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Repent at Leisure a Special Report on Debt June 26Th 2010

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Repent at Leisure a Special Report on Debt June 26Th 2010 Repent at leisure A special report on debt June 26th 2010 Debt.26.06.10.indd 1 15/06/2010 15:45 The Economist June 26th 2010 A special report on debt 1 Repent at leisure Also in this section Paradise foreclosed The boom has left Florida with an excess of houses, shops and debt. Page 3 The morning after A $3 trillion consumer hangover. Page 4 Betting the balance­sheet Why managers loaded their companies with debt. Page 6 A better bust? Bankruptcy is becoming less calamitous. Page 8 The unkindest cuts Many countries face the dicult choice of upsetting the markets or upsetting their voters. Page 9 Judging the judges Borrowing has been the answer to all economic troubles in the past 25 The travails of the rating agencies. Page 11 years. Now debt itself has become the problem, says Philip Coggan AN is born free but is everywhere in duce euphoria. Traders and investors saw In a hole Mdebt. In the rich world, getting hold the asset•price rises it brought with it as Stagnation, default or ination await. The of your rst credit card is a rite of passage proof of their brilliance; central banks and only way out is growth. Page 12 far more important for your daily life than governments thought that rising markets casting your rst vote. Buying your rst and higher tax revenues attested to the home normally requires taking on a debt soundness of their policies. several times the size of your annual in• The answer to all problems seemed to come. And even if you shun the tempta• be more debt. Depressed? Use your credit tion of borrowing to indulge yourself, you card for a shopping spree because you’re are still saddled with your portion of the worth it. Want to get rich quick? Work for national debt. a private•equity or hedge•fund rm, using Throughout the 1980s and 1990s a rise borrowed money to enhance returns. in debt levels accompanied what econo• Looking for faster growth for your com• mists called the great moderation, when pany? Borrow money and make an acqui• growth was steady and unemployment sition. And if the economy is in recession, and ination remained low. No longer did let the government go into decit to bolster Western banks have to raise rates to halt spending. When the European Union consumer booms. By the early 2000s a countries met in May to deal with the Acknowledgments vast international scheme of vendor • Greek crisis, they proposed a ¤750 billion Apart from those quoted in the text, special thanks go to nancing had been created. China and the ($900 billion) rescue programme largely Mark Adelson, Thorhallur Arason, Wayne Archer, Amy Baker, Ken Baird, Jon Baldvin, Joe Carson, George Cooper, oil exporters amassed current•account sur• consisting of even more borrowed money. Richard Duncan, Sebastien Eisinger, Kathleen Gallagher pluses and then lent the money back to the Debt increased at every level, from con• McIver, Sigurdur Gudjonsson, Alan Hudson, Jon Jonsson, developed world so it could keep buying sumers to companies to banks to whole Matt King, Gyl Magnusson, Arnaud Mares, Richard McGuire, Brian Peters, John Psaropolous, William their goods. countries. The e ect varied from country Rizzetta, James Russell, Je rey Sacks, Maarten Those who cautioned against rising to country, but a survey by the McKinsey Slenderbroek, Peter Spratt, Jon Taylor, Richard Tett, debt levels were dismissed as doom•mon• Global Institute found that average total Loukas Tsoukalis, Arsaeli Valfells, Barrie Wilkinson, Martin Winn and Mike Zelouf. gers; after all, asset prices were rising even debt (private and public sector combined) faster, so balance•sheets looked healthy. in ten mature economies rose from 200% A range of additional charts and a list of sources are at And with the economy buoyant, debtors of GDP in 1995 to 300% in 2008 (see chart 1, Economist.com/specialreports could a ord to meet their interest pay• next page, for a breakdown by country). ments without defaulting. In short, it paid There were even more startling rises in Ice• An audio interview with the author is at to borrow and it paid to lend. land and Ireland, where debt•to•GDP ra• Economist.com/audiovideo/specialreports Like alcohol, a debt boom tends to in• tios reached 1,200% and 700% respectively. 