Saturday, 2 January 2010

Is the Ponzi game over?

Does this story sound familiar?
  • Debt rose to unsustainable levels in 2007
  • Imbalances in the world economy reached unprecedented levels - the Chinese trade surplus approaching $1 trillion, American public deficits around half a trillion dollars...
  • Oil and other commodities soared to historic highs
  • The financial system became overleveraged on the assumption that a permanent era of stable growth had been reached; removing the margin of error for slowdowns
The whole system reached a high-water mark and fell back; banks and the rest of the financial industry were unable to cope with the failure of a few highly leveraged firms; and we ended up in an 18-month recession.

But is it true?

Why do we think that household debt at 150% of GDP, or oil at $150 a barrel, or US public debt of $10 trillion, is unsustainable?

I'm quite prepared to believe that enough people were worried about debt to stop accumulating more of it; and that this was a contributing factor to a slowing of monetary velocity which led to the recession.

But this doesn't mean the "correct" level of debt is whatever it was ten years, or twenty years, ago.

So it's logically conceivable that we are in a Ponzi game, as William Greider, via Brenda Rosser at Econospeak suggests. But why should this be the end of it?

None of the predictions outlined in Greider's book appear to have any quantitative component; they are pure narrative and completely untestable. And even if you believe in their plausibility, there's no way to know whether the unstable level of debt is 100%, 200% or 900% of GDP; whether the concentration of power he fears is 500, 100, 30 or 2 big companies; and whether the "eventual" end of the game he predicted was to come in 1995, 2008 or 2090.

Skip over the eccentric references to "huge military expenditures on the Vietnam War as well as through what is arguably, an accompanied global oil price hike that was deliberately manipulated to help pay for it" and ask yourself this question:

Does anyone have a theory which predicts a stable long-term level for public debt, private debt, Chinese trade surpluses, oil prices or the dollar exchange rate?

If not, then it's nonsense to suggest oil is "too expensive" or there's "too much debt". I'd be confident in placing a bet that in 2030, one of the figures mentioned in this article will be at least three times its current level. I don't know which one, but I know we need to lose our attachment to the nominal values of today's economic variables.

2 comments:

Anonymous said...

Interesting article. I have listened to the conservatives bang on about the public sector debt and the wailing and gnashing of teeth with increasing frustration. I have yet to hear anybody in the Conservative Party explain in a clear and logical fashion why the current level of debt is 'unsustainable'. Similarly, I really do not understand the haste with which they want to repay the debt; in the old days of banking there was a rule 'lend short, borrow long'. Surely it is better to repay at an easily affordable rate over a medium to long term, as opposed to rapid repayment using funds generated not from income, but through 'savings' created through redundancies and reduction in investment?

Leigh Caldwell said...

I'd agree with you broadly.

Having said that, there is a distinction between reducing the ongoing annual deficit (so we are not building up even more debt) versus repaying the debt that is already accumulated.

It is reasonable to say that in the long-term the government shouldn't incur new debt of 12% every year. But nobody is arguing for this anyway.

I'd say it's pretty safe for us to build up a 60, 70% or 80% public debt figure in the short term if it helps keep economic growth going. Growth (and inflation) will have a much bigger impact on making the debt affordable than any plausible amount of public sector cuts.

The Conservative view on cutting the public sector is much more to do with that being a policy goal in itself, than it is about genuine fiscal restraint. Now that might be a defensible policy, but I'd respect them more if they stood up and said it rather than using scare stories about debt.