Countries scaled to their debt levels

InThe World Map of Debt Jeff Desjardins shows a map of the world with countries scaled to their debt to GDP ratio.

Our government should be borrowing more

In Low 10-year bond rates are the deal of the century but Abbott's not at the table Peter Martin writes that our Government is basically being offered free money.

The 10-year bond rate is the rate at which the government can borrow for 10 years at a fixed rate of interest. Right now it's just 2.55 per cent, an all-time low.

By way of comparison in the 1970s it exceeded 10 per cent, in the 1980s it passed 16 per cent, in the 1990s it passed 10 per cent, in the 2000s 5 per cent, and until now in this decade it has usually been above 3 per cent. It dived below 3 per cent at the end of last year and is now just 2.55 per cent, the lowest in living memory.

If Australia was to borrow, big time, for important projects that took the best part of a decade to complete, it would have no risk of ever having to fork out more than 2.55 per cent a year in interest. The record low rate would be locked in for 10 years.

Australia's inflation rate is currently 2.3 per cent. Although it will almost certainly fall in the wake of the collapse in oil prices when it is updated next week, the Reserve Bank has a mandate to keep the rate centred at about 2.5 per cent. That means that right now our government is being offered billions for next to nothing, billions for scarcely more than the expected rate of inflation.

Martin goes on to list any number of projects that could be funded this way. Martin does have a warning of us though:

The risk is that bad projects would be chosen over good ones and the money wasted.

...

He says even cheap money should be spent well

Mosler rejects the theory that government debt is bad

In Mosler lays down tablets on the economy, stupid Peter McAllister talks to economist Warren Mosler about his theories that government debt isn't bad but government surpluses can be. That's provided the debt is in the country's own currency (unlike Euro-zone countries).

The GFC increased public debt

Michael Pascoe in Why our financial minnows are still too big to fail takes a look at a recent speech by Reserve Bank Governor Glenn Stevens. Stevens gave a "carefully considered presentation on how economic policy makers handled and perhaps should handle the global financial crisis".

One of Steven's observations Pascoe highlighted was the increase in public debt due to the GFC:

And then there was another “it’s not about Australia” observation by the governor that nonetheless is worth remembering in the local political context:

“One of the difficulties has been that public debt burdens rose sharply. This was partly as a result of the cost of fiscal stimulus measures and bank recapitalisations in some cases, but it was mainly because of the depth of the downturn in economic activity.

"A financial crisis and deep recession can easily add 20 or 30 percentage points to the ratio of debt to GDP, and did so in a number of cases.”

If you don’t like the (relatively low) level of Australian government debt now, consider what it might be if we hadn’t “gone early and hard” with stimulus. 

And, no, it wasn’t just China that saved Australia from recession – one of the more obviously weird claims regularly made from the loonier edge of the right.

The immense wealth held in tax havens

Heather Stewart in Wealth doesn't trickle down – it just floods offshore, research reveals looks at a report about the vast wealth hidden away in tax havens.

Using the BIS's measure of "offshore deposits" – cash held outside the depositor's home country – and scaling it up according to the proportion of their portfolio large investors usually hold in cash, he estimates that between $21tn (£13tn) and $32tn (£20tn) in financial assets has been hidden from the world's tax authorities.

"These estimates reveal a staggering failure," says John Christensen of the Tax Justice Network. "Inequality is much, much worse than official statistics show, but politicians are still relying on trickle-down to transfer wealth to poorer people.

"This new data shows the exact opposite has happened: for three decades extraordinary wealth has been cascading into the offshore accounts of a tiny number of super-rich."

In total, 10 million individuals around the world hold assets offshore, according to Henry's analysis; but almost half of the minimum estimate of $21tn – $9.8tn – is owned by just 92,000 people. And that does not include the non-financial assets – art, yachts, mansions in Kensington – that many of the world's movers and shakers like to use as homes for their immense riches.

It seems this hurts poorer countries in particular. In many cases wealth hidden offshore exceeds the value of the debt such a country might have.

He corroborates his findings by using national accounts to assemble estimates of the cumulative capital flight from more than 130 low- to middle-income countries over almost 40 years, and the returns their wealthy owners are likely to have made from them.

