The Global Debt Bomb: Crisis in Reality or in Thinking?

This month’s Recovery Partners’ Blog features a double-barreled treat: Direct access to the latest Ipsos Reid Global Advisor Analysis released just this morning, followed by commentary by Dr Lloyd Atkinson summarized from a speech he delivered in Toronto almost two months ago, and who, with his customary prescience, seems to have anticipated the very gloomy findings of the Ipsos Reid missive.

According to Canada’s leading pollster “If economists and others expected a full recovery rebound based on this trajectory they would be sadly mistaken. ….The theory goes that a rebound looks like an alphabet letter: a ‘V’ or a ‘U’ or maybe a ‘W’. However, what is evident now is a new letter: ‘L’. This flat line has had a long run now so we can actually add it to the lexicon. Clearly the region that is the worst is Europe for obvious reasons and if not for Germany’s constant and robust confidence, it would be a forgone basket case.”

Further, according to Ipsos Reid “By two months time we’ll probably know the measure of the malady. Let’s hope it’s a passing chill and nothing more” The full release of the survey findings and analysis are provided here and the Ipsos press release is here.

Scary stuff.

Now let’s turn to the summary of the address given by Lloyd.

THE GLOBAL DEBT BOMB: CRISIS IN REALITY OR THINKING?

By Lloyd Atkinson

The global debt problem  — especially the global sovereign debt problem – is so pervasive and severe that we are virtually guaranteed several years of sub-par growth characterized by low employment growth, low inflation, low interest rates and low overall stock-market returns.  About the only thing not likely to be low is financial market volatility.    But it is not the only possible outcome.  It could be so different, so much better, if our leaders were to adopt a very different approach, which I will discuss here  One warning however:, the policy prescriptions are so startlingly different from current policies virtually everywhere in the Western world that they are unlikely to be championed by most politicians or electoral majorities – at least for the next while.

Austere budget policies, in the form of expenditure cuts and/or tax increases, are the near-universal response to burgeoning government debt.  Look at Greece, Portugal, Spain, Italy – and virtually every other nation state in the European Union; look at the federal, provincial and municipal governments in Canada, and Federal and State & Local governments in the U.S.  As many critics have pointed out, the implementation of such austere policies may actually make the debt/deficit problems worse.  The proposed solution by those critics is clear: expand government spending and/or cut taxes to reinvigorate the economy.  The problem with this view is that there are circumstances when expansionary fiscal policies will work, and other circumstances when they will not.  Unfortunately, the debate over the matter almost never gets properly cast.

What was lost in all of this tumult – and which is still not understood by a great many commentators is that each of the peripheral Euro-zone countries had violated the most fundamental law of macroeconomics: it is not possible for any economy to sustain a level of total economy-wide spending larger that its total economy-wide income.  It can be done for a while – by borrowing or by printing money – but even those avenues have their limits: in the case of borrowing, the ultimate loss of confidence of lenders; and in the case of printing money, inflation, or in the extreme, hyperinflation.

We all need to be reminded of this basic fact: the total income available for distribution, or redistribution, is no more or less than the total value of its production of goods and services.  If fiscal actions undertaken by government have the consequential effect of causing total national spending to exceed total national income, the outcome will not be sustainable.  Borrowing, or, where available, printing money, are stopgap measures only. Either national spending has to be reined in, or total income increased in ways that are sustainable.

I am led to one ineluctable conclusion: Governments and their leaders can never see the writing on the wall until their backs are to it? Maybe that’s just human nature.

But is not the U.S. in more or less the same boat?   What is taking place there is one of the messiest fights ever over the proper role and size of government – a debate that has never really taken place in Europe, and I dare say, in Canada.  The U.S. tax code is a mess, and so are the Medicare and Medicaid programs.  But don’t doubt that they can be fixed in ways that are much easier than in Europe.  Second, the U.S. has the ability to print money – the most popular means these days being called “quantitative easing” (QE).  Indeed, since quantitative easing is all about the purchase of assets – toxic and otherwise – by the U.S. Fed in exchange for “money”, the U.S. Central bank has accumulated a huge portfolio of securities in the past few years.  And while the creation of money in that way was essential to the rescue effort following the 2008 crisis, there will come a day with the return of more normal financial market conditions when the Fed will have to unload its portfolio of securities which will present its own challenges.

Notwithstanding the extensive use of quantitative easing, and major fiscal stimulus, the U.S. economy has been performing sub-par.  In part this has to with the fact that the 2008 crisis hit the economy so hard that all these measures provided only partial offsets.  Monetary policy, in the form of near zero interest rates and quantitative easing, has been the only policy tool holding the whole thing together.

It would appear that Canada has fared quite well by comparison, the result in part of a more conservatively managed and regulated financial sector that has stood up well against the onslaught, and a good bit of luck, most notably the strengthening in commodity prices that provided much welcome offsets to the weaknesses taking place elsewhere in the economy.  But to acknowledge this good fortune, it would be wrong to conclude that all is well.  When one looks at the combined Federal, Provincial, Municipal debt/deficit totals, there is not a lot to brag about: as percentages of GDP, both are not much different from the U.S., and by further comparison with the U.S., we have a lot less tax wiggle room.

