Lessons of 2008 Forgotten – Debt Threatens to Undo the World Again (+2K Views)

Politicians in the U.S., and across the developed world, want you to believe that debt isn’t a big deal and that they can help their cities and countries grow their way out of indebtedness [as long as they are just given] a bit more time. A recent report by the Bank Of International Settlements, however, explains how difficult such a task will be. Let’s have a look at some of the report’s key passages.

So writes James Gruber (asiaconf.com) in edited excerpts from his original article* entitled The Markets’ Worst Kept Secret.

[The following article is presented by  Lorimer Wilson, editor of www.munKNEE.com and the FREE Market Intelligence Report newsletter (sample here – register) and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]

Gruber goes on to say in further edited (and in some place paraphrased) excerpts:

The Bank Of International Settlements (BIS) annual report outlines, in a clear and often confronting way, the realities of the world’s indebtedness and how current money printing and low interest policies won’t fix the problems emanating from 2008. The BIS has credibility as it was one of the very few institutions to warn of excesses in the lead up to the financial crisis. I can’t recommend the report highly enough.

The Extent of the World’s Debt Problem

First, the BIS details the extent of the world’s debt problem. It says total debt in large developed market and emerging market countries is now 20% higher as a percentage of GDP than in 2007 [and, as such,] the level of debt as clearly unsustainable...The primary reason given is that studies have repeatedly shown that once debt-to-GDP rises above 80%, it retards economic growth. Obviously, if money is being spent on servicing debt, then there’s less to spend on investment etc. Most developed market economies now have debt to GDP levels exceeding 100%.

The BIS [points out that] current long-term bond yields for major advanced economies are around 2% [as per the chart below], well below the average of the two decades leading up to the crisis of 6%, and that if yields were to rise just 300 basis points across the maturity spectrum (and still be below average), the losses would be enormous. Under this scenario, [as shown in the chart to the right below] holders of U.S. Treasury securities would lose more than US$1 trillion dollars, or almost 8% of U.S. GDP. The losses for holders of debt in France, Italy, Japan and the U.K. would range from 15% to 35% of GDP. Banks, being the primary holders of this debt, would be the biggest losers and ultimately such losses would pose risks for the entire financial system.

The BIS doesn’t let emerging countries off the hook either. It suggests that while debt may be lower in these countries, they’ve benefited from rising asset and commodity prices, which are unlikely to be sustainable and, therefore, caution is warranted here too.

The Policies of Developed Markets Central Banks

Now we get to the juicy bit where the BIS calls the extraordinary policies of developed market central banks into question. For a conservative institution such as the BIS, the language is nothing short of scathing:

“What central bank accommodation has done during the recovery is to borrow time –

• time for balance sheet repair,
• time for fiscal consolidation, and
• time for reforms to restore productivity growth.

The time has not been well used, however, as continued low interest rates and unconventional policies have made it –

• easy for the private sector to postpone de-leveraging,
• easy for the government to finance deficits, and
• easy for the authorities to delay needed reforms in the real economy and in the financial system.

After all, cheap money makes it –

• easier to borrow than to save,
• easier to spend than to tax,
• easier to remain the same than to change.”

Waiting Will Not Make Things Easier

The BIS report continues, saying:

“Governments hope that if they wait –

• the economy will grow, driving down the ratio of debt-to-GDP.

Politicians hope that if they wait –

• incomes and profits will start to grow again, making the reform of labour and product markets less urgent.

Waiting, however, will not make things any easier, particularly as public support and patience erode.”

BIS Recommendations

The BIS recommends urgent, broad-based reforms which principally involve –

• cutting back on regulation to allow high-productivity sectors to flourish and for growth to return,
• further cuts by households to their debts,
• governments getting their balance sheets in order and
• regulators making sure banks have the capital to absorb any risk of potential losses of the type mentioned above.

The Math of Debt

It’s worth elaborating on why the current path appears unsustainable, as the BIS alludes too. Put simply, debt is a promise to deliver money. If debt rises faster than money and income, it can do this for a while but there comes a cut-off point when you can’t service the debt. When that happens, you have to cut back on the debt, or de-leverage in economic parlance.

There are four ways to de-leverage:

1. You can transfer money (Germany transfers money to Cyprus)

2. You can write down the debt. Note though, that one country’s debt is another’s asset.

3. You can cut back on the debt. These days, that’s looked down upon and consequently called austerity.

4. You can print money to cover the debt.

Since 2008, we have seen countries employ all four of these methods but the real key is to make sure that interest rates remain below GDP [growth] rates. If that happens, debt-to-GDP levels will gradually fall. If not, they’ll inevitably rise…[If, for example,] bond yields rise to the post-war average of 6% in the U.S., and interest rates increase to comparative levels, nominal GDP would have to be above 6% for debt-to-GDP levels to decline. If you understand this, then you’ll realise that talk of “tapering” in the U.S. is likely a load of baloney.