In many cases, , the total worth of these assets far exceeds the value of the overseas debts of the countries they came from.

The struggles of the authorities in Egypt to recover the vast sums hidden abroad by Hosni Mubarak, his family and other cronies during his many years in power have provided a striking recent example of the fact that kleptocratic rulers can use their time to amass immense fortunes while many of their citizens are trapped in poverty.

The world's poorest countries, particularly in sub-Saharan Africa, have fought long and hard in recent years to receive debt forgiveness from the international community; but this research suggests that in many cases, if they had been able to draw their richest citizens into the tax net, they could have avoided being dragged into indebtedness in the first place. Oil-rich Nigeria has seen more than $300bn spirited away since 1970, for example, while Ivory Coast has lost $141bn.

Assuming that super-rich investors earn a relatively modest 3% a year on their $21tn, taxing that vast wall of money at 30% would generate a very useful $189bn a year – more than rich economies spend on aid to the rest of the world.

Australia's debt is fine

Greg Jericho in Is Australia's government debt really as bad as Tony Abbott claims? explains why Australian Government debt is not a cause for concern.

Bluntshovels calls austerity for what it is

In Austerity is bullshit El Gibbs writes that austerity isn't about reducing debt, it's "about a bunch of rich, mostly blokes, cutting the heart out of the social safety net".

Government debt - it's more complicated than what it seems

Bernard Keane and Glenn Dyer in Here’s the real story of Australian debt explain why Australia's debt is not a problem. They highlight that if Australia had tried to maintain surpluses during the GFC the country would probably have gone into recession. They also have concerns about future Governments:

The danger, as the continuing depression in Europe illustrates, comes if politicians take seriously the sort of cant about debt pushed by News Ltd and start treating budget outcomes and debt reduction as ends in themselves, rather than tools of economic management. A fiscal policy that goes beyond addressing the structural problems of our tax and spending frameworks to a cut-debt-at-all-costs policy not merely has the potential to drive the economy into recession, but it would risk thereby increasing what little debt problem we have through reduced economic growth and tax revenues.

But Eslake doesn’t see much danger from austerity-driven politicians. Instead, he is concerned that an incoming Coalition government, should one eventuate, will repeat the mistakes of the Fraser years and fail to use its position to drive necessary fiscal discipline. “Like the Fraser government, an Abbott government may be divided between a leader who distrusts markets, has little interest in economics and is actually contemptuous of economists, a National Party that has reverted to its traditional agrarian socialism, and reformist liberals like Hockey, Robb, Turnbull and Sinodinos.”

As it turns out, the world of debt is a lot more complicated than journalists and editors might have us believe.

Krugman on Cyprus

Paul Krugman has now written several articles on the current financial crisis in Cyprus.

In Hot Money Blues he ponders whether we might see a move to increase limits on international capital flows.

In Cyprus, Seriously he suggests that the best thing for Cyprus to do is to withdraw from the Euro.

A good article on American debt

Nobel laureate Robert M. Solow, emeritus professor of economics at the Massachusetts Institute of Technology,explains why US Government debt does and doesn't matter: Our Debt, Ourselves.

Why Government debt isn't necessarily bad

In Avoiding the B word the Mainly Macro blog gives an imaginary interview explaining why Government debt can be good.

Growing income equality may harm the economy

Jonathan Rauch has written an essay called Inequality and Its Perils:

Emerging research suggests that the growing gap between rich and poor harms the U.S. economy by creating instability and suppressing growth. 

The essay appears to argue three points:

• Rising inequality reduces demand within the economy. This is because the rich tend to spend a smaller proportion of their income than those on lower incomes.
• To make up for this lower demand, Governments and banks ease credit requirements, thus creating a credit splurge.
• All the income at the top needs somewhere to go. It tends to end up in the financial markets and other forms of investment with high liquidity. In the US the financial sector ended up making up around 40% of the total profits in the economy. To quote the essay: "Alas, when the recession struck, the financial sector’s gigantism and complexity helped turn what might have been a brush fire into a meltdown."

This all results in an unstable economy that far from being resilient to shocks actually amplifies them.

