th century debtors’ prisons existed today, they would be overflowing with inmates, including private individuals, state representatives and, arguably, an illustrious cast of central bankers advocating loose monetary policy.
Debt in its various forms exploded over recent decades. Advanced economies saw private credit as a share of GDP rise from 50% in 1950 to 170% in 2006 according to economists Carmen Reinhart and Kenneth Rogoff (
, 2013). The financial crisis boosted credit growth, particularly sovereign debt. Advanced economy public debt increased by 34% of GDP between 2007 and 2014, Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten according to the IMF.
Half of global debt issued over the past seven years went to emerging-market economies, much of it to Asia. China alone accounted for about one-third of the rise in global debt since 2007, according to the McKinsey Global Institute. While China’s sovereign debt is relatively low at 42% of GDP, household (36%) and corporate non-financial sector debt (157%) soared due to the inflows from the developed world.
“Low interest rates provided Asia with cheap money, an incentive to get into debt,” says Stefan Scheurer, Asia expert with Allianz Global Investors’ Global Capital Markets team. “China and other Asian nations accept an increasing level of debt in an effort to boost growth.”
A TOXIC BREW
Such credit growth, combined with the “alphabet soup of CDOs, CDSs and CDSs squared provoked the crisis of 2008,” says Lord Adair Turner, chairman of the Governing Body of the New Economic Thinking Institute, in a PROJECT M interview. As increasing real estate prices lead both borrowers and lenders to believe that more lending is a good thing, housing prices increase. This lies at the core of financial crises in Japan in the 1980s and Spain, Ireland, the UK and US in 2008, as Claudio Borio (Bank for International Settlements) has found and as Turner agrees.
Debt levels close to or more than 100% of GDP choke economies around the world. “Such an enormous amount of debt hardly ever goes away. All it does is shift around from one sector of the economy to another or from one country to another,” Turner told PROJECT M.
Lord Adair Turner
Currently chairman of the governing board at the Institute of New Economic Thinking, Turner chaired the UK Financial Services Authority from 2008 until 2013. He led the McKinsey practice in East Europe and Russia in the early 1990s and was director general of the Confederation of British Industry 1995-2000. He was vice-chairman of Merrill Lynch Europe (2000-06).
He became a cross-bench member of the House of Lords in 2005; served as the first chairman of the Climate Change Committee (2008-12) and chaired the Pensions Commission (2003-06) and the Low Pay Commission (2002-06).
While many economists speak of good and bad debt, that is debt the borrower can repay or not, Turner does not share this distinction. In his view, even good lending can produce harmful effects as through lending, banks add money and purchasing power, thus making an economy more unstable. “We need to ask why debt contracts exist, what benefits they bring and what risks they inevitably create. We need to question whether banks should exist at all.”
The damage done by the crisis was formidable and it is not the bailout costs Turner has in mind. They “were the small change.” More importantly, national incomes and living standards in many countries are 10% below where they could be and likely to remain there. These losses and the debt overhang are a drag on the global economy. To escape it, Turner controversially suggests that
governments stimulate economies by printing money to finance fiscal deficits.
DEBT CYCLES ON STEROIDS
In his view, “the fundamental problem is that modern financial systems left to themselves inevitably create debt in excessive quantities.” The pre-crisis common belief that one objective (low and stable inflation) and one policy tool (interest rates) is enough to lead to economic disaster. Turner suggests limiting banks’ ability to lend money to avoid another “debt cycle on steroids” as it occurred in the lead up to the 2008 crisis. “Debt pollution, like environmental pollution, must be constrained by public policy.”
Yet there is no ideal benchmark for the ratio of debt to GDP at which debt becomes a drag on economic growth. It is a matter of increasing risk as the wrote in early 2015. The key question then is whether growth can be achieved in the absence of debt expansion. Turner’s answer is yes. “It should be possible and is essential to develop a less credit-intensive growth model.” The Economist
To achieve this, the drivers of credit growth – real estate, rising inequality and global imbalances – have to be addressed. Turner calls for policies relating to new designs of urban living, real estate taxation, minimum wages and social benefits. Bank capital required for lending ought to be increased while borrowers should also be required to have higher capital resources before receiving a mortgage.
In other words: The finance industry is in for a long and difficult withdrawal treatment if it is up to Adair Turner.