STUMBLING ON – FOR HOW MUCH LONGER?
It has become customary, as each New Year begins, for analysts and commentators to rush into print with forecasts of what they think is going to happen in the coming twelve months.
In wishing you all the very best for 2016, I have no intention of conforming to this pattern. Instead, I plan to investigate the structure of a global economy which has become addicted to borrowing.
In any case, where the economy is concerned, I do not claim to know when things are going to happen. After all – to quote Keynes – “markets can remain irrational longer than you can remain solvent”.
But I do think we know what has to happen, even if the timing is uncertain.
At some point, a global economy which has turned into a giant Ponzi scheme has to implode.
The Ponzi economy
That the world has turned its economy into a gigantic Ponzi scheme is surely beyond doubt. There seems no other way to describe a system that, as well as being massively indebted, can only function by adding yet more debt. The big problem isn’t so much the debt mountain itself as the inability to function without an uninterrupted diet of new credit.
During 2000-07, and excluding the purely inter-bank or “financial” sector, the world took on $38 trillion of new “real economy” debt, meaning that $2.20 had been borrowed for each $1 of reported “growth”. Since then, and despite a banking crisis which ought surely to have caused at least a pause for thought, we have borrowed $49 trillion, or $2.90 for each “growth” dollar.
Even these ratios, scary though they are, flatter to deceive, because the “growth” denominator is itself phoney. Such “growth” as has been reported has really amounted, of course, to nothing more than the spending of borrowed money.
What is striking is quite how inefficient and wasteful this is, and the waste is easy to see if you look at the main “borrow-to-grow” culprits.
Not all borrowing is wasteful, and a rational observer might have thought that the world’s biggest borrowers would at least have something to show for their borrowing binge. This new debt might have been invested in productive capacity or infrastructure, for example, or it might have been spent in pursuit of greater equality, or the improvement of social conditions.
In reality, the vast majority of this new debt has, instead, been wasted. The biggest borrower of recent years – China – has lavished borrowed money on capacity that nobody needs, whilst the Americans and the British, amongst many others, have poured money into inflating their property markets, and boosting consumption beyond what they can really afford.
As the old English song reminds us, “the Grand Old Duke of York” marched his 10,000 men up to the top of a hill, only to march them down again. This was a comparatively innocuous piece of futility – so far as we know, none of his men came to any harm, and the physical exercise may even have done them some good.
What the Duke’s modern successors have done, by contrast, has more in common with Humpty Dumpty – they have marched their economic troops up to a precipice from which the only way down is to fall.
The debt addicts’ club – open to all
In order to set the Ponzi economy into some context, let’s put some figures on it. In the United States, total “real economy” debt (which excludes inter-bank borrowing) increased by $19.4 trillion – in real, inflation-adjusted terms – between 2000 and 2014, whilst real GDP expanded by only $3.7 trillion. Britain, meanwhile, added £1.9 trillion of new debt for less than £400bn on “growth” over the same period.
I spent part of the holiday period unearthing quite how much debt countries added for each dollar of “growth” over a period starting at the end of 2000 and ending in mid-2015. Unsurprisingly, the league is topped by Portugal ($5.65 for each $1 of growth), Ireland ($5.42) and Greece ($5.39). Britain’s ratio ($3.46) is somewhat flattering, in that the UK has used asset sales as well as borrowing to sustain its consumption. The average for the Eurozone ($3.54) covers ratios as diverse as Germany (just $1.87) and France ($4.22). China’s $2.56 looks unexceptional until you note that the more recent (post-2007) number is much worse. Economies which seem to have been growing without too much borrowing (such as Brazil and Russia) are now experiencing dramatic worsening in their ratios, generally in the wake of tumbling commodity prices.
In the proverbial nutshell, then, the world has become addicted to borrowing money, spending it, and passing this off as “growth”. This is a copybook example of a pyramid scheme, which in turn means that the world’s most influential economic mentor is neither Keynes nor Hayek, but Charles Ponzi.
The descent into irrational economics
The stages in which this madness has developed are instructive in themselves. In the 1990s, when growth was quite robust, the main formative influences were ultra-cheap energy, technological innovation and the opening up of the former Soviet economies. From 2000 to 2007, a deceleration in underlying growth was masked by escalating indebtedness, with countries like America, Britain, Ireland, Greece and many others blatantly using borrowed money to boost consumption.
By 2008, debt had become so excessive that the world economy ground to a halt. This was when, on any rational analysis, deleveraging was required. However, and far from retrenching, the world adopted cheap money policies instead, most notably by using money created out of the ether to inflate capital markets and thus manipulate yields (the market cost of borrowing) down to artificially low levels.
Clearly, there are two main aspects to this collective madness. The first of these is a deterioration in underlying (that is, non-borrowed) economic expansion, whilst the second is a propensity to try to rig the growth equation by borrowing.