Why monetary policy isn't working and fiscal consolidation will makes things worse

In Monetary policy, The broken transmission mechanism The Economist has a great article on why monetary policy is not working in the USA and Europe:

SINCE the crisis hit in 2008, there has been a sharp divide between those who believe that the monetary authorities have been insufficiently aggressive and those who believe that central banks have done everything possible given that households and businesses have no interest in taking on new debts. For what it’s worth, a poll of more than 300 research associates at America’s National Bureau of Economic Research conducted for an article in the print edition reveals that the overwhelming majority (76%) believe that monetary policy has not been too tight. Nearly half believe that fiscal rectitude has been a principal cause of the slow recovery.

The article then goes on to explain why monetary policy hasn't been effective. It concludes with:

None of this is to say that asset purchases, statements about the future path of inflation and nominal income, or interventions in the foreign exchange markets will have literally no effect. However, it seems clear that current circumstances are causing these monetary policy actions to be far less effective than they otherwise would be. Marginal spenders are constrained by their desire (or need) to retrench. Most of the people who get the biggest benefit from central bank action are the people who already own lots of financial assets (the rich).

The fiscal authorities need to step up and do the job that the central banks cannot. Specifically, by running large budget deficits, governments can maintain the total level of spending in the economy while allowing households and businesses to repay their debts and accumulate savings. This is not a new insight, but it has gained popularity in the last few years thanks to the work of Richard Koo, the chief economist of the Nomura Research Institute who coined the term “balance sheet recession” to describe what happened to Japan after the collapse of its asset bubble in the early 1990s. (The paper is well worth reading in full.) Unfortunately, many governments across the globe seem more concerned with the abstract goal of balancing their budgets than with the important task of restoring their economies to health.

Recommended reading, as is the paper by Richard Koo in the above link. Here's where Koo explains how problems caused by the GFC could cause a depression if not correctly treated:

More importantly, when the private sector deleverages in spite of zero interest rates, the economy enters a deflationary spiral because, in the absence of people borrowing and spending money, the economy continuously loses demand equal to the sum of savings and net debt repayments. This process will continue until either private sector balance sheets are repaired or the private sector has become too poor to save (i.e., the economy enters a depression).

To see this, consider a world where a household has an income of $1,000 and a savings rate of 10 percent. This household would then spend $900 and save $100. In the usual or textbook world, the saved $100 will be taken up by the financial sector and lent to a borrower who can best use the money. When that borrower spends the $100, aggregate expenditure totals $1,000 ($900 plus $100) against original income of $1,000, and the economy moves on. When demand for the $100 in savings is insufficient, interest rates are lowered, which usually prompts a borrower to take up the remaining sum. When demand is excessive, interest rates are raised, prompting some borrowers to drop out.

In the world where the private sector is minimizing debt, however, there are no borrowers for the saved $100 even with interest rates at zero, leaving only $900 in expenditures. That $900 represents someone’s income, and if that person also saves 10 percent, only $810 will be spent. Since repairing balance sheets after a major bubble bursts typically takes many years — 15 years in the case of Japan — the saved $90 will go un-borrowed again, and the economy will shrink to $810, and then $730, and so on.

This is exactly what happened during the Great Depression, when everyone was paying down debt and no one was borrowing and spending. From 1929 to 1933, the U.S. lost 46 percent of its GDP mostly because of this debt-repayment-induced deflationary spiral. It was also largely for this reason that the U.S. money supply shrank by nearly 30 percent during the four-year period.

The discussion above suggests that there are at least two types of recessions: those triggered by the usual business cycle and those triggered by private sector deleveraging or debt minimization. Since the economics profession never considered the latter type of recession, there is no name for it in the literature. In order to distinguish this type of recession from ordinary recessions, it is referred to here as a balance sheet recession. Like nationwide debt-financed bubbles, balance sheet recessions are rare and, left untreated, will ultimately develop into a depression.

Koo also makes a very important point:

Flow of funds data for the U.S. (Exhibit 9) show a massive shift away from borrowing to savings by the private sector since the housing bubble burst in 2007. The shift for the private sector as a whole represents over 9 percent of U.S. GDP at a time of zero interest rates. Moreover, this increase in private sector savings exceeds the increase in government borrowings (5.8 percent of GDP), which suggests that the government is not doing enough to offset private sector deleveraging.

