Debt is the real beast to confront
Adam Jasser
June 25, 2009
“Few want to admit it but reckless government borrowing and benign monetary policies over the past decades are the main source of our current problems.”
At this week’s OECD forum “The Crisis and Beyond”, there was precious little in terms of specific recipes for coming out of the global economic mess apart from almost universal (and by now familiar) calls to rip apart greedy bankers and CEOs who allegedly got us into it. Whether the discussion was devoted to investment, jobs, pensions or energy there were lots of appeals to policymakers, bankers and business to do their “utmost” to get us back on track.
The “let’s do something about it” attitude is probably a way of trying to bolster our collective morale by making us believe that indeed there are magic formulas and if only our politicians were bold and well-informed enough (which they obviously aren’t), they could take us out of trouble in a moment.
And yet, reading between the lines one could discern a completely different message – that the policy mistakes the West has perpetuated for decades have been so grievous that policymakers can in the short term only limit the damage. No one will admit it, but it seems we simply have to go through this purgatory for some time until we come to a new, sustainable mode of existence. This new mode of existence will not, as some would have us believe, mean any major shift in the private sector capitalism but exactly the opposite – a revolution in the public sphere. More specifically, in how governments, central banks (and ultimately consumers who fund them) handle debt.
Few want to admit it but reckless government borrowing and benign monetary policies over the past decades are the main source of our current problems. Greed and excess consumption sure played a role but even here in Paris you could hear a veiled suggestion from OECD officials that it was loose monetary policy and government piling up of debt that fed the beast of speculation, arbitrage and gluttony, inflating various asset bubbles, including in the housing market.
So in the short term, policymakers must indeed “do their utmost” not to let the entire system collapse. They are doing a pretty good job of that by, for example, resisting the temptation to indulge in protectionism (the OECD says that despite a lot of talk about protectionism, a study they conducted shows little evidence of it so far). They can direct stimulus packages towards innovation and investment, improve regulation and find smart ways of dealing with toxic assets. The OECD is giving good marks to the global reaction to the crisis, which it rewarded in a with a slight upward revision to its growth forecasts (link). The fact that there is some coordination in the response is also laudable because it sets a barrier against the return of a tribal, nationalistic and beggar-thy-neighbour economic policy that had in the past led to wars and calamity.
REAL CHALENGE – DEBT
Yet, the short-term fixes are peanuts compared to the real challenge facing leaders of Western democracies, which is to design policies and communication strategy that will prepare societies for a fundamental change in the way we manage public finances. It is a daunting task because in the process, the major Western economies must dismantle two pillars of their recent rise in prosperity (or appearance of it) – low interest rates and accumulation of public debt. It is a hard act because politicians would have to admit that excessive borrowing they had indulged in to buy votes is the root cause of this crisis rather than the greed of capitalist fat-cats. The central bankers, these omnipotent, independent gods, also contributed by not keeping interest rates high enough to exact a price for this reckless accumulation of debt. By making money too cheap and by borrowing excessively, many Western central banks and governments (followed by many emerging market counterparts) have created a huge room for financial speculation and risk taking which in turn spurred the property bubble and other asset price anomalies exposed in the current crisis.
So in a nutshell, a lot of Western prosperity in the last few decades had been built on debt rather than real value added. It is mind boggling that most Western governments, including the United States, have failed to use the peace dividend resulting from the end of the Cold War to systematically reduce their budget deficits and create public finance surpluses. Such surpluses would have justified low interest rates, kept consumer demand at sustainable levels and reduced debt servicing costs, freeing funds for investment. Most importantly, surpluses would give the governments plenty of scope to loosen up fiscal policy in times of external shocks or domestic slowdowns. So not only the crisis would not have been so severe, but there would be non-controversial tools to deploy to counter the cyclical slowdown. Some countries have done just that – Australia and Finland for example. The rest lived as if there was no tomorrow and the biggest drama now is that the necessary fiscal loosening is translating into a de facto bankruptcy of several major economies, U.S. included. Hence the biggest debate these days is about the timing of the exit from the expansionary fiscal and monetary policy before it results either in a default by a major economy, bondholder panic, high inflation or all of those at the same time. The truly horrid realisation, reflected in the OECD report, is of course that the exit should but cannot start soon. “Withdrawing the stimulus too soon would be dangerous”, Angel Gurria, OECD Secretary General told the forum on Wednesday.
But he and other OECD officials are actually admiring Germany for already now setting the ground for fiscal consolidation. The constitutional limits on deficit Germany is introducing is a step in the right direction and shows policymakers in Berlin are aware of the long-term fix. Poland, too, has a constitutional limit on its debt, set at 60 percent of GDP, which is a step in the right direction. The trouble is that many other EU nations, including France, are still clinging to the myth that we can live on debt.
THEY KNOW IT, DON’T THEY?
The OECD stressed this week that for the euro zone the exit strategy from excess debt must be coordinated to be effective. Chances for that are limited at the moment but we must be careful not to overstate this risk.
OECD officials say most Western policymakers have learned their lesson on debt and loose monetary conditions. They are conservative, however, with going public with the implications for two reasons – one good, the other less auspicious. The good is that indeed the main short-term task is to restart the economies and restore confidence. Premature talk of major structural reform could have adverse “psychological effect” and therefore it is simply too early to let the cat out of the bag. But the second reason is that governments are simply afraid to confront the electorates with the unpopular message in general. The danger is that they will use the first reason to mask the second for too long.
And the truth they are afraid of spelling out is that the rich West must radically reduce debt. This will translate into a more modest way of life, leaner (but not dysfunctional) welfare state and higher interest rates in the long run. The OECD seems to be aware of that indicating that the potential output of its members is set to decline by a few percentage points. This message sounds tough to deliver to voters because we have made economic growth into a fetish. But at the same time, we are urging more “green” growth, more socially and environmentally balanced economic development and we are criticising consumerism and excess, all of which seems to be chiming in with the public mood in the West. So policymakers must now make the connection between the two and show that slower growth and sound public finances are as much part of the formula for the future as going green and socially responsible. This message will take time and a lot of convincing to sink into the minds of many Western societies, which have been taught to accept wealth built on perpetual budget deficits as something natural. The ability to convince democratic majorities of the need for this paradigm change will be the true test of leadership for politicians on both sides of the Atlantic. They should not fear this challenge, they should relish it. Who knows – maybe voters are actually tired of lies and could reward honesty?
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