We have pondered the lack-of-growth issue here before, and the main factors in the deterioration seem to have been higher energy and commodity prices, and a growing preference for speculative rather than earned gain.
On the former, expansion in the emerging economies – and Western economic consumption increasingly funded by debt – created big rises in commodity demand, which in turn drove the prices of energy, minerals and food sharply higher.
As for the latter, why bother with the effort and risk of investing and innovating when, with the full encouragement of the government, you could make money effortlessly, and seemingly without risk, just by making leveraged bets on property and other asset markets?
To put it another way, it would be illogical to expect innovation-based growth in a system which instead promotes the speculative.
Where borrowing is concerned, several causal factors can be identified. One of these is globalisation. Let me be clear that there is nothing wrong in principle in transferring production from costly, increasingly-inefficient Western countries to more innovative and cost-effective locations in the emerging world.
What was gravely mistaken, however, was trying to reduce production in the mature economies whilst maintaining, or even increasing, those same countries’ consumption. The big corporates that drove globalisation wanted the inherent contradiction of low-paid workers who are also big-spending consumers, a paradox that Henry Ford, for one, knew to be nonsense.
In an effort to tackle the disconnect between poorly-paid workers and big-spending consumers, a resort to debt became inevitable, at least in the absence of far-sighted restraint exercised by the authorities. This process began with the recycling of emerging economies’ surpluses into the pockets of Western consumers, something which was promoted not only by a profit-hungry banking system but also by policymakers whose creed of “light-touch” regulation blinded them to the implications of basing growing consumption on ever-increasing debt.
By the time of the banking crisis, the practice of borrowing-to-consume – in macroeconomic terms, passing off the spending of borrowed money as “growth” – had become not just habitual but addictive. Such was the scale of global debt in 2008 that cutting the cost of borrowing became the only way of staving off mass default. Of course, making borrowing ever cheaper might be intended to keep already-overstretched debtors afloat, but it also makes further borrowing virtually inevitable.
No way down?
In short, Ponzi economics has taken on a momentum of its own, and today’s economic troops keep marching up the debt hill because, unlike the Grand Old Duke, no-one knows how to march them back down again.
The world’s capital markets mirror a global economy in which debt is enormous and real growth is in very short supply. The market value of capital assets looks inflated on any rational analysis which equates the value of an asset to the stream of income to be expected from that asset over time.
The global economic problem is analogous to the old lady who lives in a big house but has very little money coming in. Like her, the global economy is “asset-rich, income-poor”. The old lady could, of course, sell her large property, but this option is not open to a global economic system whose assets can only be sold to their existing owners.
Property markets are a classic instance of this problem. If you multiply the average price of a nation’s properties by the number of those properties, you can come up with a very impressive asset value for the housing stock as a whole. The snag, of course, is that the only people to whom this housing stock could be sold are the people who already own it.
This makes the supposed aggregate “value” of the housing stock purely notional or, to be more blunt about it, all but non-existent.
Obvious though this is, it has not prevented many countries and many millions of people from believing themselves to be wealthy when this is simply not the case.
Britain is a good – by which, of course, I mean a bad – example of this delusion. Property prices have escalated, which can make a theoretical national balance sheet (and the balance sheets of individual households) look comfortingly impressive. Take away the purely notional and unrealisable value of the housing stock, however, and you arrive at a situation in which most of the asset side of the equation does has no saleable value, whilst the debts and other liabilities are all too real.
I use Britain as an example of this situation because the illusion of prosperity founded on inflated, unrealisable asset values masks a very hazardous reality, in which debts are enormous, reported output numbers flatter to deceive, the structure of the economy is seriously unbalanced, and a dependency on sustaining consumption by selling assets and borrowing from abroad is not sustainable within any realistic definition of that term.
But the UK is simply a microcosm of a much broader economic problem. Periodic wobbles in global capital markets are an inevitable symptom of a situation in which asset values are inflated whilst, at the same time, the global economy’s only real engine of growth – China – has certainly decelerated, even if it has not come off the rails altogether.
A bang, not a whimper
How, in the absence of growth, can inflated capital values be sustained? The answer, of course, is that they can’t. Like all Ponzi schemes, this ends with a bang, not a whimper.
This is why I find forecasts of a ‘big fall’ or ‘sharp correction’ in markets hard to swallow. Ponzi schemes don’t end gradually, any more than someone can fall off a cliff gradually, or be “slightly pregnant”. The Ponzi economy simply continues for as long as irrationality prevails, and then implodes.
Capital markets, though, are the symptom, not the cause. The fundamental problem is an inability to escape from an addictive practice of manufacturing supposed “growth” on the basis of borrowed money.
The authorities – like the much-maligned Duke – might find a way of marching the economy back down the hill.
But such rational retreats are rarely, if ever, how Ponzi schemes end