Koo later writes:

Countries in balance sheet recessions such as Spain are desperately in need of fiscal stimulus but are unable to take advantage of the rapid increase in domestic savings and are therefore forced to engage in fiscal conso lidation of their own. That causes the aforementioned $100 to be removed from the income steam, prompting a deflationary spiral. And since the countries receiving those savings are not borrowing and spending them, the broader eurozone economy is rapidly weakening. It is no wonder that the Spanish unemployment rate is over 21 percent and Irish GDP has fallen more than 10 percent from its peak.

Fund flows within the eurozone were following the opposite pattern until just a few years ago. Banks in Germany, which had fallen into a balance sheet recession after the telecom bubble collapsed in 2000, aggressively bought the debt of southern European nations, which were denominated in the same currency but offered higher yields than domestic debt. The resulting capital inflows from Germany poured further fuel onto the fire of housing bubbles in these countries.

There is thus a tendency within the eurozone for fund flows to go to extremes. When times are good, funds flow into booming economies in search of higher returns, thereby exacerbating the bubbles. When the bubbles finally burst, the funds shift suddenly to the countries least affected by the boom.

The problem with these shifts is that they are pro-cyclical, tending to amplify swings in the economy. Countries that are in the midst of a bubble and do not need or want additional funds experience massive inflows. Meanwhile, countries facing balance sheet recessions and in need of funds can only watch as money flows abroad, preventing their governments from implementing the fiscal stimulus needed to stabilize the economy.

[...]

One way to solve this eurozone-specific problem of capital shifts would be to prohibit member nations from selling government bonds to investors from other countries. Allowing only the citizens of a nation to hold that government’s debt would, for example, prevent the investment of Spanish savings in German government debt. Most of the Spanish savings that have been used to buy other countries’ government debt would therefore return to Spain. This would push Spanish government bond yields down to the levels observed in the U.S. and the U.K., thereby helping the Spanish government implement the fiscal stimulus required during a balance sheet recession.

The Maastricht Treaty with its rigid 3 percent GDP limit on budget deficits made no provision for balance sheet recessions. This is understandable given that the concept of balance sheet recessions did not exist when the Treaty was being negotiated in the 1990s. In contrast, the proposed new rule would allow individual governments to pursue autonomous fiscal policies within its constraint. In effect, governments could run larger deficits as long as they could persuade citizens to hold their debt. This would both instill discipline and provide flexibility to individual governments. By internalizing fiscal issues, the new rule would also free the European Central Bank from having to worry about fiscal issues in individual countries and allow it to focus its efforts on managing monetary policy.

In order to maximize efficiency gains in the single market, the new restriction should apply only to holdings of government bonds.  German banks should still be allowed to buy Greek private sector debt, and Spanish banks should still be allowed to buy Dutch shares.

In retrospect, this rule should have been in place since the beginning of the euro. If that were the case, none of the problems the eurozone now faces would have materialized. Unfortunately, the euro was allowed to run for more than ten years without the rule, accumulating massive imbalances along the way. It may take many years to undo the damage. 

Koo concludes with:

It is laudable for policy makers to shun fiscal profligacy and aim for self-reliance on the part of the private sector. But every several decades, the private sector loses its self-control in a bubble and sustains heavy financial injuries when the bubble bursts. That forces the private sector to pay down debt in spite of zero interest rates, triggering a deflationary spiral. At such times and at such times only , the government must borrow and spend the private sector’s excess savings, not only because monetary policy is impotent at such times but also because the government cannot tell the private sector not to repair its balance sheet.

Although anyone can push for fiscal consolidation in the form of higher taxes and lower spending, whether such efforts actually succeed in reducing the budget deficit is another matter entirely. When the private sector is both willing and able to borrow money, fiscal consolidation efforts by the government will lead to a smaller deficit and higher growth as resources are released to the more efficient private sector. But when the financial health of the private sector is so impaired that it is forced to deleverage even with interest rates at zero, a premature withdrawal of fiscal stimulus will both increase the deficit and weaken the economy. Key differences between the text book world and the world of balance sheet recessions are summarized in Exhibit 17.

