Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.
– Charles Dickens, David Copperfield
The McKinsey Global Institute recently released a very interesting report titled Debt and (not much) deleveraging. In this report they found that between 2007 and the second quarter of 2014, the total global debt had grown by $57 trillion. The total global debt as of the second quarter of 2014 stood at $199 trillion or 286% of the global GDP.
In 2007, the total global debt had stood at $142 trillion or 269% of the global GDP. This means an increase in debt at the rate of 5.3% per year. What is interesting is the comparison between 2000 and 2007, which allows us to analyse the increase between 2007 and 2014 in a much better way.
In 2000, the total global debt was at $87 trillion or around 246% of the global GDP. Between 2000 and 2007, the global debt went up at the rate of 7.3% per year.
In comparison, the global debt between 2007 and 2014 has gone up by only 5.3%. Further, between 2000 and 2007, the total global debt went up by 2300 basis points to 269% of the global GDP. In comparison, between 2007 and 2014, the global debt went up by 1700 basis points to 286% of the global GDP. One basis point is one hundredth of a percentage.
So, yes the growth in debt has slowed down since 2007, but the debt is still growing. And that is something to worry about. As the McKinsey report points out: “Seven years after the global financial crisis, global debt and leverage have continued to grow. From 2007 through the second quarter of 2014, global debt grew by $57 trillion, raising the ratio of global debt to GDP by 17 percentage points [1700 basis points]. This is not as much as the 23-point increase [2300 basis points] in the seven years before the crisis, but it is enough to raise fresh concerns.”
In fact, the breakdown of the total global debt makes for fairly interesting reading. The growth in household debt has slowed down considerably to 2.8% per year between 2007 and 2014. Between 2000 and 2007 this was at 8.5% per year. This rapid increase in global debt was the major reason behind the global financial crisis.
In the aftermath of the financial crisis, the governments around the developed world have printed a lot of money to drive down interest rates, in the hope of people borrowing and spending more, and economic growth returning.
But that hasn't happened. People don't seem to be in the mood to make the same mistake again and end up with excess borrowing, as they had in the past.
While the rate of rise in household debt has slowed down considerably, the same cannot be said about government debt. The total government debt all around the world had stood at $33 trillion as of 2007. It has since jumped to $58 trillion, a jump of $25 trillion, at the rate of 9.3% per year.
During the period between 2000 and 2007, government debt had increased at the rate of 5.8% per year to $33 trillion (from $22 trillion).
Governments all around the world in the aftermath of the financial crisis have increased their expenditure, in the hope of reviving economic growth. The countries which were in the biggest mess in the aftermath of the financial crisis saw their governments raise the most amount of debt.
“Not surprisingly, the rise in government debt, as a share of GDP, has been steepest in countries that faced the most severe recessions: Ireland, Spain, Portugal, and the United Kingdom,” the McKinsey report points out.
This explains the dramatic jump in government debt since 2007. As the McKinsey report asks: “This raises fundamental questions about why modern economies seem to require increasing amounts of debt to support GDP growth and how growth can be sustained.”
In the past, very few countries have been able to repay their debt, once they have crossed a certain level. In fact, one of the rare occasions in history when a country did not default on its debt either by simply stopping repayment or through inflation was when Great Britain repaid its debt in the 19th century.
The country had borrowed a lot to finance its war with the American revolutionaries and then the many wars with France in the Napoleonic era. The public debt of Great Britain was close to 100 percent of the GDP in the early 1770s. It rose to 200 percent of the GDP by the 1810s.
It would take a century of budget surpluses run by the government for the level of debt to come down to a more manageable level of 30 percent of the GDP. (Budget surplus is a situation where the revenues of a government are greater than its expenditure.) Between 1815 and 1914, tax revenues of the British government exceeded its expenditure by several percent of the GDP. (Source: Thomas Piketty's Capital in the Twenty-First Century).
It is worth remembering here that this was during a time when Great Britain ruled large parts of the world.
There have been a few other examples of countries repaying their debt. In the aftermath of the Second World War, the total government debt in the United States was at 121% of GDP. In the United Kingdom it was at 238% of GDP. Both the countries brought down these huge ratios over the next two decades. The United States through strong economic growth and the United Kingdom through austerity i.e. the government cut down on its expenditure and hence, borrowed lesser.
In the recent past, Canada brought down its government debt level from 91% of GDP in 1995 to 51% in 2007. This happened because of strong global growth as well as commodity exports. But such examples are rare. The point being that countries more often than not tend to default once their debts reach high levels.
What does not help is the fact that most developed countries are not going to see fast economic growth in the foreseeable future.
As the McKinsey report points out: “To generate the growth needed to begin reducing government debt ratios in the most indebted nations today would require real GDP growth rates far higher than are currently projected. In our model, GDP in Spain, France, Portugal, the United Kingdom, and Finland would have to grow by two percentage points more than the current forecasts, reaching real growth rates of 3.6 to 5.5 percent a year. The Japanese economy would have to grow almost three times as fast as the consensus outlook—2.9 percent vs. 1.1 percent.”
So, it doesn't look like that economic growth will come to the rescue of the total global government debt. How about austerity?
In many parts of Europe, economic growth is likely to be negative in the near future. As Mark Blyth writes in Austerity—The History of a Dangerous Idea: “As the economy deflates, debts increase as incomes shrink, making it harder to pay off debt the more the economy craters. This, in turn, causes consumption to shrink, which in the aggregate pulls the economy down further and makes the debt to be paid back all the greater.”
In this environment if the government cuts down on its expenditure (and in the process its borrowing and absolute debt) it hurts the economy further. The private sector has cut down on its expenditure and if the government does the same, economic growth collapses further.
Taking all these factors into account it can safely be said that—all is not right on the global front.
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)
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Updated Date: Apr 07, 2015 17:29:53 IST