1 2 A special report on debt The Economist June 26th 2010 2 The burdens proved too much for those only way they can maintain their desired two countries, plunging them into nan• level of spending. Another reason is opti• It’s a drag 2 cial crisis. Such turmoil is a sign that debt is mism; they believe the return on the bor• US GDP growth in $ per additional $ of debt* not the instant solution it was made out to rowed money will be greater than the cost be. The market cheer that greeted the EU of servicing the debt. Crucially, creditors 1.0 package for Greece lasted just one day be• must believe that debtors’ incomes will 0.8 fore the doubts resurfaced. rise; otherwise how would they be able to From early 2007 onwards there were pay the interest and repay the capital? 0.6 signs that economies were reaching the But in parts of the rich world such opti• 0.4 limit of their ability to absorb more bor• mism may now be misplaced. With ageing rowing. The growth•boosting potential of populations and shrinking workforces, 0.2 debt seemed to peter out. According to their economies may grow more slowly 0 Leigh Skene of Lombard Street Research, than they have done in the past. They may 1956 70 80 90 2000 10 each additional dollar of debt was associ• have borrowed from the future, using debt Sources: Bureau of Economic *All domestic ated with less and less growth (see chart 2) to enjoy a standard of living that is unsus• Analysis; Federal Reserve; non-financial debt The Economist 3-year moving average tainable. Greece provides a stark example. Stopping the debt supercycle Standard & Poor’s, a rating agency, esti• The big question is whether this rapid mates that its GDP will not regain its 2008 rather than Forgive us our trespasses. build•up of debta phenomenon which level until 2017. The Live 8 campaign in 2005 tried to Martin Barnes of the Bank Credit Analyst, Rising government debt is a Ponzi shame developed nations into forgiving a research group, has dubbed the debt su• scheme that requires an ever•growing pop• the debts of poor countries, particularly in percyclehas now come to an end. Debt ulation to assume the burdenunless sub•Saharan Africa. Economists have de• reduction has become a hot political issue. some deus ex machina, such as a techno• veloped the concept of odious debt in Rioters on the streets of Athens have been logical breakthrough, can boost growth. As which citizens should not be forced to re• protesting against the junta of the mar• Roland Nash, head of research at Renais• pay money borrowed by tyrannical or kets that is imposing austerity on the sance Capital, an investment bank, puts it: kleptocratic rulers. Interest payments on Greek economy, and tea•party activists in Can the West, with its regulated industry, debt are often regarded as an onerous bur• America, angry about trillion•dollar de• uncompetitive labour and large govern• den placed on the poor; interest is seen as cits and growing government involvement ment, a ord its borrowing•funded living an unjustied reward for capital, a concept in the economy, have been upsetting the standards and increasingly expensive pub• that goes back to Aristotle and is implicit in calculations of both the Democratic and lic sectors? the Christian idea of usury. Islam forbids it Republican party leaderships. Sovereign default is far from inconceiv• altogether. The book of Deuteronomy sug• To understand why debt may have be• able. Many people are forecasting that gested a debt amnesty every seven years, come a burden rather than a boon, it is nec• Greece, despite its bail•out package from which survived into later Jewish custom. essary to go back to rst principles. Why the EU and the IMF, will be unable to repay But conventional morality has not al• do people, companies and countries bor• its debts in full and on time. Faced with the ways been on the side of the borrowers. row? One obvious answer is that it is the choice between punishing their popula• Some regard debt as the road to ruin and tions with austerity programmes and let• the failure to repay as a breach of trust. In ting down foreign creditors, countries may the 18th and 19th century debtors in Britain Owe dear 1 nd it easier to disappoint the foreigners. were often thrown into jail (as in Charles Debt as % of GDP, 2008 Defaults have been common in the past, as Dickens’s Little Dorrit), though Samuel Financial* Non-financial businesses Carmen Reinhart and Ken Rogo showed Johnson spotted the aws of the practice: Households Government in their book, This Time is Di erent. We have now imprisoned one generation Adam Smith, a founding father of econom• of debtors after another, but we do not nd 0 100 200 300 400 500 ics, noted in The Wealth of Nations that that their numbers lessen. We have now Japan when national debts have once been ac• learned that rashness and imprudence † Britain cumulated to a certain degree, there is will not be deterred from taking credit; let Spain scarce, I believe, a single instance of their us try whether fraud and avarice may be South Korea having being fairly and completely paid.
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