With massive private sector deleveraging continuing in the U.S. and in many other countries in spite of historically low interest rates, this is no time to embark on fiscal consolidation. Such measures must wait until it is certain the private sector has finished deleveraging and is ready to borrow and spend the savings that would be left un-borrowed by the government under an austerity program.

There will be plenty of time to pay down the accumulated public debt because the next balance sheet recession of this magnitude is likely to be generations away, given that those who learned a bitter lesson in the present episode will not make the same mistake again. The next bubble and balance sheet recession of this magnitude will happen only after we are no longer here to remember them.

Koo has written a great paper. Compulsory reading.

Paul Krugman on European austerity

It seems that too many policy makers and advisors have forgotten the errors of the great depression. But not Paul Krugman. In Europe’s Austerity Madness Krugman argues that all austerity is doing is inflicting additional pain on those that are already hurting. Why is this happening?

Part of the explanation is that in Europe, as in America, far too many Very Serious People have been taken in by the cult of austerity, by the belief that budget deficits, not mass unemployment, are the clear and present danger, and that deficit reduction will somehow solve a problem brought on by private sector excess.

Beyond that, a significant part of public opinion in Europe’s core — above all, in Germany — is deeply committed to a false view of the situation. Talk to German officials and they will portray the euro crisis as a morality play, a tale of countries that lived high and now face the inevitable reckoning. Never mind the fact that this isn’t at all what happened — and the equally inconvenient fact that German banks played a large role in inflating Spain’s housing bubble. Sin and its consequences is their story, and they’re sticking to it.

Worse yet, this is also what many German voters believe, largely because it’s what politicians have told them. And fear of a backlash from voters who believe, wrongly, that they’re being put on the hook for the consequences of southern European irresponsibility leaves German politicians unwilling to approve essential emergency lending to Spain and other troubled nations unless the borrowers are punished first.

Recommend reading.

Krugman on the need for debt and deficit

Paul Krugman, in Money for Nothing, explains why Government debt and deficits are not currently a problem in the USA and why interest rates on that debt has gone down. He does on to write:

So what is going on? The main answer is that this is what happens when you have a “deleveraging shock,” in which everyone is trying to pay down debt at the same time. Household borrowing has plunged; businesses are sitting on cash because there’s no reason to expand capacity when the sales aren’t there; and the result is that investors are all dressed up with nowhere to go, or rather no place to put their money. So they’re buying government debt, even at very low returns, for lack of alternatives. Moreover, by making money available so cheaply, they are in effect begging governments to issue more debt.

And governments should be granting their wish, not obsessing over short-term deficits.

Obligatory caveat: yes, we have a long-run budget problem, and we should be taking steps to address that problem, mainly by reining in health care costs. But it’s simply crazy to be laying off schoolteachers and canceling infrastructure projects at a time when investors are offering zero- or negative-interest financing.

You don’t even have to make a Keynesian argument about jobs to see that. All you have to do is note that when money is cheap, that’s a good time to invest. And both education and infrastructure are investments in America’s future; we’ll eventually pay a large and completely gratuitous price for the way they’re being savaged.

That said, you should be a Keynesian, too. The experience of the past few years — above all, the spectacular failure of austerity policies in Europe — has been a dramatic demonstration of Keynes’s basic point: slashing spending in a depressed economy depresses that economy further.

I think it's worth emphasising Krugman's point that the USA needs to do something about their deficit, but not now. Right now they need to stimulate their economy, not depress it.

Krugman on the cause of Europe's woes

Paul Krugman in Rogoff's Bad Parable writes that, apart from Greece, the cause of southern Europe's financial problems were huge private capital inflows rather than Government debt. Indeed, Government debt to GDP had been falling prior to the crisis.

What brought on the crisis were huge private capital inflows. Don’t think runaway politicians; think German Landesbanken lending money to Spanish cajas, fueling a real estate bubble.

So what was the big problem with the euro? Not so much that it promoted these flows; it probably did, but the GIPSIs aren’t the first economies bond markets have temporarily loved not wisely but too well. No, the key problem is lack of a way to adjust when the music stopped.

Michael Pascoe on the Greek tragedy

Last year Michael Pascoe wrote an interesting article on the economic crisis in Greece The Greek tragedy - shoot the chorus. Ever so often I go looking for it so I can send it to other people. As I can't find where I've referenced it before I'm going to do so here so hopefully I can easily find it in the future.

