How to get out of the debt trap – without printing more money
Andrew Sheng considers the policy options open to major economies, including China, to reduce debt, before another global crisis hits
All of us are worried about growing global debt as a precursor to another round of crises. After the last global financial crisis of 2007-2009, global debt rose to more than US$200 trillion, or US$27,000 for each person in the world. Since 2.8 billion people, or nearly 40 per cent of the total, live on US$2 per day, there is no way that the debt can ever be repaid. The bulk of debt owed by governments, banks and companies will be repaid by creating more debt. If we are happy to create money, we should be happy to create more debt. Right?
Wrong. The right question is not about the size of the debt or liability but, where is the net asset? Individually, we can always repay the debt if we spend less than we earn, or have invested in an asset that generates sufficient income to pay the interest. Collectively, governments can always borrow to repay. Countries only get into trouble when they owe foreigners and cannot raise enough foreign exchange to repay their debt.
Charles Goodhart, emeritus professor at the London School of Economics and one of the foremost thinkers on money and banking, has written a series of important articles for Morgan Stanley, analysing the current debt crisis. The reason we ended up with more debt than ever is due to three factors since 1970 – the willingness of the financial sector to lend, the increase in global savings relative to investment, and the demand for safe assets. Goodhart attributed the structural increase in savings to favourable demographics in the past 40 years.
This increase created a global savings glut, which meant lower real interest rates. The willingness of emerging markets to park their savings in advanced countries in the form of official reserves, and the banks’ willingness to extend credit at lower interest rates created the boom in “financialisation”. Lower interest rates encouraged speculative activity rather than investments in long-term productive projects.
When the bust occurred, the advanced central banks wanted to avoid a debt implosion and added to the bubble by lowering interest rates and flooded the markets with short-term liquidity. The quantitative easing stopped the crisis widening, but its initial success enabled politicians to avoid taking tough action on structural reforms. The result was slower growth from declining productivity, even as companies and governments continued to borrow. In short, we are in a debt trap.
Central banks are now actively using negative interest rates and are desperate enough to think about helicopter money. Negative interest rates as a policy tool was invented by small countries like Sweden and Switzerland to discourage large capital inflows that created excessive currency appreciation. But for the euro zone and Japan to try that would actually destroy their banks’ profitability, which is why bank shares dropped after these were introduced. If banks think they will lose money, they will cut lending to the real sector further, negating the objective of quantitative easing to stimulate growth.
Helicopter money is not about central bankers jumping out of helicopters to atone for their mistakes, but about central banks financing a massive increase in fiscal expenditure – monetary creation on a truly large scale. If this happens, watch out for a rise in gold prices.
Goodhart analyses three options for getting out of the debt trap. The first is to deleverge by swapping debt for equity, being tried by China. This is feasible when the country is a net lender and both borrowers and lenders are state-owned entities. The second option is to use inflation to reduce the real value of debt. As recent experience showed, getting inflation even up to target is tough. The third option is to induce lenders and borrowers to renegotiate their debt or make the debt permanent. This is both painful and difficult and is unlikely to be adopted.
For countries with net savings and large public assets, like China, there is a fourth option: rewrite the national balance sheet. After three decades of growth, China has also accumulated net assets equivalent to 166 per cent of gross domestic product. That can be injected as equity into the overleveraged enterprises and banks if – and only if – the governance and return on assets can be improved under better management. In the short term, a clean-up of the overleveraged enterprise sector and local government debt, embedded in the official and shadow banking system, will help sustain long-term stable growth.
Andrew Sheng writes on global affairs from an Asian perspective