THE END OF LIVING-ON-TICK?
In the first part of this series, I explained, in outline, why the global economy resembles a giant Ponzi scheme. Here, I look at exposure to the unwinding of this unsustainable state of affairs.
The start of 2016 has witnessed sharp falls in equity markets around the world. It is much too early to say whether this marks the beginning of the end for Ponzi economics, so I must emphasise that the focus here is the fundamental issue of an economy built on passing off the spending of borrowed money as “growth”.
As there are two main dimensions to the global economic Ponzi, there are likely to be two main categories of economic impact when it implodes.
The first of these is the capital side, where two things have happened. We have created a debt mountain, much of which can never be repaid, and indeed can only be serviced thanks to extreme manipulation of the monetary system. At the same time, this borrowing binge has pushed up asset values (including equities, bonds and property) to extremely inflated levels
Pretty obviously, the collapse of “Ponzi economics” is likely to cause extensive defaults, combined with sharp falls in capital values.
This discussion looks at the second, perhaps less obvious consequence of the ending of the global economic Ponzi scheme. Logically, the ending of Ponzi economics may mean that those countries which are accustomed to living beyond their means may no longer be able to do so.
First, though, let’s recap, very briefly, on how the world economy has become a giant Ponzi scheme.
The Ponzi economy
As regular readers will know, I have long argued that we are living in a global economy that has mutated into a giant Ponzi scheme. Here, in brief, is why I believe this.
Between 2000 and 2007, global “real economy” debt (which excludes the inter-bank or “financial” sector) increased by $38 trillion, which equated to $2.20 of new debt for each $1 of reported “growth” in the economy.
In 2008, when the debt mountain brought the system close to collapse, the authorities worldwide responded with policies based on ultra-cheap money. Part of this strategy included the use of newly-created money to inflate capital markets, thereby driving down yields.
Between 2007 and 2014, and far from retrenching, the world borrowed a further $49 trillion which, at $2.90 for each “growth” dollar, was even worse than what had been happening before the crisis.
As the old saying has it, when you find you’re in a hole, you should stop digging. Where the global economy is concerned, however, this advice has been turned on its head.
Our response to finding ourselves in a hole has been to carry on digging – and the response of the authorities has been to hand out bigger shovels.
After excess borrowing created systemic risk, central banks responded by distorting monetary policy to support an over-indebted system. All along, we have routinely passed off the spending of borrowed money as “growth”, which in turn means that the growth-to-borrowing equation is, in reality, even worse than the numbers set out above.
Borrowing has become addictive, whilst speculation has extensively displaced investment and innovation as a way to make money.
After all, why would you bother to invest in starting a business – exposing yourself to risk, delay, uncertainty, regulation and taxation – when you could simply put money into assets and watch the authorities increase its value for you?
Meaningful downside – the end of living on tick
Pretty obviously, the Ponzi characteristics of the global economy imply a tendency to live beyond our means. I use two, essentially complementary methods of gauging the extent to which this is happening.
The first of these is the SEEDS system, a surplus energy economics tool which calculates underlying value created in the “real” economy of goods and services. The second is a “conventional” measure which compares economic growth with net changes in outstanding debt, to reveal the relationship between borrowing and growth.
To understand what is going on, it helps to distinguish between “two economies” – one of these is the “real economy” of goods and services, labour and resources, and the other is the “financial economy” of credit and debt. The gap between the two is the extent to which we are mortgaging the future. Since SEEDS categorises all money and credit as “claims” on the output of the real economy, the term “excess claims” is used to describe the gap between the “financial” and the “real” economies.
There has probably always been an “excess claims” element in the financial economy. It has become customary for us to live beyond our means to a limited extent, and there is nothing necessarily wrong with this anticipatory practice, so long as the excess is modest, which in turn means that “mortgaging the future” takes place at a level which is reasonable, and does not place an unrealistic burden on the economy of the future.
What has happened in recent years, however, has departed a long way from any definition of reasonable behaviour. In 2000 – but expressed at constant 2014 values – the financial economy exceeded the real one by almost $2 trillion, which meant that the world was “living beyond its means” to the tune of about 4% of global GDP. By 2008, and reflecting big growth in debt in the intervening years, this gap had widened, to $4.1 trillion, or 5.9% of GDP.
Far from retrenching in response to the banking crisis, the gap between the financial and the real economies has widened, according to SEEDS, to $5.9 trillion, which means that, in 2015, 7.8% of global GDP came from mortgaging the future. On current trends, this figure is set to reach 9.6% of GDP by 2020, and 11.8% by 2025, though the likelihood of the Ponzi economy surviving even until 2020 looks pretty remote.
The problem with this, of course, is not just that it is not sustainable, but also that the size of the “mortgage” taken out on the economic future keeps growing. Back in 2000, this accumulated “mortgage on the future” stood at $24 trillion, or 53% of global GDP. My estimate for the end of 2015 is $85 trillion, or 112% of GDP. Were the Ponzi economy to continue to 2020, the future would probably have been mortgaged to the tune of $120 trillion, or 150% of GDP.