The welfare state did not cause the Euro crisis

On the We are all dead blog Matt Cowgill has written that The welfare state is not to blame for the Euro crisis. It's an interesting post that shows that the idea that the "Euro crisis is a crisis of the welfare state, caused by high taxes and/or welfare spending as a proportion of GDP" is just plain wrong. In a series of graphs Matt shows that the assertion that "European countries tax & spend too much, and that the bond markets have finally stopped the party" is false.

Matt notes that:

The European sovereign debt crisis is about a currency area that encompasses too many diverse regions, with too little fiscal integration and weak oversight. It’s about a central bank that is reluctant (or unable, depending on your point of view) to play the role of lender of last resort. In the case of Greece, yes, it’s about a government that spent too much, taxed too little, and fiddled its books to hide its deficit. But look at Ireland: it’s a low-tax, low-spending country that was held up as a paragon of fiscal virtue by conservatives before 2007. George Osborne declared Ireland to be “a shining example of the art of the possible in long-term economic policymaking.”

The crisis is not about the welfare state. I can’t understand Carr’s motivation in suggesting otherwise.

This is a blog post well worth reading, but then so it the rest of Mark's blog.

Ross Gittins on Economic History and Debt

Ross Gittins has written an interesting article discussing the findings of the book This Time Is Different: Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff.

According to Gittins, the authors of the book studied financial crisis going back more than 800 years and found many that history seems to repeat:

In their landmark study of hundreds of financial crises in 66 countries over 800 years, Reinhart and Rogoff find oft-repeated patterns that ought to alert economists when trouble is on the way. One thing stops them waking up in time: their perpetual belief that ''this time is different''.

But, as we're witnessing at present, even when economists and financial market players have been hit over the head by reality, their ignorance of history stops them understanding what happens next. Wall Street and Europe fondly imagined the Great Recession was behind them, only to discover it's still rolling on.

So the current problem with sovereign debt was eminently predictable if people had been familiar with similar crisis of the past.

The authors say a more accurate name would be the Second Great Contraction. ''The aftermath of systemic banking crises involves a protracted and pronounced contraction in economic activity and puts significant strains on government resources,'' they say.

They show that, in the run-up to America's subprime crisis, standard indicators such as asset price inflation, rising leverage (debt relative to the value of assets), large sustained current account deficits on the balance of payments and a slowing trajectory of economic growth exhibited virtually all the signs of a country on the verge of a severe financial crisis.

Gittins then points out that the culprit is not just greed but excessive debt.

The authors' studies lead them to a different culprit: debt. Credit is crucial to all economies, ancient and modern. Progress would be a lot slower without it. So the point is not that credit is bad, but that it's dangerous stuff.

''Balancing the risks and opportunities of debt is always a challenge, a challenge policymakers, investors and ordinary citizens must never forget,'' the authors say.

But ''if there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by government, banks, corporations or consumers, often poses greater systemic risks than it seems during a boom.

''Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are.''

It seems that sovereign debt defaults aren't as unusual as we think.

We've come to believe sovereign debt defaults are unthinkable and extremely rare. This may be partly because ''a large fraction of the academic and policy literature on debt and default draws conclusions based on data collected since 1980''.

The book focuses on two particular forms of financial crises: sovereign debt crises and banking crises. The present global crisis began with failing banks and has now proceeded to the threat of sovereign debt default.

Which, having looked at more than a mere 30 years of data, we now discover is quite common. Had economists been researching the question with the diligence of Reinhart and Rogoff - who put most of their effort into assembling a massive database covering 66 countries for up to 800 years - they may have come up with a little statistic it would have been handy to know a bit earlier.

On average, government debt rises by 86 per cent during the three years following a banking crisis. And that's not the cost of the bank bailouts. It's mainly because banking crises ''almost invariably lead to sharp declines in tax revenues as well as significant increases in government spending''.

Gittins concludes that:

Had we known our history, it wouldn't have surprised us that, when you start with heavily indebted governments, a banking crisis soon leads to a sovereign debt crisis.

I guess debt is like explosives. If used well it can allow you to accomplish far more, but if handled carelessly it can destroy everything you've built.