Real U.S. GDP growth is expected to be close to 1% in the second quarter, with inflation at around 1.1%, resulting in nominal GDP growth of 2.1%. Many expect this nominal GDP to rise to +3% over the next 12 months but, even at those levels, bond yields can’t be allowed to rise much further (with 10-year yields at close to 2.5%). Otherwise, debt-to-GDP ratios will rise, impeding future growth and making budget cuts, tax rises and more money printing inevitable.

If the U.S. does taper and bond yields there rise, this would put upward pressure on bond yields in Europe. With GDP growth near zero and still exorbitant debt levels, higher bond yields would quickly crush the Euro zone.

The above is why central banks can’t allow higher bond yields and interest rates. Of course, central banks don’t control long-term bond yields; markets do. If central banks want low bond yields, markets will comply until they don’t, that is, until they don’t trust that the current strategies of central banks are working. Given that investors are still enamoured with the every word and hint of Ben Bernanke and his ilk, it would seem that the time when bond markets do turn ugly is still a way off.

Dreaded Reform

The BIS points out that reform is also critical to better economic growth for the developed world and lower debt burdens but on this front, however, it’s amazing how little restructuring has actually occurred in the U.S. and Europe. In the U.S., for instance, can you name one piece of significant reform which has reduced regulation and led to growth in new prospective sectors? I can’t, but maybe I’ve missed something.

[The fact is that] U.S. banks have killed [any efforts of reform] and the trend of the U.S. results season seems to bear this out…It’s hardly surprising that current policies are benefiting banks at the expense of the real economy. After all, not only did banks get massive bailouts in 2008 but they’ve been given almost free money from the Federal Reserve via QE ever since. The banking sector is not back to 2007 levels but it’s gradually getting there. Who would have thought this would happen just 6 years after the biggest debt bust in more than 70 years? It’s somewhat ironic that instead of the U.S. or Europe, it’s Asia which may be about to lead the way on the reform front…

Risk of Another Debt Bust?

It’s hard to see the U.S, Europe, Japan and other developed world countries implementing reform in time to prevent their debts from rising further and possibly imploding. In other words, many of the fears of the BIS may well come true.

The above may sound pessimistic and, to some, melodramatic, but the reality is that little has been done in the past six years to restructure economies and cut debt i.e. learning the lessons of 2008. Because we’ve partially recovered from that traumatic period, that’s led to complacency. All the while, the debt that caused the bust in the first place has compounded and threatens to undo the world again. Let’s hope it doesn’t come to that.

[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]

*http://asiaconf.com/2013/07/20/the-markets-worst-kept-secret/

Related Articles:

1. “This Time is Different: Eight Centuries of Financial Folly” – A Book by Reinhart and Rogoff

Highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked. Words: 1264 Read More »

2. Economics Can’t Trump Mathematics & the Math Says US In a Debt Death Spiral

1 Comment

The madmen who are responsible for the coming economic disaster continue to behave as if they can manage to avoid it.  Violating Einstein’s definition of insanity, they continue to apply the same poison that caused the problem. These fools believe they can manage complexities they do not understand. We are bigger fools for providing them the authority to indulge their hubris and wreak such damage. Read More »

3. U.S. Economy: Reduce Spending (Future Depression) OR  Keep Spending (Future Hyperinflation)

1 Comment

The U.S. government is in what is known as a “debt death spiral”. They must borrow money to repay prior debts. It is as if they are using their Visa Card to make an American Express payment. The rate of new debt additions dwarf any rate of growth the economy can possibly achieve. The end is certain, only its timing is unknown, and, once interest rates begin to rise, and they will, it’s game over. Read More »

4. Why the End of This Economic Death Spiral Is So Hard to Call

Leave a comment

Whether you are an investor, concerned citizen or merely someone trying to understand the current economic situation, you should be worried. Watch this video to get an outstanding overview of what is occurring.  It is probably the best short explanation as to why the end of this economic death spiral is so hard to call. Read More »

5. Bonds Getting Slaughtered, Interest Rates to Rise Dramatically, Economic Bubbles to Implode

Leave a comment

What does it look like when a 30 year bull market ends abruptly? What happens when bond yields start doing things that they haven’t done in 50 years? If your answer to those questions involves the word “slaughter”, you are probably on the right track. Right now, bonds are being absolutely slaughtered, and this is only just the beginning. So why should the average American care about this? Read More »

1 Comment

The global financial system is potentially heading for massive amounts of trouble if interest rates continue to soar. So what does all this mean exactly? [Let me explain.] Read More »

7. Deflationary Pressures In Economy Are Primary Concern of the Fed

2 Comments

Despite the Fed’s recent communications that they are planning to “taper” the current monetary program by the end of this year – the index is suggesting that their interventions, in one form or another, are unlikely to end anytime soon. The threat of “deflation” remains the Fed’s primary concern. Read More »

