Published in Business Spectator (Melbourne), 13 February 2013
Talk about the looming global currency war obscures an unpleasant reality: monetary policy remains the West’s only weapon to prevent imminent insolvency. Unfortunately, the medicine may kill the patient, rather than the disease.
Since the beginning of the global financial crisis, we have witnessed symptoms of the West’s economic malaise in over-indebted and over-committed governments. But if you thought that the eurozone crisis was bad and that the US fiscal cliff was a nightmare, you ain’t seen nothing yet. The fiscal problems of the Western world are so deep that they cannot be solved by some last-minute deals struck in the early morning hours.
A few weeks ago, Morgan Stanley Research circulated a short research note with the seemingly technical title ‘Investment Lessons from Financial Repression’. Its content was anything but harmless. Morgan Stanley’s assessment said: “considering all assets and liabilities, sovereigns are highly indebted, if not insolvent”.
The bank’s analysts came to this conclusion by treating governments like corporations, aggregating their current and future assets and liabilities into one single balance sheet. Unlike conventional measures of existing government debt as a percentage of economic output, the inclusion of future tax revenues and government expenditure makes it possible to get a more realistic long-term view of a nation’s economic viability.
The results are shocking. On this calculation, Spain, the United Kingdom, Ireland and Greece all had public debt worth more than 1000 per cent of their current GDP. The US was not far behind at about 800 per cent. Germany and France fared a little better in this calculation, but at more than 500 per cent of GDP their debt positions could hardly be described as reassuring.
The fiscal gap identified by Morgan Stanley is large but not out of line with other projections. Last year, the OECD presented an alternative way at looking at the developed world’s public debt disaster.
The Paris based organisation calculated the changes required in governments’ primary budget balances required to reduce debt to just 50 per cent of GDP by the year 2050. In doing so, they even excluded spending pressures from pension, health and long-term care spending. Despite this omission, the necessary turnaround to make government finances sustainable was enormous. Japan would have to consolidate its public finances by 9.6 of GDP per year, the US by 6.9 per cent and the UK by 5.8 per cent. It is not an exaggeration to say that such large and permanent changes in government spending are unlikely to be achieved in a democracy without risking civil war.
Boston University economist Laurence Kotlikoff, who has conducted extensive research around the US fiscal gap, has been warning for many years that official debt figures do not tell the full story. He recently calculated that the real US debt, including all future revenue and expenditure, now stands at $US222 trillion – not the official $US16 trillion that the fiscal cliff debate was about. This would yield a debt to GDP ratio of just over 1400 per cent – or a very simple conclusion: The US is not fighting bankruptcy; it is already bankrupt.
The only way in which bankrupt governments like the US can keep living in the manner to which they are accustomed is by printing money. And although they may not do this directly, central banks are making it possible. Soaking up government debt through unorthodox monetary policy, ie. quantitative easing, they allow governments to continue spending as if nothing had happened.
There are two basic problems with these policies, however. The first is the most obvious. Historically, printing money on such large scales has always been the surest way to debase a currency. It may not happen immediately, and it may not even be visible for a while, but it is a matter of logic that a vastly inflated monetary base will sooner or later result in the destruction of a currency’s value.
The second problem is for the global economy. As most developed world central banks (with a few notable exceptions) are engaged in saving their governments from default, they are fuelling a global currency war – whether they intend to achieve competitive devaluations of their currencies or not. It may not even be a central bank’s primary goal to subdue its currency’s external value, but by providing support to its government on a scale like the US Fed, which has tripled its monetary base since the start of the global financial crisis, a weakening of the exchange rate is inevitable.
Unfortunately, for as long as the underlying fiscal problems of Western governments are not addressed and corrected, there is no escape from this march towards economic Armageddon.
In order to keep over-spending governments’ fiscal heartbeats going, monetary policy will come to the rescue – simply because there is no other way out. In the medium term, this will trigger both a debasement of currencies and increase tensions between trading partners. Currency wars and retaliatory trade policies will be the result. Both could bring globalisation as we took it for granted over the past two decades to its knees.
At the moment, monetary policy presents itself as part of the solution to the West’s sovereign debt crisis. If current policies continue much longer, it will become clear that it is part of the problem.
Central banks and governments are complicit in upholding the illusion of an all-caring, omnipotent and omni-responsible state. The longer they pretend this is viable, the more complete the destruction of the West’s economies and societies will be in the end.
What the West desperately needs is an exit strategy from this road to ruin. It needs to shrink its governments and social services to a level that can be financed out of taxes when its population ages. It needs to wean itself off the sweet poison of fresh central bank money. And it needs to find a way to remain competitive with the world’s more dynamic economies of Asia and Latin America.
If it fails to find this exit strategy, the West as the world’s dominant economic centre and indeed the global economic model will be history within decades.