encumbrance of
debt.

But widespread bankruptcies are probably socially and politically
unacceptable. The alternative is some mechanism for refinancing debt on
terms which are more favourable to borrowers (replacing short term debt at
higher rates with longer-dated paper at lower ones).

The final option is to raise nominal GDP so it becomes easier to finance
debt payments from augmented cashflow. But counter-cyclical policies to
sustain GDP will not be enough. Governments in both the United States and
the United Kingdom need to raise nominal GDP and debt-service capacity, not
simply sustain it.
There is not much government can do to accelerate the real rate of growth.
The remaining option is to tolerate, even encourage, a faster rate of
inflation to improve debt-service capacity. Even more than debt
nationalisation, inflation is the ultimate way to spread the costs of debt
workout across the widest possible section of the population.

The need to work down real debt and boost cash flow provides the motive,
while the massive liquidity injections into the financial system provide the
means. The stage is set for a long period of slow growth as debts are worked
down and a rise in inflation in the medium term.

John Kemp, formerly an economist for RBS Sempra in London, has joined
Reuters as a columnist on commodities and energy markets.

>From Google: John Kemp, formerly an economist for RBS Sempra in London, has
joined Reuters as a columnist on commodities and energy markets.



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