8. We’re Headed for Crippling Deflation First & Then Rampant Inflation – Here’s Why

1 Comment

Are we headed for rampant inflation or crippling deflation? I believe that we will see both.  The next major financial panic will cause a substantial deflationary wave first, and after that we will see unprecedented inflation as the central bankers and our politicians respond to the financial crisis. [Let me explain why I think that will unfold.] Words: 1025  Charts: 3 Read More »

9. What Causes Interest Rates to Rise? Is That Good or Bad?

Don’t get too worked up over interest on the national debt or what will happen when interest rates rise because, by then, we’ll likely be talking about ways to cool down the economy. [Why?] Because interest rates on US government debt are really a function of economic growth.  If the economy is weak the Fed will pin short rates to stimulate the economy and if rates rise it’s going to be a function of better days ahead. Words: 525 Read More »

10. Gov’t Debt Will Keep Increasing Until the System Implodes! Are You Ready?

Why are so many politicians around the world declaring that the debt crisis is “over” when debt-to-GDP ratios all over the planet continue to skyrocket?  The global economy has never seen anything like the sovereign debt bubble that we are experiencing today. This insanity will continue until a day of reckoning arrives and the system implodes.  Nobody knows exactly when that moment will be reached, but without a doubt it is coming. Are you ready? Words: 1270

11. A Disaster of Unprecedented Proportions (The End Of The World As We Know It) Is Coming Sometime This Decade and It Will Be Irreversible!

“The end of the world as we know it” is what David Korowicz predicts is coming sometime this decade – an “ultimate” crash that will be irreversible – TEOTWAWKI! Words: 1395

12. Nothing Can Be Done to Avoid Coming World-wide Depression! Here’s Why

Governments everywhere are becoming more distressed and desperate as economic realities dominate the political doublespeak. The world is at a dangerous point. Much of what we thought we knew and assumed regarding governmental behavior and economics is beginning to be reassessed. Governments of the world are out of money and out of ideas. The Ponzi scam that has been perpetrated for over fifty years is collapsing under its own weight. There are not enough suckers and capital left to sustain the fraud. [Let me explain further.] Words: 999

13. Eric Sprott: More Government Spending Is NOT the Answer to Our Economic Woes – Here’s Why

In today’s overleveraged world, greater deficits and government spending, financed by an expansion of public debt and the monetary base (“the printing press”), are not the answer to our economic woes. In fact, these policies have been proven to have a negative impact on growth. [Therefore] as long as we continue down this path, the “solution” will continue to be the problem. There is no miracle cure to our current woes and recent proposals by central planners risk worsening the economic outlook for decades to come. [Let us explain.] Words: 1510

14. What Will the Outcome of All the QE Mean for the U.S. (and the World)?

At the risk of looking/sounding like some crazed religious fanatic usually seen carrying a sign or proclaiming: “Repent, the end is near,” I shall avoid the word “repent”. To me, the rest of that proclamation appears accurate and reasonable, at least with regard to our economic condition. [Let me explain:] Words: 1896

15. The $64 Trillion Question Is: “When and How Does the Debt Death Spiral End?”

We are in the latter stages of the debt death spiral where debt and interest payments can only be made by adding more debt. This process has a sure ending. Like the flush of a toilet, the spiral goes faster and faster until it finally ends. [Let me put forth just how serious the problem is.] Words: 431

16. Richard Duncan: IF Credit Bubble Pops Civilization Won’t Survive the Depression that Follows

Our civilization would not be able to handle such a transition from an expansionary credit based economy where goods and services were readily available into a paradigm of credit contraction, supply shortages and destitution and this is what is coming. There is no way to prevent it – only to defer it until a later date – and that day will soon be upon us. Words: 590

17. Current Distortion of Interest Rates is Unsustainable & Will Have Dire Consequences

Interest rates have been manipulated to keep them extremely low in an attempt to stimulate the economy but…unless deficits are dramatically reduced…. interest rates will eventually rise and government interest expense will double or triple from the amounts being paid today. That potentially triggers a debt death spiral, where government has to borrow more than otherwise expected. It also raises the credit risk and could ratchet interest rates up again. It has happened to Greece, Portugal, Spain and other European countries already this year and could well happen in the U.S. too. Words: 595

18. Eventual Rise in Interest Rates Will Be Downfall of U.S. – Here’s Why

Everyone who purchases a Treasury bond is purchasing a depreciating asset. Moreover, the capital risk of investing in Treasuries is very high. The low interest rate means that the price paid for the bond is very high. A rise in interest rates, which must come sooner or later, will collapse the price of the bonds and inflict capital losses on bond holders, both domestic and foreign. The question is: when is sooner or later? The purpose of this article is to examine that question. Words: 2600