Of course, within global totals, not every country lives beyond its means. Prior to the collapse in energy prices, major oil exporters (including the Gulf countries and Norway) were living within their means, something which was reflected in the Sovereign Wealth Funds (SWFs) that some of these countries had been able to accumulate.
Against this, some countries live beyond their means to an extent which far exceeds the global average.
One of the more striking examples of this is the United Kingdom. For 2014, the SEEDS system estimates the value of the UK real economy at £1.49 trillion, about £300bn smaller than reported GDP. This in turn implies that some 17% of British GDP is sourced from mortgaging the future.
Such numbers are not difficult to cross-reference to national data. In the British case, 2014 GDP was swelled by a near-£100bn current account deficit, which means that almost 6% of UK GDP in that year came courtesy of foreign creditors. A rather larger (£126bn) chunk of GDP resulted from a reporting component known as “imputed” rent – this may or may not be a legitimate way of measuring housing utility, but the important point is that it is a “non-cash” form of income. Most importantly, British borrowers took on an additional £107bn in debt during 2014, which exceeded the reported increase in nominal GDP.
The current government has tried to reduce the dependency on borrowing, but the structure of the economy remains biased towards activities financed by borrowing.
For many countries, borrowing at rates which far exceed reported growth has become a way of life (see table). Over the decade from 2004 to 2014, Britain borrowed £2.2 trillion for an increase in nominal GDP of £537bn, a borrowing-to-growth ratio of 4.0:1. The United States economy expanded by $5.1 trillion whereas debt increased by $19.7 trillion, a ratio of 3.9:1. The ratio for the Eurozone was 4.8:1, though this masked a range running from Germany’s 1.6:1 to Ireland’s double-digit ratio. The use of borrowing to create growth was markedly more modest in Russia (1.1:1), India (1.3:1), Brazil (1.6:1) and China (2.65:1).
These ratios do not necessarily correspond to the downside that countries can anticipate after the Ponzi economy has crashed, but they are useful indicators. Countries which habitually live far beyond their means face a rude awakening when this ceases to be viable modus vivendi.
In order to indicate the downside that economies may face if living on credit ceases to be a viable practice, the next table sets out indicative data for selected countries. These are ranked by estimated proportionate exposure.
Against reported GDP for 2014 is set the SEEDS calculation of the size of the real economy. Since this calculation includes estimates of economic rent for energy consumed, it tends to be lower than GDP, except where countries are major energy exporters, in which case they may be “owed” economic rent by importers. It is also adjusted for current account deficits or surpluses.
Taking France simply as an example, the difference between GDP (€2.13 trillion) and the real economy (€1.88 trillion) is €248bn. Of this, €20bn is the current account deficit, and the remaining €229bn is the estimated economic rent on energy consumed. The implied adjustment from the financial economy to the real economy is thus 12% of GDP.
For further comparison – and to reassure anyone who does not want to place undue reliance on SEEDS estimates of the underlying real economy – the table also includes the current account balance, and the relationship between growth and borrowing. Thus, foreign creditors contributed €20bn to French GDP in 2014, whilst nominal growth (of €16bn) was far exceeded by net new borrowing (€216bn).
The assumption being measured here is that the collapse of Ponzi economics means that it ceases to be feasible for countries to run a current account deficit, or to go on borrowing, either from abroad or with internally-created credit. On this basis, the French economy would shrink by 12% in a post-Ponzi environment.
As the table shows, Britain and Japan face the biggest potential downside amongst the economies listed here. In neither case is this altogether surprising. The UK runs a very large current account deficit, and has been a big net seller of assets, as well as a big borrower, over a lengthy period. Though the fiscal deficit is shrinking, official projections are predicated on an offsetting increase in private borrowing, and show widening deficits in the household sector.
The Japanese authorities, meanwhile, have opted for policies of exchange rate depreciation and huge QE in what might be regarded as a rather desperate attempt to escape from more than twenty years of economic stagnation.
It must be stressed that these estimates are indicative only, and that countries might well continue with internal debt creation in a post-Ponzi environment. Of course, these calculations are based on on-going wealth generation, not balance sheets, so do not include vulnerability to default.
This focus on income is intentional – heavily indebted countries might need to move into some form of default, but the really big and immediate problem likely to be posed by the implosion of Ponzi economics is the ending of an ability to run the economy on incremental credit.
In a post-Ponzi situation, pleasing creditors (by keeping to debt repayment schedules) is likely to be a much smaller and far less pressing challenge than living within straitened consumption, slumping investment, sharply reduced tax revenues and an inability to go on adding yet more debt. Sharp falls in capital markets, and especially in property prices, are also likely to have a severe chilling effect, especially in countries where price-to-earnings multiples are most extreme.
The conclusion, then, is that countries which have habitually run their economies on the basis of passing off borrowing as “growth” could be in for a rude awakening when the global economic Ponzi implodes.
How many governments, businesses or, indeed, individuals are aware of this risk is an interesting matter for conjecture.