It should be apparent from this discussion that the task facing the world economy of righting the ship listing under the weight of global debt is indeed daunting.  But in truth, that is only the half of it!!  The globe not only must struggle with burdensome sovereign debt matters, it has to do it at the same time as it tries to meet the crushing new demands being imposed by the relentless aging of populations

The challenges posed to policymakers by aging populations are double barreled.  To meet the needs of the elderly, whose average life expectancy keeps advancing, ever greater resources must be provided by those who are producing the country’s goods and services – in other words, from those who are working.  However, over time, and at an increasingly rapid pace, the percentage of the population made up of workers will be shrinking.  To illustrate, Canada this year, for the first time, is experiencing more exits from its workforce than entrants.  And although today there are about 4 workers per 2 retirees, by 2030, the numbers will be 2 to 2.

Why are these ratios so important?  Because meeting the resource demands of the elderly must come from each country’s national income; that is, from the employed population.  The alternative?  To pare back the support for the elderly: cut social security payouts; cut health care benefits; cut other elderly programs; impose or expand inheritance taxes.    This would be construed as an assault on hard-earned entitlements.    And as the elderly continue to make up an increasingly large percentage of the eligible voters, this concentration of political power is unlikely to change dramatically even if the young get out to vote.

Virtually every major country is drowning in debt.  Debt service costs eat up huge amounts of the budget, a situation that can only get worse once interest rates move from their current emergency low levels to more normal levels as the economic picture stabilizes and then improves, as it most assuredly will – maybe four to five years down the road.  Because of a double whammy effect – continued sluggish growth as the world economy struggles to bring debt down to more manageable levels resulting in only a slower pace of sovereign debt growth, not a decline; and the gradual increase in interest rates as world growth strengthens, carrying with it further increases in sovereign debt to meet higher debt service costs – the overall debt burden has little or no prospect of being much lighter four or five years from now, unless economic growth were to speed up significantly.

So what is the prospect of a sharp advance in global growth in the years and decades ahead?

As far as labour force growth is concerned, the numbers almost everywhere promise to be low.  For decades the birth rates in most of the so-called developed world have been well below the 2.1 rate needed to replace the population. In any event, the point to be made is abundantly clear: if labour force growth is all we can rely on, then we are in for some very challenging times.  Bluntly put, it will not be possible to both service significantly larger amounts of government debt and meet the needs of an aging population without very material increases in taxes and/or sharp cuts in program spending.

This of course leads naturally to the discussion of productivity.  Improving productivity is, the only reliable and sustainable way of getting out of the mess we find ourselves in.  To get to 4% real growth in the economy year after year – which is what I estimate is necessary to throw up the revenue needed by government to meet current program requirements and service the debt –  means compound growth in labour productivity of almost 3% per year.  To achieve anywhere near that rate will be judged by some as near impossible given that, notwithstanding a great many government initiatives in that direction, including material cuts in corporate taxes, we in Canada have been able to eke out productivity gains of barely 0.5% annually for a long time.

A great many things can be done to improve production efficiency.  At the top of the list has to be business investment, the well-documented source of strong productivity growth over time and across countries.  Why business investment in Canada has been so weak in the past few years is a mystery to me, even after taking account of the uncertainties created by the financial crisis in 2008.  The strong Canadian dollar combined with the notable improvements in many business balance sheets should have been a much stronger spur to investment.  But it did not happen.

There is also much more that Government can do.  But in order to justify the more it could do, there first has to be a better acknowledgement of the magnitude of the daunting tasks we face to meet both the debt/deficit challenges and those of our aging population.  Only then could we set about the task of rooting out inefficiencies wherever we find them

The point of the whole exercise to improve productivity is that there will result a higher level of national income, and we are all aware that higher incomes generate higher tax revenues.

Sticking with the revenue theme, there is much more that governments could do to generate savings that could be used to meet the needs of the elderly and debt service/retirement.  Consider major reform of public sector pensions and benefits that have been talked about ad nauseum in the press; significantly raising the age of eligibility for CPP/QPP and OAS to possibly 75; rewriting the Canada Health Act to permit private enterprise.  This suggests that no one should kid himself that anything less than draconian measures will bring about the conditions necessary to meet the needs of current and future generations.  And as draconian as the measures must be here, rest assured they will be more gut-wrenching overseas in Europe.

Lloyd Atkinson is an economic superstar who offers authoritative perspectives on international economies, financial markets and global trends. A captivating speaker, he has the ability to explain complex issues in applicable, understandable terms.

For nine years, Dr. Atkinson served as Vice Chairman, Chief Investment Officer, and Chief Strategist at Perigee Investment Counsel Inc.

Prior to joining the investment management industry in 1994, Dr. Atkinson was Executive Vice-President and Chief Economist at the Bank of Montreal where he also served as the head of the bank’s Investment Committee of the Pension Fund Society. Previously, he spent four years working for the United States government in Washington, D.C., first as Senior Advisor at the Joint Economic Committee of the U.S. Congress, and then as Deputy Assistant Director of the U.S. Congressional Budget Office. He taught economics and finance at a number of American universities, including the University of Michigan and the University of Maryland, and has also served as a consultant to the U.S. delegations at the International Monetary Fund and the World Bank.

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