Home' Trinidad and Tobago Guardian : January 11th 2015 Contents SBG10 FINANCE
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt JANUARY 11 • 2015
When does the level of debt in
an economy become "too
much?" It is a hard question
to answer, not least because
debt is a highly useful tool,
allowing business to invest
for the future and consumers
to smooth their spending
through the course of their lives. To a degree, a higher level
of debt is a sign of the greater sophistication of an econo-
my.In a new report BCA Research defines the period since
World War II as a "debt supercycle" in which debt levels have
inched persistently higher. This trend has been driven by the
use of monetary policy to stabilise the economy in the wake
of shocks such as the 23 per cent fall in the Dow Jones Industrial
Average on October 19, 1987.
"Policy-makers were always able to limit the economic and
financial damage of recessions and other shocks by easing
policy enough to trigger a new private-sector leverage cycle,"
Now BCA thinks that the debt supercycle has come to an
This is not because the overall level of debt has fallen.
Indeed, if one excludes the financial sector, the global level
still is rising. In the developed world, however, monetary policy
has failed to create a credit boom in the private sector, even
with the help of zero short-term interest rates.
Before the 2007-2008 crisis, mainstream economists did
not seem to pay much attention to debt. The view seemed
to be that any loss to creditors would be canceled out by gains
to debtors: Net world debt is zero, as a wag recently tweeted.
This view has been shown to be fundamentally wrongheaded,
however, in the past seven years.
The first problem is that a great deal of debt is secured
against property. The late economist Hyman Minsky argued
that this relationship naturally would lead to bubbles, as easier
credit standards pushed up property prices and higher prices
encouraged banks to offer easier credit terms.
When property prices fall, however, both the debtor and
the creditor can suffer: The debtor loses his equity, while the
creditor has to write down the value of the loan. This is exactly
what happened in 2007 and 2008 as home prices fell. Individual
homeowners lost their wealth and their homes, and banks
saw their capital eroded.
In their book "House of Debt: How They (and You) Caused
the Great Recession, and How We Can Prevent It from Hap-
pening Again" (University of Chicago, 2014), economists Atif
Mian and Amir Sufi show that those parts of America which
were worst hit by the crisis were those where the equity stakes
of homeowners were lowest. This was not a zero-sum game.
In addition, the higher the debt level, the more debt has
to be refinanced each year and the greater the potential for
a crisis of confidence if creditors are unwilling to extend the
loans. So, while there is no magic threshold for the ratio of
debt to GDP beyond which economic growth is slower and
default is certain, the risks increase as the ratio grows.
Another problem is that the debt ratio is hard to bring down
in the absence of rapid economic growth, which the western
world has found hard to generate. Default simply causes the
debt to be reshuffled: When consumers fail to repay, banks
must be rescued, so the debt ends up on the government s
Inflation might bring down the debt-to-GDP ratio, but only
if creditors can be hoodwinked, or bullied, into not demanding
higher yields to compensate. In any case inflation is hardly
the issue: The euro-zone is now in deflation, with the headline
rate falling 0.2 per cent in the year to December, thanks to
falling energy prices. The core rate, which excludes energy,
food, alcohol and tobacco, still is positive, at 0.8 per cent.
For now the developed world has reached a fragile stasis
in which a high level of debt is sustainable only with very low
interest rates. Any attempt to push rates to what were once
normal levels is fraught with danger: Sweden, which started
down the path in 2010, has had to cut rates back to zero.
The tricky question, though, is whether significant economic
growth is achievable in the absence of rapid debt expansion.
Consumers will not want to borrow unless their wages are
rising, but real wage growth has been sluggish. Companies
will not want to borrow until they see signs of buoyant
consumer demand. Governments are unwilling or unable to
provide another burst of stimulus.
In sailing terms, it is rather like the doldrums, a patch of
ocean where boats become becalmed. Japan has been in the
doldrums for more than a decade, and has managed not to
sink, but Japan is a relatively homogeneous society. Other
developed nations might not be so lucky.
Greece, which may vote for a debt-repudiating government
on January 25, will be the first test.
@2014 The Economist Newspaper Ltd. Distributed by
the New York Times Syndicate
The higher the debt level, the
more debt has to be refinanced
each year and the greater the
potential for a crisis of
confidence if creditors are
unwilling to extend the loans.
Falling off the supercycle
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